net worth

Net Worth: What It Is and Why It Matters

Net worth is a term commonly thrown around in personal finance circles.

However, unless you’re well-versed in finance topics it’s likely you don’t pay much attention to your net worth and you may not even know what it is.

In fact, you may associate it with the holdings of the rich and famous more than everyday people.

While many are more likely to use income as a measure of financial status, it is really a persons’ net worth that paints a more complete picture of their finances.

Read on to learn about net worth, what it is, why it matters, and how to calculate yours.

 

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What is Your Net Worth?

Simply put, your net worth is the sum of all your assets minus your liabilities.

Think of assets as things with value that you possess such as retirement accounts, real estate, savings/checking accounts, and even vehicles and other material possessions if they have value.

Liabilities, on the other hand, are debts you owe. These can include loans, credit card debt, mortgages, etc.

Note that it is possible for an item to be both an asset and a liability (discussed more below).

Thus, an easy way to look at net worth is that it is the value of what you own after accounting for what you owe.

A very simple example would be an individual with $10,000 in their savings account who owes $2,000 on their credit card. In this case, you would take the $10,000 (asset) minus $2,000 (liability) for a net worth of $8,000. In this case it is positive.

On the other hand, it is entirely possible (and probable for many Americans) to have a negative net worth.

This means that their debts (what they owe) are more than their combined assets.

For example, let’s reverse the example above and say an individual has $2,000 in savings but also has $10,000 in credit card debt.

In this case, the asset of $2,000 minus the liabilities of $10,000 means this individual has a net worth of – $8,000.

 

Why Does Net Worth Matter?

Why does it matter?

In the example above we discussed a hypothetical scenario where an individual had a negative net worth of – $8,000. At this point you’re probably thinking that person is in pretty bad shape, or at least not the best financial shape.

But, what if instead we had told you that this same individual makes $100,000, has a beautiful new home, and drives a nice new car.

Would your perception of their financial situation be different?

Most likely, if only given their income and the major items they own you’d probably think they were doing very well.

This perception of an individual’s financial status based on material possessions and income is why knowing your net worth is so importation.

On the surface, someone may look like they have it all, but income and possessions will only tell you part of the story.

It is only through looking at an individual’s net worth that you can see their true financial situation.

It’s like a credit score, except in this case the number represents a snapshot of your overall financial situation. Those with a higher net worth have a more secure financial situation.

A high income may cover for a low or negative net worth, but it provides little protection or flexibility. Those with a low or negative net worth are ill prepared for illness or injury, job loss, economic downturns, and may even struggle to retire.

Put another way, a low or negative net worth makes you reliant on your job to stay financially afloat. If you lose that income you lose the ability to pay for your liabilities.

On the flip side, the higher your net worth the less dependent you are on your income to stay afloat and the more prepared you are for unforeseen hardships.

And while some of you may not be worried about losing your job or other struggles, you’d better make sure you focus on your net worth if you want to retire someday.

 

How to Calculate Your Net Worth

Now that we have you thinking about your net worth, the next step is to learn how to calculate it.

Some of you may be apprehensive to actually see where you stand financially and be reluctant to calculate yours.

Facing your true financial situation may be scary, but it is necessary to know where you stand so that you can make a plan moving forward. Knowing where you stand will also make you more conscious of future purchases and the liabilities you add to your situation.

You may even be motivated to start saving for retirement, or saving more.

So, let’s get to it.

 

Calculating Your Net Worth Number

Calculating your number requires you to make a list of all the assets and liabilities you currently have and then find the difference between them.

 

1. Calculate Your Assets

Remember, assets are anything that has value.

There are many differing schools of thought on what should be included as assets, with many individuals choosing to only include liquid assets (assets that can be quickly turned to cash) and retirement accounts. Others may include appreciating assets like a home or other real estate.

However, an asset can be anything you have that has value. Generally, people only include items as assets if they hold a value of a thousand dollars or more, but you can include anything you think is relevant.

Common assets include:

  • Cars and other vehicles that still have value
  • Real estate and land
  • Cash
  • Savings/checking accounts
  • Retirement accounts
  • Brokerage accounts
  • Ownership in business
  • Livestock or other animals

Once you have your list of assets write down their approximate market value. In other words, if you were to sell these items approximately how much money could you expect from each?

After you determine the approximate value for each asset, add them together to find the value of all your assets.

 

2. Calculate Your Liabilities

Next, you must make a list of liabilities. Liabilities are anything you owe to someone else.

Common liabilities include:

  • Student loans
  • Credit cards
  • Mortgage
  • Auto loans
  • Personal loans
  • Payday loans

Again, once you have your list you’ll need to write down the amount you owe for each liability.

Then, add the amount for each liability to get your total liabilities.

As you can see from the two lists, some items can be included as both assets and liabilities. For instance, the market value of your home is an asset while the mortgage you owe is a liability. Similarly, the value of your vehicles is an asset while the amount you owe in auto loans is a liability.

Hopefully when you complete this exercise the value of any major items you’ve purchased are higher than what you still owe on them.

 

3. Calculate the Difference Between Your Assets and Liabilities

The final step is to find the difference between your assets and liabilities.

To do so, you need to put the numbers you calculated into a simple formula.

Assets – Liabilities = Net Worth

It’s really important that you put the assets first in this formula so you get an accurate picture. Think of assets as being positive for your finances and liabilities as being negative. Liabilities represent money you owe to others, so it’s important to subtract them from the overall picture.

The number you get at the end is your net worth.

 

What Does Your Net Worth Number Mean?

Your number can be positive or negative.

If your net worth is positive it means that you have more assets (good financial things) than liabilities (bad financial things).

On the other hand, if it’s negative then you have more things you owe to others than things you own.

As discussed above, a negative net worth makes you more reliant on your income and less able to withstand financial hardships.

If you’ve calculated your net worth and feel discouraged, don’t despair.

Your number will be constantly changing based on your financial moves. Each month you make a payment on a loan your number is improving and each contribution to a retirement account also positively impacts your net worth.

Now that you know where you stand, make a goal to improve your net worth. For some, that will mean going from a negative net worth to a positive one. For others, it may mean increasing their net worth to $100k. You may even want to compare your net worth to net worth targets based on your age to inspire your journey.

Whatever your goal, you now know exactly where you stand, as well as where your assets and liabilities are.

Focus on eliminating liabilities and acquiring assets to increase your net worth and insulate yourself from financial hardships.

 

Moral of the Story

The average person likely uses income as the primary indicator of financial health, but what they should really be using is net worth.

Net worth paints a more accurate picture of your overall financial situation by providing a snapshot of what you own versus what you owe.

It also shows you how reliant you are on your income and how protected you are from financial hardship.

The good news is that net worth is constantly fluctuating, and no matter where you currently stand you can begin improving yours today.

Focus on accumulating assets, avoiding liabilities whenever possible, and paying down those liabilities you do have.

Talk about Money Saved.

 

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