Not sure what “net worth” is or how to calculate it?
Net worth is a typical technique to quantify personal wealth. For most individuals, it’s a straightforward calculation that can be done on the back of a cocktail napkin.
Everyone should understand and calculate their net worth on a monthly basis. Fortunately, there are various applications available that can automatically calculate and track your net worth for free.
What is Net Worth?
Your net worth is just the amount of your assets less the sum of your obligations (more on both later). A positive net worth exists when your assets exceed your obligations. If your obligations outweigh your assets, your net worth will be negative.
To give an oversimplified example, consider a high school student who recently established her first bank account and credit card. She has $100 in her bank account and a $40 charge on her credit card. Her net worth is $60, which equals $100 in total assets minus $40 in total liabilities.
Your net worth reflects your financial prosperity. Over the course of your work, you hope to accumulate a large enough net worth to comfortably retire. Because in retirement, you’ll rely on a combination of passive income from your investments, gradual asset sales, and maybe Social Security benefits. Ideally, you can accomplish this without worrying about running out of money before you die.
So, net worth serves as a meter for measuring your progress toward financial independence and retirement. However, it also influences your capacity to purchase a home, assist your children with college tuition, and manage every other part of your finances.
It’s worth noting that your income does not display in your net worth. I’ve seen high-income workers who spend every penny they make, resulting in a negative net worth. I’ve also met folks who have a low wage yet save a lot of money and have a large net worth.
Your net worth is a financial snapshot of your complete fortune at a given period in time. It does not track your financial flows.
How to Calculate Your Networth
The arithmetic required in calculating net worth is as basic as adding and subtracting.
You just tally up all of your assets, then all of your obligations, and then deduct your total liabilities from your total assets.
Even yet, not everyone understands the distinction between an asset and a liability. Here’s a brief comparison of personal assets and liabilities.
Assets
Your assets are everything you own that has a monetary worth. They might be liquid, like a bank account, or non-liquid, like your house. A liquid asset simply implies that you do not need to sell it in order to receive its monetary worth.
Some typical instances of assets include:
The market worth of your house
The market worth of your automobile
The amount of your investment accounts (including your brokerage account and retirement funds such as a 401(k) or IRA).
The total amount in your checking and savings accounts, including certificates of deposit (CDs) and money market accounts
The monetary value of an entire life insurance policy
Notable objects of worth you own, such as paintings, furniture, expensive jewelry, or collectibles.
Because the value of personal property such as artwork and jewelry can be very subjective, only consider them as assets after having them properly assessed.
Liabilities
Liabilities, unlike assets, reflect obligations or sums owed to others. Your overall obligations are defined by the total loan balance outstanding, not the monthly payments owed.
Common instances of liabilities are:
Mortgage loans
Automobile loans
Credit Card Balances
Student loans
Personal loans
Outstanding medical bills.
Back taxes.
Liens and judgments against you.
Sample Net Worth Calculation
Imagine you hold the following assets:
Home market value is $180,000.
Vehicle market value is $5,000.
IRA: $7,000
401(k): $13,000
Other Investment Accounts: $5,000
Emergency fund: $5,000.
Checking account: $2,000.
Your overall assets amount to $217,000. However, you also have the following liabilities:
Home mortgage: $160,000.
Vehicle loan: $3,000.
Total credit card balance: $1,000.
Student debts are $2,000
This takes your total liability to $166,000.
So your net value is just $217,000 less $166,000 = $51,000. That indicates your whole monetary fortune at the moment.
In two months, it will seem different—perhaps you will pay off your credit card bill, reducing your liabilities by $1,000. If nothing else changes, your net worth will have reached $52,000.
Should I include home equity?
Traditionally, individuals include their home equity in their net worth calculations. I personally dislike doing so.
To begin with, it exists just on paper. You cannot invest it so that it will compound for you. You may tap into your home equity without selling, but only by incurring new debt. So, until you’re ready to sell, the equity in your house has no significant influence on your other finances.
You also cannot expect to leave the settlement table with all of your equity in cash. When you sell, you must pay real estate agent commissions, transfer taxes, and other closing charges. Typical net worth estimates that involve home equity overlook these expenses, rendering them erroneous and unrealistic.
Finally, home equity might give you a false impression of achievement and riches. Homeowners may look at their equity and say, “Wow, we’re richer than we thought!” And then they go out and purchase that expensive automobile they’ve been coveting, instead of saving and investing in actual long-term growth opportunities.
I advocate that you overlook home equity when calculating your net worth and instead focus on growing wealth by investing your money.
Uses and Limitations of Networth
Net worth is a straightforward and practical approach to assess your financial fortune. In fact, it is one of three financial measures that you should review once a month. The other two are your savings rate and FIRE ratio, which is the percentage of your living costs that can be met with passive income.
As previously said, you will eventually have to rely on your retirement savings. Your net worth reflects your progress toward your desired nest egg. Determine how much you need to retire and use your net worth as a progress indicator. Once you have that net worth, you may retire early, regardless of your age.
Your net worth might also influence what investment options are available to you. Some investments in the United States are only available to authorized investors, who have a net worth of more than $1 million (or high wages). Otherwise, Uncle Sam believes you don’t know enough about money to invest wisely.
However, net worth does not indicate your income, cash flow, or monthly budget. While a greater income makes it simpler to accumulate a large net worth, and you can utilize it to invest in passive income streams, net worth is only a snapshot of your wealth at the time.
How to Track Your Net Worth I use Mint.com to monitor my net worth automatically. I linked all of my bank and investment accounts to it, and each time I check in, it gets the most recent data from them.
I check my progress once a month, on the same day. By doing it at the same time every month, you can compare apples to apples, as the ebb and flow of your monthly budget might distort the statistics. You may have more money at the start of one month from a recently earned salary than you had in the middle of another month after spending it on expenses.
Mint lets you create a monthly budget and informs you when you deviate from it. They also show a graph of your net worth’s growth over time to assist you understand it.
Alternatively, Personal Capital records your net worth and investments. If neither of those solutions appeal to you, consider these Mint alternatives.
Using any of these platforms simplifies the process of measuring your net worth, increasing the likelihood that you will track your progress each month. Tracking your success is important because it keeps wealth creation in your mind and makes it concrete, which helps you stay on track for your long-term financial objectives.
In Conclusion
While net worth is an important indicator, it is only one part of your financial arsenal.
Complement net worth checks with budget analysis and monitoring tools, and create a financial plan that includes short- and long-term financial goals such as house ownership and retirement. Create a budget with Tiller or Personal Capital to achieve these objectives, and utilize net worth checks to ensure you’re on pace to reach them.
As you increase your net worth, seek to create passive income sources. With enough passive income, you no longer need your day job to support your living expenses. When you no longer need your 9-to-5 job to survive, you have a whole new set of alternatives for your employment, family life, where you reside, and your whole lifestyle.
