Understanding net worth is relatively simple. Your net worth will be all of your assets (both financial and non-financial/) minus your liabilities. Why do you need to know your net worth at any given time? For many people, it shows them where they stand as far as their overall financial health, and also, understanding net worth helps them make critical decisions in their life moving forward. In this article, we take a closer look at the concept of net worth and how to calculate it.
What Is Net Worth?
As mentioned, it constitutes the total of all assets minus the liabilities you have. So, for instance, you’d factor in the value of your home, vehicles, jewelry, available cash, retirement accounts, anything of this nature, and then you will subtract out all of the liabilities and debts you have. Such might include mortgages, personal loans, student loans, car loans, and so forth.
In theory, your net worth is the cash value that would be assigned if you took everything you owned and sold it and then used the proceeds to pay off all remaining debt/loan mortgages. In some cases, for some people, this number might be harmful. Net worth isn’t necessarily always positive. For example, those just starting on their own recently having graduated from college are just beginning in their careers and thus may have more debt than assets to their name. This then would likely result in negative net worth.
That said, this net worth number should be used as a starting point. Hopefully, over time, you will see this number start to improve and grow. Use your net worth calculation to gauge your progress through the years and thereby understand how you are managing financially.
Calculating Your Net Worth
The formula is a pretty simple one. As mentioned earlier, you add up all assets and then subtract all liabilities. However, the tricky part is making sure that you include all assets and all liabilities. Especially if you have several investments, many tangible assets, and by the same token, a few different debts, ensuring you include everything can take some time and organization.
However, once you gather all of the relevant information, you will have it moving forward. You update/add to the list each year and keep track of the overall progress of that number. What is included as far as assets and liabilities, and how exactly do you factor in some non-cash items? Below we break down each category you need to have when calculating net worth.
Start with the more significant, more obvious assets that you have. Your house, any other real estate holdings, vehicles, to include boats, RVs, and the like. You will list all of these assets out and then figure out the market value of each. If you are self-employed, you will also have the total value of your business in your asset column.
After listing out the more critical tangible items you have, you will want to gather information on all cash and liquid assets you currently have. Such would include stocks, retirement funds, CDs, and any investments of this nature.
You also may have some valuable items but don’t necessarily fall into either of the above categories. For example, this may include jewelry, art, coin collections, antiques, and family heirlooms of value. Essentially if something is valued over $500, you would likely have this in your assets when calculating net worth.
The easy part then is adding all of the above items and respective values together—this is how you will arrive at the value of your total assets.
Much like calculating your asset value, you will start with more significant debts. Things such as mortgages, car loans, student loans, more enormous credit card debts would fall into this category.
Then you will note all of your smaller, personal debts and applicable loans in the liability column.
Finally, as with the assets, you will add all outstanding debts, loans, and mortgages. The resulting number is the total liabilities that you have.
Once you know your total assets and total liabilities, you have all you need to calculate them. Next, it is a simple subtraction—the liabilities form your asset value. Again, the number may be harmful if your debts exceed your assets. This gives you a starting point to work from as you track your progress and improve that net worth over the next few years. Ideally, you will do this process once a year and thus compare numbers from one year to the next. If you don’t notice progress, then perhaps it is time to make some changes in your budgeting, investing strategy, loan payoff approach, among other things you can do to improve your net worth.
The Bottom Line…
One thing when it comes to calculating net worth is to be conservative. In other words, don’t overinflate the value of the assets that you hold. Make sure they are in line with current market values, otherwise you are only creating an unrealistic net worth valuation. And again, by tracking your net worth from year to year you can get a better sense of where you may need to make some adjustments. Maybe you have more money than you could put toward debt repayment, or perhaps invest more into a savings or retirement account. The key is to make smart decisions and thus increase your overall net worth as you progress in your life and career.
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