Confused about the meaning of “net worth” or how to arrive at a figure for it?
The concept of “net worth” has emerged as a standard method of evaluating financial success. Most folks can perform the math on the back of a cocktail napkin.
Every individual has to be able to, and monthly should, assess their financial position. Now more than ever, you may take use of free and automated resources to keep tabs on your financial standing.
What Is Net Worth?
Simply put, your net worth is the value of your assets less your debts (more on both shortly). Having a positive net worth means that your assets exceed your obligations. A negative net worth occurs when one’s debts are greater than one’s assets.
To simplify things, picture a high school senior who has just gotten her first bank account and credit card. Her credit card amount is $40, but she has $100 in her bank account. Subtracting her entire debts of $40 from her total assets of $100 yields a net worth of $60 for her.
Wealth is measured by how much you have in your net worth. Your long-term goal as an employee should be to accumulate sufficient wealth so that you may retire in style. For the simple reason that when you finally do retire, you won’t have to worry about working again and will instead rely on investment income, asset sales, and maybe even Social Security. It would be ideal if you could do this without worrying about money running out before you die.
You may track your progress toward financial security and retirement with the help of net worth. It also affects your capacity to save for retirement, send your children to college, and maintain any other standard of living you might have.
Pay attention to the fact that your salary has no bearing on your net worth. I’ve met wealthy people who blow through their money and end up with a negative net worth. A lot of the wealthy individuals I know have low salaries, but they save a lot of money each year.
A person’s net worth is a measure of their wealth as of a specific date. In other words, it is not a method for gauging your financial stability.
How to Determine Your Net Worth
To determine one’s net worth, all that is required is basic arithmetic: addition and subtraction.
You take a hard and fast approach by tallying up all of your assets and debts and then deducting those two figures.
Even yet, not everybody has a crystal clear idea of what constitutes an asset and what constitutes a liability. Consider this a high-level look into one’s assets and debts.
Everything you own that may be sold or traded for cash is considered an asset. They might be easily convertible to cash, like a bank account, or more difficult to convert, like a house.
An asset is considered liquid if its value may be immediately converted into cash without the need to sell the item beforehand. The following are some examples of assets that are commonly used:
- The price at which your house may be purchased on the open market
- How much your cars are worth in today’s market
- You have a certain amount of money saved in several investment accounts.
- How much money you have in liquid assets like bank accounts, savings accounts, and other fixed-income investments like CDs and money markets
- A full
life insurancepolicy’s cash worth
- Your most prized possessions are those that hold sentimental or monetary worth for you.
Personal property such as artwork and jewelry should only be included in an asset valuation if a professional appraisal has been obtained.
Contrary to assets, liabilities signify money owed to third parties. The whole loan balance is what counts against your overall liabilities, not the sum of the monthly installments. Common forms of exposure to risk include:
- Mortgage financing
- Auto loans
- Balances on credit cards
- Loans for students
- Loans for individuals
- Expired medical bills
- Taxes owed
- You have liens and judgements against you.
Illustration of Net Worth Calculation
Imagine that you own the following:
- Home market value: $180,000
- Vehicle market value: $5,000
- IRA: $7,000
- 401(k): $13,000
- Other financial assets: $5,000
- Fund for emergencies: $5,000
- Account balance: $2,000
You have a total of $217,000 in assets. However, you must also consider the following risks:
- Mortgage amount of $160,000
- Money to put toward a car: $3,000.
- There is a $1,000 balance on all credit cards.
- Loans for college: $2,000.
Your current debt is now $166,000 total. Therefore, your current wealth is merely $51,000 ($217,000 minus $166,000). That sum is equivalent to your current financial assets.
The picture will change in two months if, for example, you pay off your credit card bill and reduce your liabilities by $1,000. Your wealth will have increased to $52,000 if nothing else happens.
Is it necessary to include my home equity?
The equity in one’s house is typically factored into a person’s net worth. It’s not something I like doing myself.
To begin, it is just conceptual at this point. It can’t be invested to earn interest on your behalf. Without selling your property, you may borrow against your equity. Therefore, the equity in your property has no bearing on your overall financial situation until you decide to sell it.
Nor should you assume that you will receive all of your equity in the form of cold, hard cash at the settlement table. Selling a home involves a number of expenses, including the fee paid to the real estate agent, transfer taxes, and other closing charges. These fees are typically not factored into conventional measures of financial well-being that incorporate home equity, leading to unrealistic and erroneous conclusions.
Last but not least, having equity in your house might give you a false impression of success and riches. When homeowners calculate their equity, they may get the false impression that they have more money than they actually do. Instead of saving and investing in things that grow in value over time, they go out and purchase that flashy automobile they’ve always wanted.
Don’t use the value of your property when figuring out how wealthy you are; instead, put your money into investments.
Net Worth’s Applications and Limitations
The calculation of one’s net worth is a straightforward and practical financial indicator. It’s one of three key financial indicators you should review on a monthly basis. The other two metrics are your rate of savings and your FIRE ratio, or the proportion of your monthly costs that are covered by investments or other passive income. (Find more about additional indicators of one’s financial health here.)
You should prepare now to retire and rely on your savings, as described above. How far along you are in terms of amassing your emergency fund is reflected in your current net worth. If you’re trying to save for retirement, you should have a good idea of how much money you’ll need. Regardless of your age, you can retire early if your net worth reaches this threshold.
The extent to which you may participate in various investing possibilities is also related to your net worth. U.S. law restricts participation in some investments to “accredited investors,” defined as those with a net worth of $1 million or more (or with high salaries). If you can’t handle your finances, Uncle Sam won’t trust you with his money.
However, net worth doesn’t reveal anything about how much money you make or how much money you spend every month. Although a higher income facilitates the accumulation of a larger net worth and a larger net worth may be put to work investing for passive income streams, it is important to remember that net worth is only a snapshot of your wealth at any one time.
How to Automatically Track Your Net Worth
When it comes to keeping tabs on my financial situation, I rely on Mint.com’s automated tracking. I linked all my financial and investment accounts, and now whenever I check in, it updates itself with the most recent information from those accounts.
I like to evaluate my development once a month on the same day. Due to the ebb and flow of your monthly budget, it is best to do this at the same time each month so that you can make fair comparisons. After you first get paid at the start of the month, you may have more money than when you’ve already spent most of your salary on expenses halfway through the month.
Regarding financial planning, Mint is a useful tool that may assist in the creation of a monthly budget and provide warnings if you start to deviate from it. Moreover, they plot a line chart of your wealth accumulation over time so you can see the big picture.
Or, you may use Personal Capital to keep tabs on your financial standing and investment portfolio as well. If neither of them appeal to you, you may always try one of these alternatives to Mint.
The ease with which these tools make monthly tracking of your net worth possible increases the likelihood that you will really do it. And it is important to maintain track of your progress because it puts the process of accumulating wealth in the forefront of your mind and makes it more concrete, which in turn helps you stay on track to achieve your long-term financial objectives.
An individual’s net worth is a useful indicator, but it is not the only tool in their financial toolbox.
In addition to regular checks on your net worth, you should also use budget analysis and monitoring tools to create a financial plan that takes into account both immediate and long-term needs and wants, such as paying off debt and saving for retirement. Use a budgeting tool like Tiller or Personal Capital to help you save money and keep track of your progress toward your objectives.
It’s important to focus on creating passive income sources at the same time you’re working to increase your net worth. If you have sufficient passive income, you won’t need a regular source of income like a job to get by. When you no longer have to rely on a 9 to 5 job for survival, you’re free to make many more decisions about your career, family, and general way of life.