In financial circles, the term "net worth" is used when referring to an individual's wealth. Being clear about what makes up your net worth is the first step in making informed decisions about managing and protecting what you own.
The most telling aspect of individual wealth is ownership of non-liquid assets such as homeowner's equity, retirement accounts, investments, and art work. A professional in private practice also owns business equity. For purposes of definition, we can refer to these items as "capital assets."
At any given point in time, consumable items you own contribute relatively little to your net worth. In the short term consumption prevents you from saving, and in the long run it is a drag on your ability to accumulate wealth.
Capital Assets
Two important characteristics of a capital asset are that its owner does not use it for consumption and that it has a tendency to increase in value over time. The food in your fridge and the funds in your checking account are assets allocated for consumption.
Do not mistake a large annual income with wealth. A true measure of your wealth will be in direct proportion to the value of equity in real estate that you own and to the value of your retirement savings.
The Element of Risk
Risk is the likelihood that a loss will occur. Considerations of risk are most likely to come up in discussions about buying stocks when in reality it is one of the least risky activities that we undertake. It is much better to have a broader view of risk since it affects all aspects of your life including when and how to drive your car. Setbacks can take the form of losses from fire, theft, professional liability, a business investment turned sour and disability.
If you want to shelter your assets from potential liability due to your activities, whether personal or professional, then you must investigate the planning options available to you. Scrambling when a loss is imminent puts you at a disadvantage because your ability to make sound decisions will be clouded and your options might be limited.
The most common ways of dealing with the potential for loss are insurance policies and incorporating business enterprises. Financial planning techniques allow you to maintain some manner of control over an assets in certain circumstances.
When it comes to investments, the key is to determine the level of risk that you are in a position to tolerate.
Since you cannot totally avoid risk, managing it should be an integral part of the decision-making process in both your personal and professional life.
Read our article on
Probate Proceedings.
Read our article on trusts.
Protecting What You Own
The focus of estate planning is usually how you will maintain control over your assets or at least have a say in their disposition in the event of death or mental incapacity. Most planning techniques involve a change of ownership or a “transfer,” either in the present or in the future. And they all carry tax consequences.
There are state laws that dictate what happens if you die without a formal and valid plan. For instance, this may mean that your spouse gets one third of your estate and the children get the rest. The default rules can have harsh consequences. They do not take into account estranged spouses who are not divorced. The rules do not provide for who gets the art work versus who gets the stocks and bonds. And no special consideration is given to the most needy or deserving heir.
A good starting point for estate planning is who your loved ones are and how your capital assets will ultimately be distributed among them.
Additional Factors
Other factors that will affect a financial plan are:
• minimizing taxes
• charitable donations
• limitations of the planning tools available in your individual situation.
Planning tools include wills, trusts, buy-sell agreements, and insurance policies.
Just as any other tool, they serve important functions when used in the proper situation and in the right way.
Copyright 1994-2004 The Gauthier Law Firm, PC
