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Your net worth is the excess of your assets over your liabilities. Simply put, net worth is the difference between what you own and what you owe. If your assets exceed your liabilities, your net worth is positive. On the other hand, if your liabilities exceed your assets, your net worth is negative.
Your net worth gives you a snapshot of your current financial situation. If you calculate your net worth today, you’ll see the end result of everything you’ve earned and everything you’ve spent so far. While this figure is useful – for example, it can serve as a wake-up call if you’re completely out of pocket, or confirm that you’ve done well if you’re doing well – tracking your net worth over time gives you a more meaningful overview of your finances.
When calculated periodically, your net worth can be considered a financial report card that allows you to assess your current financial situation and can help you determine what you need to do to reach your financial goals.
KEY TAKEAWAYS:
- Your net worth is the excess of your assets over your liabilities, i.e. what you own over what you have to pay.
- Assets include investments, bank accounts, brokerage accounts, retirement funds, real estate and personal property such as your car or jewelry.
- Liabilities include mortgages, loans, credit cards, student loans and other debts.
- Whatever your financial situation, knowing your net worth can help you assess your current financial situation and plan for the future.
- Your net worth will fluctuate, but it’s not the day-to-day figure that matters, but the overall trend; as you age, your net worth should ideally increase.
- By knowing where you stand financially, you’ll be more aware of your expenses, better prepared to make sound financial decisions, and more likely to achieve your short- and long-term financial goals.
Net worth
Your assets are all the valuable items you own that can be converted into cash. Examples include investments, bank and brokerage accounts, retirement funds, real estate, personal property (vehicles, jewelry and collectibles) and, of course, cash. Intangible assets, such as your personal network, are also sometimes considered assets. Liabilities, on the other hand, represent your debts, such as loans, mortgages, credit card debts, medical bills and student loans. The difference between the total value of your assets and liabilities is your net worth.
One of the difficulties in calculating your net worth is assigning an exact value to all your assets. It’s important to make conservative estimates when assigning a value to certain assets, to avoid inflating your net worth (i.e. having an unrealistic view of your wealth). Your home, for example, is probably your most valuable asset and can have a major impact on your financial situation. Determining the exact value of your home – by comparing it to similar homes recently sold in your area, or by consulting a qualified real estate professional – can help you calculate a realistic net worth.
However, there is some debate as to whether personal residences should be considered assets for the purposes of calculating net worth. Some financial experts believe that the net worth and market value of your home should be considered as assets, as these values can be converted into cash in the event of a sale.
Notably However, other experts believe that even if the homeowner receives money from the sale of his or her home, this money should be used to buy or rent another home. In other words, the money received becomes a new liability – the cost of replacing the house. Of course, if the house sold is more valuable than the replacement home, part of the value of the previous house can be considered an asset.
Important: Because it’s easy to inflate the value of your assets, it’s better to err on the conservative side when assigning financial value.
What Does It Mean?
Your net worth can tell you a lot. If the figure is negative, it means you owe more than you own. If it’s positive, it means you own more than you owe. For example, if your assets are USD 200,000 and your liabilities are USD 100,000, your net worth is positive by USD 100,000 (USD 200,000 – USD 100,000 = USD 100,000). On the other hand, if your assets are USD 100,000 and your liabilities USD 200,000, you will have a negative net worth of minus USD 100,000 (USD 100,000 – USD 200,000 = – USD 100,000). A negative net worth does not necessarily indicate that you are financially irresponsible; it simply means that, at the moment, you have more debts than assets.
Like the stock market, your net worth will fluctuate. But, like the stock market, it’s the overall trend that matters. Ideally, your net worth should continue to increase as you get older, pay down debt, increase the value of your home, acquire more assets, etc. At some point, it’s normal for your net worth to fluctuate. At some point, it’s normal for your net worth to decrease as you begin to use your savings and investments as retirement income.
Because each person’s financial situation and goals are unique, it’s difficult to establish an “ideal” net worth that applies to everyone. Instead, you’ll need to determine your ideal net worth – the level you’d like to achieve in both the short and long term. If you’re not sure where to start, some people find the following formula useful in determining a “target” net worth:
Target Net Worth=[Your Age−25]∗[51∗Gross Annual Income]
For example, a 50-year-old with a gross annual income of $75,000 might aim for a net worth of $375,000 ([50 – 25 = 25] x [$75,000 ÷ 5 = $15,000]). This does not mean that all 50-year-olds must have the same net worth. The formula can simply be used as a starting point. Your ideal net worth could be much higher or much lower than the guideline, depending on your lifestyle and goals.
Why Your Net Worth Is Important
When you see the black-and-white financial trends in your wealth statements, you’re forced to confront the reality of your financial situation. Analyzing your wealth statements over time can help you determine 1) where you stand, and 2) how to get there. It can encourage you when you’re moving in the right direction (i.e. reducing your debts and increasing your assets), and call you to order if you’re not. The way forward could include the following:
Spend Wisely
It’s important to know your net worth, as this can help you identify areas where you’re spending too much money. Just because you have the money to buy something doesn’t mean you have to buy it. To avoid accumulating unnecessary debt, ask yourself whether it’s a need or a want before making a purchase. To reduce unnecessary spending and debt, your needs should account for the majority of your spending (remember, you can falsely pass off a want as a need). That $500 pair of shoes fills a need for shoes, but a cheaper pair could do just as well and keep you on track financially).
Pay Down Debt
Analyzing your assets and liabilities can help you develop a debt repayment plan. For example, you may be earning 1% interest on a money market account while paying off a credit card at 12% interest. In the long run, it may make sense to use the money to pay off the credit card debt. If in doubt, analyze the figures to see if it makes financial sense to pay off a particular debt, taking into account the impact of no longer having access to this money (which you may need in an emergency).
Save and Invest
Your net worth figures may encourage you to save and invest money. If your net worth statement shows that you’re well on the way to achieving your financial goals, this may encourage you to keep going. On the other hand, if your net worth indicates that there’s room for improvement (for example, over time, you have smaller and smaller assets and larger and larger liabilities), it may give you the spark of motivation you need to take a more aggressive approach to saving and investing your money.
Why Knowing Your Net Worth Is Important FAQs
What Is the Difference Between Net Income and Net Worth?
You earn income if you work for someone or run a business. Your net income is your income after taxes and payroll deductions, such as Social Security and the money you pay into your 401(k). It’s different from your net worth, which is the total value of everything you own, minus all your debts.
How Often Should I Calculate My Net Worth?
There’s no set rule for how often you should calculate your net worth. For some people, a quarterly net worth calculation makes sense, while for others, an annual calculation is preferable. Some advisors also suggest recalculating after a major purchase or sale, such as a house or car.
What Does Liquid Net Worth Mean?
Net worth is the part of your net worth that can be easily converted to cash in a day if necessary, versus an asset that would take time to convert, such as jewelry or real estate.
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