Target Networth or Target Debt Reduction

First let me apologize to those folks that follow my blog, since I have gone through some very difficult family times recently with the passing of both my father and my father-in-law, all within the month of April &ellipse; not to mention their necessary trips to physicians and hospitals. May they both rest in peace. :-)

If your networth is increasing, should you target debt reduction? Or the other side of the coin would be to focus their financial efforts to target debt networth, or both simultaneously?

This may seem like a rather silly question, since this can be asked of both our personal finances and also of the Federal government. I know that people often examine public debt versus GDP. In the past I’ve primarily been more for reigning in public debt so that comparison to GDP is lower.
Thanks to Quicken I can easily pull up a networth report very quickly. I don’t look at it as a philosophical question either, since if you have $0 in debt, you are inherently in a much better position than someone with any debt unless it is a very, very low ratio.

Why worry about it since my networth compared to 1 year & 3 months ago is up by 161.76%, while I allowed my debt to unfortunately climb by 16.7%, during the same time :-( – although it is largely due to the purchase of some musical instruments and a little unplanned vehicle expenses. Now I am already planning to reduce the debt somewhat quickly although the target time frame is 4-5 years away.
I should also mention that neither our house, nor the associated mortgage debt are included in the networth. If I did include that, the networth would have increased by 242.5% during the same time since it is a shorter term mortgage.

So since there is often the sense of debt vs GDP comparison, wouldn’t debt vs networth be an equivalent comparison? If so, that would put the ratio at 261.8% last year vs 121.4% 1 year & 3 months later. That was due to our choice to budget for required pay-down of debt and diverting the extra funds toward savings and/or retirement savings.

I also believe that this becomes considerably more difficult when you involve an entire family (i.e. children) or even simply a spouse. After all, once you have begun your journey into marriage/parenthood, things can change due to the desire not to hurt their feelings, or because their friends have the latest gadgets while you’re still playing your old Sega Genesis and have never sent a text from your phone in your life because you don’t want to get a

In an attempt to make it easier to be subjective and easier to assess the best choice given the many variables involved in making the choice to target networth or target debt reduction, I believe one should define some limits:

  • if the debt is associated with an asset that is truly a stream of income, you can look past it and not include it in this analysis
  • let’s for a moment take “feelings” out of the picture and this is often the most difficult to do but must be done until the choice has been made for the path you will take
  • let’s also remove the extreme of a low percentage of debt to savings where you owe very little or not debt in comparison of savings. To put this one simply, if your savings to debt ratio is 75% or more (meaning you owe only 25% more than you have saved), then it seems like you’re on the right path
  • let’s finally remove the extreme of a high percentage of debt to savings where you owe multiple amounts of the total income in debt also, since this should go without saying that you either should seek a bankruptcy attorney or simply remove any expenditures except for transportation to work, minimize food purchases, and keeping a roof over your head

With those limitations in place, you can now determine which is the best way to proceed.

With about a month”s worth of savings built up in a combination of savings, checking, and brokerage accounts. I feel comfortable in focusing my efforts in paying down the debt because our non-mortgage debt has climbed and I want to ensure that it doesn’t get out of control. Personally I’d prefer to have it all gone overnight but that isn’t happening unless I receive some additional income.

Now total up the debt and divide it by the amount of your total networth (which is the sum of all your assets minus the sum of your debts). This should always go down, if even a little bit every month. That is as long as you are not overspending, or even worse … continuously overspending. Fundamentally, if you follow this basic premise, you will be increasing your networth as you pay down debt.
The higher that this ratio is, the more you need to focus on paying the debt off.

This may also be a good time to figure out how long it should take you to pay off your debt completely. Simply divide your total debt by the amount of money that you pay on it every month to see how many months it will take you to pay off the debt under the current scenario. Note that this isn’t exact, since there is usually interest that is charged on the debt that you owe, but it will give you a rough time table that you will have the debt eradicated.

PS: This article comes from having experienced both a negative and/or decreasing networth and an increasing networth.

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