Do you think you're rich? Maybe you are. Maybe you're not.
We suggest a reality check. Don't go by your feelings because your wealth could be just an illusion.
Take the case of a friend of mine, Anita, who tied the knot last year.
Her family screened through various marriage proposals before she finally met the 'right' guy. Of course, the black Merc, a bungalow in a posh locality, dinners at classy restaurants, all helped her make her decision.
A few months after their very expensive wedding, her 'rich' husband declared bankruptcy.
Apparently, he didn't own any of the assets. Not the car, nor the house. He had even borrowed for the wedding.
Now, the loan sharks were threatening to take away her jewellery.
She is back home with her parents.
Perception matters!
My aunt worries about her husband.
He owes around Rs 3,00,000 on his credit card and has a personal loan. He is now thinking of going in for a car loan.
She is in a state of panic and is sure they will end up as paupers.
Actually, she does not really have a reason to worry.
Her husband earns quite well -- his take home is around Rs 80,000. His total debts are around 32% of his annual income. He can comfortably pay off the loans and save. And, none of his assets are mortgaged.
The moral of both the stories? Find out what is really 'yours' and whether or not you are really in a desperate financial state.
What is it that I really own?
This might pleasantly surprise you. List where all your money is.
~ Shares
~ Mutual fund/s
~ Bank deposit/s
~ Company deposit/s
~ Savings account/s
~ Bonds
~ Employee Provident Fund
~ Public Provident Fund
~ Post office schemes
~ Life insurance schemes
Now, list all the assets where your money is tied. This refers to what you can sell to get money. These will be assets whose value will increase over time.
~ Home/s
~ Land
~ Paintings
~ Antiques
Then there are assets whose value will decrease over time.
~ Car/s
~ Bike
~ Electronic equipment
The value of jewellery could fall or rise, depending on the jeweller you are selling it to and his opinion on whether the purity of gold is questionable or whether the design is out of fashion (Read Why jewellery is a bad investment).
Now put a realistic, current market value at the side of each: What would people pay to buy this?
If they are investments like PPF, then check out how much is in the kitty.
And, yes, if any of your friends owe you money, put it down. But do so only if you are sure you are going to get the money back. If you have to write it off, don't take it into account.
What is it that I owe?
Some loans are secured loans. If you do not pay some loans, the lender will come and take away the asset you are buying. For example, your car can be taken away if you do not pay your car loan.
~ Car loan (when you take a loan to buy a car)
~ Hypothecate your car to take a loan (a loan is given based on the value of the car and the car is the security)
~ Home loan (when you take a loan to buy a home)
~ Home mortgage (when you mortgage your home to take a loan just like you hypothecate your car)
~ Loan against your shares
~ Loan against your PPF
Other loans
~ Credit card loans
~ Personal loans
~ Education loans
~ Loans from family/ friends
If it is an interest free loan, do not calculate the original value of the loan; look at the balance payment you need to make. If you took a loan of Rs 1,00,000 and have paid back Rs 15,000, you should consider the loan to be Rs 85,000 now.
If there is an interest component, just total up the remaining Equated Monthly Installments.
Figuring out your worth
Now, calculate your net worth. All you have to do subtract what you owe from what you own.
You will be pleasantly surprised or rudely shocked.
If your net worth shows a negative figure, you are in trouble. Tear up your credit card now!
If it's positive, you are headed in the right direction.
Do note, these calculations do not take into account your monthly earnings. So, even if your net worth is negative, don't fret. See how you can use your monthly earnings to take care of your loans.
How this helps...
In case you think this is an exercise in futility, you are wrong. There are many reasons how this can be useful.
1. Getting to know where you stand will make you plan your finances better in the future. You will be able to see at a glance where the bulk of your savings are right now.
It will also tell you if the bulk of your investments are in assets that can or cannot be exchanged easily for cash.
2. You can decide if you really can afford to take a loan or if it is better to wait till you beef up your savings.
3. If your net worth is negative, maybe you should go easy on your spending.
4. It will also give you an indication as to where the bulk of your salary is going. Is it towards servicing loans, is it going into your savings or is it just being spent?
This will prove a good reality check.
And yes, the next time someone tells you how much they earn, always ask them how much they owe!
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