Since a balance sheet provides a snapshot of your net worth at a particular time, you can track changes in your assets, liabilities, and net worth by comparing balance sheets entries at different time points. For ease of demonstration, I convert the two-column balance sheet into a single-column format in Figure 3, below.
Figure 3: Multi-Year Personal Balance Sheet for:
Dr. John Q. Public (in thousands of dollars, at year-ends)
In this example, net worth steadily increases as assets increase and liabilities decrease. This reflects a healthy progression. When households fail to live within their means their assets decline and/or their debts increase. The result is a decrease in net worth, which is a financial planning setback.
Note that some of the entries in the balance sheet are not legitimate pillars because they are not reliable stores of value over the long term. This includes car(s), furniture, electronic equipment and any other property that can be expected to lose value over time rather than increase in value. We refer to these as depreciating assets. In contrast, legitimate pillars are appreciating assets—those whose value is expected to increase.
This observation helps us refine our earlier financial planning objective from “accumulate diverse assets” to “accumulate diverse appreciating assets.”
When you borrow additional money, your balance sheet expands. The amount of the borrowing appears on the right side as more debt, increasing total liabilities. That same amount also appears on the left side, either as cash, or as some new asset, if that’s what the borrowing was for (for example, another real estate property). This increases your total assets. As long as it’s financially affordable and emotionally comfortable for you, borrowing to gain more appreciating assets can be a good move—you’re collecting more pillars! But if you take the borrowed cash and spend it (an economist would say you “consume” the cash), you end up wasting it, and simply going more deeply into debt. Your total liabilities will go up while total assets remain the same, and your net worth will decrease. Examples of wasting borrowed money include throwing unnecessarily lavish parties, overspending on travel, and gambling.
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