Become a better investor
Lesson in Course: Investing basics (beginner, 6min )
Nicolas Cage is an award-winning Hollywood actor. He's also a meme and currently broke. What are some of the financial decisions that lead to the fall of the biggest stars?
This is what it feels like to make good financial decisions
In one of his most prominent roles, Nicolas Cage stole the Declaration of Independence as Benjamin Gates in National Treasure. At the peak of his acting career, he was one of the highest-paid actors, making $20 million for starring in movies, and had amassed a net worth of $150 million; however, that wealth did not last long.
A person's net worth is a measure of how wealthy that person is. We determine net worth by taking the difference between what we own and what we owe. Thus, we build up our net worth by increasing how much we own and/or decreasing how much we owe.
Cage's net worth of $150 million meant that the value of the things he possessed was $150 million more than what he owed. If we owe more than we own, our net worth will be negative.
Knowing our net worth gives us a snapshot of our financial circumstances, allowing us to set more realistic investment goals. In addition, tracking changes over time will tell us if we are making sound investment decisions and progress toward our financial goals. Doing so can prevent us from making mistakes, like too much spending or borrowing, that could eventually lead to bankruptcy or financial ruin.
Our assets are what we own. These are the things that we possess that have value. Some examples would be our homes, cars, cash, savings accounts, and any investments.
Our liabilities are what we owe. These are the things that we need to pay back. The mortgage we took out to buy our home, the car loan we needed to drive off the lot, the credit card debt we racked up eating out at restaurants are all examples of our liabilities.
Let's look at some of the wealthiest people in the world, the billionaires. Someone like Jeff Bezos, the founder of Amazon, has a growing net worth of above $180 BILLION, over 1,000 times richer than Nicolas Cage was at his peak. Bezos in no way has $186 billion in cash on hand. His wealth is tied to the 55.5 million shares of Amazon stock that he owns, and his net worth will therefore move up and down with the stock price. The net worth that comes from the value of priced assets like this is known as paper wealth.
With his high net worth, Cage lived a life of extravagance. He bought some bizarre things like a nine-foot burial tomb, an octopus, the first Superman comic, shrunken pygmy heads, and a 70-million-year-old dinosaur skull. As odd as some of these items are, what led to Cage’s financial demise was how he casually bought a private island in the Bahamas, a couple of castles in Europe, a dozen mansions and estates across the US, and 22 cars. On top of that, he owed millions of dollars from income and real estate taxes. Cage has been taking on as many film roles as he can to pay off his debts.
A common misconception is that someone must be very wealthy to have nice things. What if we buy those things by borrowing all of the money to pay for them? It doesn’t help to own lots of expensive stuff if we owe lots of money. In fact, our net worth will usually go down if we take on large amounts of debt because of interest.
The principles of net worth that we use personally operate the same way for companies. When looking for good companies to invest in, consider the assets and liabilities on their balance sheet. Do they own a lot of valuable assets? Have they borrowed a lot of money and therefore owe a lot? Companies that have significantly more assets than liabilities are more financially stable, making them attractive investments.
There are many unfortunate examples of athletes, celebrities, and investors who went from being fabulously wealthy to desperately broke because they mismanaged their wealth. Keeping track of our net worth over time keeps us on track to reach our goals and make sound investment decisions. In addition, it gives us feedback about our financial security and if we are becoming wealthier.
A measure of wealth determined by taking the difference between what we own and what we owe, assets minus liabilities.
Resources that we own that produce value.
Obligations that we owe and need to pay back in the future.