Your net worth, a snapshot of your financial health, is key to helping you understand the difference between what you own and what you owe. Knowing your net worth both provides insight into your current financial standing and helps create the roadmap for achieving your financial goals.
What is Net Worth?
Net worth is essentially a measure of your financial worthiness. It's calculated by subtracting your total liabilities from your total assets. In simpler terms:
Net Worth = Total Assets − Total Liabilities
How to Calculate Net Worth:
Identify Your Assets: Begin by listing all assets you own. These include cash, savings, investments, retirement accounts, real estate properties, vehicles, valuable possessions, and any other items of significant value like rare baseball cards or vintage designer clothes.
Assess Your Liabilities: Next, make a list of all your liabilities. So, things like mortgages, car loans, student loans, credit card balances, personal loans, and any other financial obligations. Maybe you owe your co-worker $20 because they spotted you for lunch or you need to pay this month’s utility bills. Write it all down.
Do the Math: Once you have a comprehensive list of your assets and liabilities, subtract your total liabilities from your total assets. The resulting figure is your net worth. Pretty easy.
Why Net Worth Matters:
Your net worth provides a clear picture of your financial health at a given point in time and can help you assess whether you're accumulating wealth or accumulating debt. If your liabilities are totaling to $10,000 but your assets are only totaling to $9,000 then you have a net worth of -$1,000. What this means is essentially, even if you liquidated all your assets, you would be unable to pay off your liabilities in full. While in the short term this may not be an issue, long term negative net worth could indicate financial stress or roadblocks in financial security. A recent college graduate may have a sizeable amount of liabilities in student loans and no assets, thus negative net worth in the short-term. But it’d be expected that, in the long term, they would be able to pay off those loans and achieve a positive net worth. But if they’re unable to reach a positive net worth in the long term, it could be a sign that their ability to work is being impacted. Such impacting factors include health issues, personal spending habits, feelings of dissatisfaction with their work or career, and a range of other roadblocks. It’s important to be able to identify these things, thus it’s best to know your net worth.
Net worth can also be used as a benchmark for checking if you’re on the right track for the following life or financial goals: retirement, debt reduction, asset allocation, emergency funds, education, estate planning, tax planning, or financial growth. As in the previous example, a negative net worth over a long period of time can indicate you’re having trouble reaching one or more of your financial goals. And an increasingly positive net worth can show that you’re steadily and successfully working towards those goals.
So how do we increase our net worth?
Reduce Liabilities: The simplest way of increasing your net worth is to reduce your liabilities. The best way to do so is to pay down high-interest debts first. So, if you have a loan with 50% interest rate and another loan with 10% interest rate, pay off the 50% one first. You could also make extra payments, consolidate debt, or negotiate lower interest rates to expedite the repayment process.
Grow Assets: On the other hand, you could increase the value of your assets. Typically, this is done through investing and growing your accumulated wealth. Methods to do this include contributing regularly to retirement accounts, diversifying your investment portfolio, or investing in income-generating assets like real estate or dividend-paying stocks.
Increase Income: For many people, the best way to grow their assets is to generate and increase their income. Opportunities that could help boost your income include a promotion, job hopping, a side hustle, or passive income streams such as social media or a side business. The math is simple in that the more income you have, the more you're able to save and invest to increase your net worth.
Control Spending: Prudent spending habits can help avoid unnecessary expenses. Budgeting effectively and distinguishing between needs and wants is key here. Sure, a $600 Dyson Airwrap could help your hair look amazing, but do you really need it? Or would that $600 better service you by paying off debt or buying food for the month.
Conclusion:
In essence, net worth serves as a barometer of your financial well-being and is instrumental in guiding your financial decisions and aspirations. Having a better understanding of how to calculate and interpret your net worth helps you work towards your long-term financial goals, whether that means striving for financial security, planning for retirement, or just aiming to build wealth.