Your net worth is the best way to know how well you are financially. Even more than the amount of cash you have in the bank.
Net Worth is the accumulation of assets (including cash) minus the amount of debt you owe in total for all the assets. If you have more money in assets than debts, then you have a positive net worth. If you have more debts than you have assets, then you have a negative net worth.
In this article, we will cover what you need to know about net worth and how you can be wealthy increasing your net worth.
Why is Your Net Worth Important?
There are several reasons why your net worth is important:
- Your net worth tracks the financial progress you make. This is only a single number, letting you track and compare it every year. A growing net worth means you are getting wealthier.
- Your net worth is considered the most accurate measurement of your wealth. When you speak of wealth, this is what is left after you pay off your bills and mortgage or rent. You can never calculate your wealth if you don’t know your net worth in the first place.
- The focus of your net worth goes beyond your income. There are people who assume that wealth is mainly focused on their annual salary. However, even if your pay is increased, this doesn’t mean that you will also have a higher net worth. Your net worth is basically the overview of your entire finances, not your income alone.
- Your net worth gives you a better perspective of your debt level. It lets you see a clearer picture of your asset and income’s value compared to your owed debts. It is a way of measuring if your debts are as bad as they seem.
- Net worth prevents over-emphasis on the value of the asset. Other people use their assets’ value when measuring their personal wealth. However, large debts can offset assets and usually, people who only focus on their assets are not really as rich as they think.
- Your net worth plays an important role during loan application. There are lenders who will be interested to know your net worth before they approve a loan made under your name. From this perspective, its importance is similar to that of your credit rating.
How Net Worth is Calculated
Your net worth is the value of your assets minus your liabilities. An asset would be anything that you own:
A liability would be anything that you have debt on and owe money to someone else:
- Credit card debt
- Personal loans
While the process can be simple, it requires you to gather all necessary information about your current liabilities and assets.
Many financial planners suggest their clients to keep a secure folder containing the information on all financial liabilities and assets that should be updated at least once every year.
What Does Net Worth Mean?
Net worth is the remaining assets of a person after deducting all their liabilities. Simply put, this is the difference between what you own and what you still owe to your lenders.
If your assets exceed your liabilities, you will have a positive instead of a negative net worth. However, it is common to have negative net worth. It just shows the things you should do before you can reach your financial goals.
When trying to calculate your net worth, you shouldn’t be surprised if this is not anywhere near to the net worth of those influential people on the news. Remember that finances are personal and every person has his or her unique goals.
Net worth also tends to increase greatly as you age. It is often the result of retirement funds and the maturing of other investments.
Some other factors like career change with higher pay also play a big role in achieving your target net worth. You might want to consider things that can affect your finances if you want to know your net worth.
What is Your Liquid Net Worth?
Liquid net worth refers to your estate’s value if it is liquidated or sold immediately and converted into cash.
The basic formula for calculating your liquid net worth is to deduct your liabilities from the assets, similar to how you determine your net worth. The only difference is that the assets should be liquid for them to be counted or easily be exchanged for physical cash.
It is an accurate definition yet there are several crucial factors you have to keep in mind to calculate your liquid net worth.
It is important since not all kinds of assets are equally accessible or equal. In case of emergencies or situations that require immediate cash, these liquid assets can be extremely valuable.
There are some benefits to keeping track of and calculating your liquid net worth. This is a crucial measure as this lets you assess your financial security.
Knowing your liquid net worth can also act as a motivation to prepare an emergency fund.
Your savings account may already have several months’ worth of your living expenses, which is considered an asset that will be added to your liquid net worth. But, what if you encounter a major expense or emergency that your current savings cannot afford to pay for?
When you know your liquid net worth, you will be able to liquidate assets if needed to pay for this large expense at the soonest time possible.
What Determines Your Net Worth?
Your assets and liabilities determine your net worth. When you speak of assets, these can include the following:
- Retirement investments – These will include retirement plans sponsored by your employer and personal retirement assets.
- Liquid assets – These will include cash in the bank, cash on hand, treasury bills, certificates of deposit, money market funds, and other cash equivalents.
- Non-retirement investments – These include investment assets you own not held in the retirement plan.
- Real estate – It includes your primary residence’s market value and other owned properties either for pleasure or for investment.
- Business equity or assets – Business owners may want to include their business’s net worth or any other substantial business assets you own.
- Personal assets – These can include jewelry, furniture, cars, and other similar personal effects.
- Personal loans receivable – These are the loans made to business associates, friends, or family. These should only be included if there is a reasonable chance of collection.
- Other assets – These include assets that don’t belong to the categories above like cash value of life insurance policies.
Your liabilities will include the following:
- Installment loans – Aside from car loans, these also include other loan arrangements on other possessions like motorcycles, furniture, or boats.
- Mortgages – These include the first mortgage on a primary residence and second mortgage or the home equity credit line if you got any.
- Student loans – These should be included by parents who are cosigners for one of their children.
- Business loans – Outstanding loans for business purposes are also personal liabilities.
- Credit cards – If you continuously track your net worth, you need to monitor these closely.
- Personal loans – These include outstanding balances of loans received from family members, friends, or business associates.
- Other liabilities – These can include tax liabilities, medical debts, or other obligations not included in the categories above.
After you tallied the complete numbers for your liabilities and assets, deduct your liabilities from the assets and the sum will be your net worth.
Reasons Why You Should Know Your Net Worth
Knowing your net worth is essential for the following reasons:
- Your net worth is a critical benchmark that will measure the failures and successes of your household throughout your life. Net worth often goes beyond your net income alone.
- It is important to know your net worth for setting your long and short term goals.
This is also essential if you want to plan your family. Early on in your career, it is likely that your net income is lower compared to your net income later on as the result of better jobs, promotions, and training.
When you have a set budget plan combined with careful planning, you will see an increase in your net worth over time.
- Tracking changes in your net worth should be made as early as possible to ensure that you make progress in the proper management of your money.
- It is a must to have cash-like or liquid assets for problems that may likely happen. Having sufficient emergency fund will give you the necessary padding for unforeseen events like job loss.
Liquidity may differ among every asset you own. Money market accounts are usually more liquid than a house or a car.
- If you want to apply for a loan to purchase a car, house, pay for college tuition, or as a business investment, you will want to go through your net worth to ensure that you can afford incremental costs you will take on.
Banks will check your financial statements that include your net worth and income state with earnings history.
- Your road map to accumulating wealth begins with determining your net worth and creating some valuable changes such as increased saving, investing, and reduced spending.
Net Worth Worksheet Calculations
It is important that your net worth is calculated on a yearly basis because you will only be able to improve something if you know how to track and measure it.
Your use of a net worth worksheet to calculate your net worth each year will give you a glimpse of the improvements you make on your financial picture.
Some benefits to using a net worth spreadsheet include the following:
- A net worth worksheet will give you a glimpse of your overall financial health and well being to help you make better and more informed decisions in your life.
- Using the worksheet to determine your personal net worth is one of the easiest ways to know your exact starting point and how far you have to travel in order to achieve all of your long term goals for your finances.
- Tracking and growing a positive net worth will not just keep you on a more positive financial track as it will also help you become qualified and other types of more attractive terms for credit.
- Identifying problem areas and setting financial goals is made easier if you know your current net worth with the help of a net worth worksheet.
What is the Net Worth Definition?
By definition, your net worth refers to the amount by which the assets you have exceed the liabilities you got. In simple terms, the net worth is the difference between what you owe and what you own.
In the event that your assets go beyond your liabilities, you will have a positive net worth. On the other hand, if you have bigger liabilities than assets, your net worth will be negative.
Your net worth gives you a quick snapshot of your current financial situation. If you will calculate your net worth right now, you will be able to see the final result of all the things you earned and all the things you spent until today.
Although the figure is quite helpful as this can serve as a wakeup call if you went off track or a confirmation that you are doing things right, tracking and calculating your net worth over time gives you a more meaningful view of the status of your finances.
If calculated every now and then, you can consider your net worth as your financial report card that lets you assess your existing financial health and help you determine the things you have to do to achieve your financial goals.