Oran Hall | Adding to your net worth in 2022

Are you planning to increase your net worth in 2022? If your answer is yes, you are in the company of many people because people want to increase their wealth, of which net worth is the prime measure.

Net worth is the difference between assets and liabilities. This applies not just to businesses, but to people. Assets are what people and businesses own and are owed, and liabilities are what they owe.

It is not entirely bad to have liabilities as incurring them can cause assets to grow and increase net worth if used effectively. What matters most is that the return on assets purchased with borrowed funds is higher than the cost of the debt.

There are three primary types of assets: liquid, investment, and personal. Liquid assets are cash or assets that can be easily converted to cash without losing their value, for example, current and savings account balances.

Another type of assets is investment assets of which there are many different types. Here are some examples: ordinary shares, preference shares, bonds and debentures, unit trust and mutual fund investments, the value of an employee’s pension fund contributions, the vested portion of an employer’s contribution to an employee’s pension account, the cash value of life insurance policies, real estate, business, and a whole range of more sophisticated investment instruments.

Investment assets have varying degrees of liquidity. Real estate is perhaps the least liquid. Ordinary shares are more liquid but can be very hard to sell in a weak market. Further, investment assets of the same type may vary in their ability to be converted to cash. Some ordinary shares may be hard to sell because of their poor quality, for example.

It generally takes time to sell real estate, and even when a buyer is found in a short time, the process of completing the sale may take time, especially if borrowed funds are being used to make the purchase.

On the other hand, unit trust and mutual fund investments are generally quite liquid. It may be possible to get sales proceeds on the same day, although this is not always the case.

Next, there are personal assets like a house, motor vehicles, furniture, and personal-use items like jewellery, and paintings. Some items generally classified as personal-use items may also be classified as investment assets, for example, high-quality jewellery. The same may be said of paintings of high quality. Residential properties also appreciate in value, and it is possible they may depreciate.

On the other side of the equation are liabilities, which may be long term or short term. An example of a long-term liability is a mortgage. Short-term liabilities are generally due to be repaid within a year and include credit card bills, other current bills, and the portion of long-term debt due within a year.

The key to increasing net worth is increasing assets and reducing liabilities or for assets to increase at a faster rate than liabilities.

Liquid assets are needed to cover the cost of day-to-day living expenses, to have funds available for emergencies, and to take advantage of investment opportunities which may arise.

Generally, though, savings are required for investment – more savings, more investments. More savvy investors often borrow to invest when conditions are favourable.

In an environment like ours in which inflation is an issue, it is very important to make real returns for net worth to grow meaningfully. This means that the returns on investment should be higher than the rate of inflation. This is why investing in ordinary shares and real estate is attractive as they tend to give returns higher than the rate of inflation over the long term.

Of note is that ordinary shares and real estate generate more than income in the form of dividends and rent, respectively. They are also major sources of capital appreciation, that is, their values increase. This is important because there is no capital gains tax in Jamaica.

On the liability side, it is critical to control debt. Credit card debt has the potential to cause serious harm to a person’s net worth. It must be controlled. Other types of debt must be controlled also. Ideally, debt should not be incurred to meet routine day-to-day expenses.

Although personal-use assets like the art produced by highly skilled individuals generally increase in value, some assets do not. Motor vehicles, for example, depreciate in value over time – even the highest-quality motor car. How then do they affect net worth?

This is not the only type of asset that has the potential to reduce net worth. Ordinary shares, for example, which can potentially cause an exponential increase of net worth, can also cause a serious decline of net worth if poor selections are made and if the market is weak. Such conditions can similarly affect unit trusts and mutual funds that invest in them.

I wish I could give a guarantee to all of my readers that their net worth will increase this year. The consolation is that it will grow in the future if the quality of the investments is solid. Meanwhile, manage liabilities well.

Have a healthy and prosperous 2022.

Oran A. Hall, author of ‘Understanding Investments’ and principal author of ‘The Handbook of Personal Financial Planning’, offers personal financial planning advice and counsel. finviser.jm@gmail.com