The determination of an individual’s net worth can be a very useful tool in the measurement of the individual’s economic status and even in the measurement of his or her financial progress from year to year. In a nutshell, your net worth is basically the sum total of all your assets subtracted from your liabilities. In other words, your net worth is the figure you get when you add up everything you own from the value of your home to the cash in your bank account and then subtract from that the value of all of your debts which may include a mortgage, car or student loans, or even credit card balances.
The Theory Behind Calculating Net Worth
In theory, your net worth is the monetary value (in cash) you would have in the event that you were to sell off all you own and then pay off all your debts. Sometimes, the value you can get may even be negative, which goes to show that you have more liabilities than assets. Even though this situation is less than ideal, it is not uncommon for college graduates or people who are about to start a career to find themselves in such a position. In that case, your net worth is also a measure of how much debt you would still owe if you emptied your bank accounts and sold everything you own to put towards your debt.
Though neither is a realistic scenario, what your net worth measures is more important than the (generally unrealistic) assumptions that are made to get to that number.
In reality, when it comes to your financial health, there is no bench mark number that is perfect and should be strived for, but you should use your net worth to track your progress from year to year and to hopefully see it improve and grow.
How to Calculate Net Worth
Calculating your net worth does not have to be a difficult undertaking. To do it, you will need some time, paper for writing and a calculator. Here are a step by step process for calculating your net worth.
Make a list of all of your assets and their estimated value
The list should include your retirement savings, your current checking and savings account balances, any bonds you might have, the total value of any stock holdings you might have, your home, and your automobiles. Even though some of these assets will have very specific and obvious values (such as your bank statement), some others will require you to make an educated guess. Websites such as Zillow or Redfin can help you offer estimated home values, and even though you should not take their estimate hook, line and sinker, they can give you a ballpark idea of what your home is worth. Kelley Blue Book or Edmunds can help you determine the value of your car. Alternatively, you can check websites like eBay and find items that are similar to yours and then use which can help you gauge the real value of other random items.
You can start by making a list of all your assets and their values on a piece of paper. For clarification, assets are everything you own that has a monetary value attached to it. It could range from liquid (like a checking account) or non-liquid (like your house). Commons examples of assets include;
- The market value of your home
- the market value of your cars
- the money in your investment account
- the money in your checking and savings
- Valuable items like works of art, jewelry, furniture et al.
When you have made of list of the assets you own and their respective value, you should sum it all together. Once you have this total, you’ve got the total value of your assets.
2. Make a list of all of your debts or liabilities
Next, you should make a list of your liabilities such as credit card balances, personal loans, mortgages, outstanding medical expenses, student loans, auto loans, back taxes home loans, liens and judgments et al.
As soon as you have made a list of all your debts, you should sum them up. This is the total amount of all of your debts.
Finally, just subtract your total debt from your total assets. The amount is your net worth.
It is not uncommon for people to have a net worth that is negative, thanks to their mortgage debts, car loans et al.
Practical Examples of how Net Worth is Calculated
Example 1: Mrs. Janet is 40 years old. She owns a house which is worth $250,000, and still owes $150,000 on the mortgage. Her 4 year old car is now only worth about $7,000, but it’s all paid off. She has $1,000 in credit card balances, $25,000 in her 401(k), about $5,000 in her savings account, and $20,000 remaining on her student loans.
We can see that her assets include;
Total assets: $287,000
Her liabilities are; Credit cards: $1,000
Student loans: $20,000
Total Liabilities: $171,000
Therefore, Mrs. Janet worth will be: $287,000 – $171,000 = $116,000
Example 2: Mr. George owns a house that costs $180,000. He owns two vehicles which costs $2,000 and $15,000 respectively. He has $7,000 in his IRA and $11,000 in his 401K. In his other investment account, there’s $5,000 and he has $4,500 stashed away as an emergency fund. He has a short term savings of $1,000 and $2,000 in his other bank accounts. All these constitute the assets he has.
On the liability side, he owes $184,000 in mortgage payments, vehicle loan of $10,000, a total credit balance of $1,000 and a student’s loan to the tune of $60,000.
From this, you can see that Mr. George’s total assets is $227,500 while his total liability is $255,000. Therefore, his net worth will be $227,500 – $255,000= -27,500
You will notice that the net worth of Mr. George is negative. This means that owes $25,500 more that he is worth in monetary terms.
Some people panic when they calculate their net worth and discover that it’s negative. This is usually the result of a young earner with a substantial amount of student loan debt and also a loan on a rapidly depreciating automobile. A negative net worth could imply that you have not earned or invested enough money yet to overcome the debts that you have amassed.
A negative net worth can also come about as a result of too much borrowing. For example, if you’ve racked up huge credit card bills, and are not paying them down. This creates a large number in the liabilities column, with no valuable asset to offset it.
How to Increase Your Net Worth
Your net worth is a snapshot of where you are at financially. It doesn’t offer information about cash flow, or your monthly income and expenses. But it does provide insight regarding how well you’re accomplishing your long-term financial goals. Once you determine your net worth, you can more easily see what items are holding you back.
Whenever you reduce the amount you have in debts or when your assets grow in value, your net worth will increase. So, you can increase your net worth by paying off your debts, saving and investing money, and reducing your spending. If you own a home, paying down your mortgage while property values rise can increase your net worth from both sides of the ledger.
On the other hand, your net worth goes down when you take on additional debt with little or nothing to show for it – particularly when you spend money on “small” things, such as clothes, food, and even interest on loans. Whenever you buy something frivolous, your net worth goes down.
How Often Should Net Worth be Calculated?
You can calculate your net worth every month. The aim behind this is to know how much you worth and as such strive to improve your net worth from what it was in the previous month. You can then use the excess fund to offset some of your debts or use them to boost your personal savings.
There are some websites that you can make use of to automatically calculate your net worth and keep track of your finances. However, if you’re worried about online security, then you can stick with your pen and paper or an excel spreadsheet.
In conclusion, calculating and tracking net worth on a regular basis is just one important item in your financial toolbox. In addition to regularly checking your net worth, you should also do budget analysis, have a tracking software, and have a financial plan in place that incorporates short-term and long-term financial goals like buying a home and retirement. Make a budget to accomplish these goals and utilize net worth checkups to make sure you’re on track to meet them.
You should have in mind that even though net worth is still a valuable indicator, it will not give you the concrete information that you will need to fully assess your financial situation. Someone who has a lot of low-interest student loan debt, for instance, may be in a far better financial situation than someone with half as much high interest credit card debt, though their relative net worths may indicate otherwise.