Net worth is one of those major financial terms that you hear about often, but many don’t have a clear understanding of what it is. Does it consist of savings? Income? What is net worth, really?
It’s one of my goals to make money as simple as possible, and net worth is one of those financial concepts you should have a firm grasp of. Whether you’re just getting started with tackling your finances or you’re a seasoned pro, you’ll end up using net worth often.
It’s a very handy tool to have on hand to get a quick idea of your finances. It doesn’t get into the nitty-gritty and sometimes doesn’t show the whole picture (more on that later). But, it’s useful to keep track of the basics while trying to reach a financial goal.
By now, you’re probably itching to know the lay of the land when it comes to what is net worth, so I’ll get on with the show! Below I’ll cover the basics of what net worth is and lead you through how you can calculate your own net worth.
What Does Net Worth Mean?
In financial terms, net worth is the difference between your assets and liabilities. This means that you take everything in your life that has financial value and subtract anything you are obligated to pay. Your resulting number would be your net worth.
It’s used as a quick snapshot to gauge your overall financial well-being. The higher the net worth, the better. This implies that they have relatively good finances and good credit. Lower net worth, however, implies that they don’t have financial security and lower credit.
This concept applies most often to individuals and companies but can also be used for sectors and even countries. In business, net worth is sometimes referred to as book value or shareholder’s equity. You may also hear the term high-net-worth individuals, which refers to those with extremely high net worth.
What is Net Worth Based On?
Net worth focuses on determining your assets and liabilities. Assets are anything that has monetary value. This can be direct cash like savings accounts or what’s in your wallet. It also includes things that could be sold for cash, like a house or car.
Liabilities are anything you’re obligated to pay back, like loans and mortgages. It doesn’t include your monthly bills like rent and utilities. The only instance is when you’re not up to date on these bills – then it would be considered debt.
Depending on whether you have more assets or liabilities, your net worth may be positive or negative. If you have more assets, you’ll end up with a positive net worth (yay!). However, for those with more liabilities than assets, the number will turn out negative.
Types of Net Worth
There are a few different kinds of net worth. So while tackling the question what is net worth, we’ll be focusing on how you can calculate your own personal net worth. But it’s important to know all the different types so you can make sure you are calculating correctly.
Personal Net Worth
Personal net worth will be our main focus for today. It calculates how much an individual has overall when you add up your assets and subtract your liabilities. If you were to sell off all your assets and pay off all your personal debt, anything remaining would be your net worth.
By the end of this post, you should have all the tools necessary to know your net worth!
When calculating personal net worth, you always look at the market value of your items. So even if you bought your car for $24,000, it might only be worth $15,000 as of today.
Business Net Worth
In general, business net worth is calculated the same as personal net worth by finding the total assets of a company minus the total liabilities. Unlike personal net worth, it doesn’t always use the current market values. When you hear of a balance sheet, this is the net worth statement.
The higher the net worth, the more financially healthy a company is considered. If a company has a rising net worth and is public, it usually means their stock prices will rise. Lenders will also look at a company’s net worth when giving out loans. Low or negative net worth may imply the inability to pay off loans.
What is Liquid Net Worth?
Another term you may hear is liquid net worth. This can be calculated by subtracting your liabilities from your liquid assets.
Liquid assets include anything that is considered cash or can readily turn into cash like savings accounts, mutual funds, stocks, bonds, etc. It doesn’t include anything that can’t immediately be turned into cash, like property, cars, or retirement accounts.
How to Find Your Net Worth
Now that you know what net worth is and the importance of it, it’s time to figure out what is my net worth. Here are the steps you need to follow to get a quick indication of your finances (AKA your net worth)!
Calculating Your Assets
Let’s begin with the fun part, everything you already own! Assets include your liquid cash (anything that can easily be converted to cash) and anything you could sell to make cash.
The easiest place to start is by looking at all your accounts and adding up their totals. This includes checking and saving accounts, your investment portfolio (mutual funds, stocks, bonds, etc.), retirement accounts like a 401(k), and cash you have on hand.
Next, you’ll add up your fixed assets which are anything you own that has cash value, such as buildings, cars, furniture, etc. Remember that you’re calculating the current market price of the item, not how much you purchased it for.
Technically speaking, everything you physically own could be considered a fixed asset. While you’re probably not going to add up every single book on the shelf or the sweaters in your closet, you might want to consider including expensive items such as jewelry and high-ticket electronics.
Calculating Your Liabilities
Not nearly as fun as calculating your assets, it’s time to figure out how much money you owe. This can include credit card debt, mortgages, student loans, personal loans (secured or unsecured), auto loans, unpaid taxes, payday loans, and more.
Most often, married or common-law couples combine their assets and liabilities and use this to calculate their combined net worth.
Example Net Worth
Once you have your total assets and total liabilities, you can now calculate your net worth. Simply subtract your liabilities from your assets to get your total net worth.
Here is an example to get you started:
- $300,000 House (current market value)
- $14,000 Mutual Funds
- $20,000 401(k)
Total assets = $334,000
- $210,000 Mortgage
- $10,000 Student Loans
- $4,000 Car Payment
Total liabilities = $224,000
[total assets] – [total liabilities] = net worth
[$334,000] – [$224,000] = $110,000
Of course, this is a very simple example, and yours will likely have plenty of more assets listed. But, it does show how basic of a concept net worth is and how you can calculate it with only paper, a pen, and a calculator.
What if I Have a Negative Net Worth?
A negative net worth occurs when you have more loans than assets. If you do see a negative number after calculating your net worth, first things first, don’t panic. For many people in the early stages of life, it’s very common to have a negative net worth.
For instance, if you have graduated college and have a high level of student loans, it doesn’t mean you’re financially irresponsible. Likewise, someone who has just purchased a home will suddenly find themselves with a large liability, a mortgage. Not all liabilities are created equal!
If you find your net worth increasing over time, then you’re in a good spot. The Federal Reserve reports that the average net worth for US households was $121,700. But for those between 65-74, that average doubles. So you can expect your net worth to only grow as you get older.
If you find that most of your liabilities fall under bad debt (credit cards, personal loans, etc.), then you need to focus on getting your debt paid off. The best way to improve net worth is by decreasing liabilities while your assets either remain the same or rise.
For those in debt, the best place to start is by sticking to a tough budget and figuring out which debt to tackle first. In some cases, you may even want to negotiate your debt. There’s a lot to paying off debt, and I have lots of budget recommendations listed on the site.
So, What is Net Worth, Really?
All in all, net worth is just a tool used by many to get a quick handle on someone’s finances. The higher the net worth, the better. However, it is not the be-all-end-all, as I mentioned above. There is such a thing as good debt, and some liabilities will turn into assets in the long run.
I hope this article has helped you answer that lingering question of what is net worth. If you have any other questions relating to net worth, feel free to leave them in the comments down below.
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