The best way to measure a person’s financial health is through knowing what is your net worth. But, how do you have a good net worth?
If you have a good net worth, you have more money and assets than debts. Knowing your net worth will help you stay out of debt as well.
Although it doesn’t sound the most important, it plays a big role in knowing the status of your financial health.
By keeping track of your net worth, you’ll be able to identify the progress you make when it comes to both saving and paying off debts.
It is an important factor to consider to know whether or not your wealth is bringing you to the right direction.
What is Net Worth?
Net worth measures the value of what you own minus what you owe or your liabilities.
Assets refer to anything you own or have owned that has monetary value such as your home or cars. On the other hand, liabilities are what you owe in debt. This includes auto loans, mortgage, and the like.
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Given this, it determines what you would have left if you were to sell all your assets to pay all your debts. While this doesn’t have a literal meaning, through identifying this it lets you see how financially well-off you are. If your net worth is positive, it means that your assets exceeds your liabilities. Having a negative net worth would then mean the opposite, wherein your liabilities are greater than your assets.
Keeping your net worth in check allows you to see if you’re spending your money the right way. It gives you the ability to identify if the financial moves you make will affect your net worth in a good way, rather than make it worse.
What Does Net Worth Mean
Net worth is defined as the measure of wealth a certain entity, person, or company has.
Although net worth does not rely on your income. In fact, income barely has anything to do with identifying net worth. It focuses more on the savings, debts, and physical assets.
It provides you with a summary of your current financial status.
This includes everything you have spent on and earned, as well as their end results.
For example:
Assume your assets in total is worth $100,000 and your liabilities is worth $40,000, your net worth would be $60,000.
This is already a great thing because your assets are more than enough to cover for your debts.
If you were to gain more assets after a year and now have a total of $180,000 and a consistent debt of $40,000, then your net worth increases to $140,000 –which is a positive outcome.
Why Your Net Worth is Important
Your net worth has much more significance than it may appear.
It is one of the most accurate ways to measure your wealth, which refers to the amount of money left after paying off all your debt. If you’re aiming to have sustainable wealth in the future, your net worth will be able to determine what changes you should make in order to achieve this.
Tracking your financial progress also helps in identifying where to make adjustments to be able to live financially stable. Through this, you’ll know if you’re net worth is growing.
The growth of your net worth highly reflects your financial status. Unlike other aspects, this doesn’t rely on the increase of income. Regardless of whether you’re making more money or not, if you’re net worth is declining or unchanging, your financial situation isn’t improving in any way.
Net worth also focuses more on actual wealth rather than physical assets. Typically, this is what helps differentiate the rich vs wealthy. If someone had around $300,000 worth of assets but $260,000 worth of debt, it doesn’t make them any wealthier than a person who has $200,000 worth of assets and only $50,000 worth of debt.
The former has $40,000 in net worth and the latter has $50,000 in net worth.
Looking at it that way, someone with more assets to offset their debt is able to achieve financial freedom sooner than someone whose assets are almost equal to the amount they owe.
What Determines Your Net Worth
Both your assets and your liabilities play an important role in determining your net worth.
Some may assume they are living well-off when they add up all the assets they currently have. But financial stability doesn’t rely on what you can afford, it is dependent on your financial strength by having more assets than liabilities.
When you have a negative net worth, it may be a cause of borrowing more than what you need. Over time you will go deeper into debt than you ever thought you could.
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Stacking up your bills can put more weight on your liabilities. If you do not pay off your bills, they hurt your net worth. Although paying off debt isn’t the only thing that can help you to increase your net worth by increasing your assets and decreasing your liabilities.
Another way to make them equal is to borrow only the amount that is necessary. With less debts to pay, there would be no need to put more money towards paying them off.
Keep in mind that every time debts get smaller, whether by paying them off or borrowing less, or every time assets increase in value, your net worth will grow.
Likewise, if you take more debt with no valuable asset to show for it, your net worth goes down.
How to Calculate Net Worth
Calculating net worth isn’t as complicated as it may sound. Although it will require you to gather all the information on your current assets and liabilities which is typically a lot of work. The data should be up-to-date to ensure the results reflect your current financial status.
The formula for calculating net worth would look a lot like: Assets – Liabilities = Net Worth.
A more detailed step-by-step process would be like this:
List down all your assets.
Large physical assets such as homes, real estate properties, and cars or other vehicles are part of the calculation. As well as savings, checking balances, retirement savings, bonds and stocks.
Personal items can be considered as long as they have a certain value. Anything over $500 could be a starting point or items like valuable jewelry, musical instruments, rare wine collections, and the like.
Take note of their value using accurate estimates of market values. Add all of these together; the total number is what represents your total assets.
List down all your debts.
Similar to the first calculation, start by taking note of the largest liabilities you have. List the most current balance you have for these loans, such as auto loans and mortgage.
Include the balance on other personal debt like student loans, credit card debt, or other personal loans you may have.
After adding all these together, you will have a total number to represent your total liabilities.
Subtract both totals.
With both totals, subtract the total liabilities from the total assets.
Net Worth Calculation Example:
After gathering sufficient date, you found that your total assets is equal to $289,000 and your total liabilities is $190,500.
To compute for the net worth, you have to find their difference.
If $289,000 – $190,500 then your net worth is $98,500.
The number doesn’t necessarily have to be completely accurate, down to the last peny., It is still significant to take note of it to make comparisons in the future of how your net worth fluctuates up and down.
By repeating this every year or more often, you will be able to differentiate and determine whether you’re making progress positively or not.
What is Your Liquid Net Worth?
Most people tend to think that their liquid net worth refers to the money they have in their savings account. Although this is one of the factors, your liquid net worth is more than just the money you have on-hand.
Liquid net worth refers to the part of your net worth that can easily be turned into cash.
Despite being almost completely identical to your estimated net worth, this doesn’t count assets that cannot be readily converted to cash.
The assets that fall under this category should be available to take out; such as investments, stocks, and the like. Cars and properties are assets, but these take more time to liquidate therefore they aren’t part of the calculation for liquid net worth.
Even when you constantly keep track of your estimated net worth, it isn’t enough to evaluate your financial security. Your liquid net worth helps you identify whether or not you will be able to make it through situations that require you to take out a big sum of money.
To make it simple, your liquid assets can serve as an emergency fund where you can have access to cash within a couple days.
This is generally useful to know what your liquid net worth is, especially for scenarios wherein you are required to pay for a large amount as soon as possible.
Why You Should Know Your Net Worth
Some people might not find it the most necessary to keep track of their financial progress when they aren’t going through any problems with finance. However, if they were to encounter a major problem financially, they are likely to end up making rash decisions that may affect their financial future negatively.
Knowing your net worth does more than merely keep track of progress. It also lets you adjust accordingly in a way that would yield you better results.
Having the freedom to make wiser decisions assures you of how your future may end up, regardless of your current financial situation. Through your net worth, you’re able to see what direction your finance is heading. Although this is a fixed value, it can increase depending on the choices that you make.
Familiarizing yourself with your net worth may make you cautious of where you spend your money. This is one way to improve your net worth.
Spending on small things like clothes and the like is a normal occurrence, but not when it’s excessive. The number of designer brands you own won’t make you any wealthier, especially if these assets won’t cover for the debt that you owe.
Don’t Have A Negative Net Worth
If your net worth is at a negative, it should get you to start paying off debts and start buying assets. This doesn’t mean using all your money and reserves to pay them off. It simply refers to making debt repayment a higher priority. While it would be best to simply put more effort into paying them off, another way to grow your net worth is by gaining more assets.
Although these choices have consequences if acted upon too quickly.
Whether the result is a positive or negative, your net worth is something you have control over. The decisions you make should bring you more sure benefits, rather than more risks.
By knowing your net worth, you are allowing yourself to be more mindful of your financial activities.
Therefore preparing you for bigger decisions that will greatly affect your status, as well as help you achieve more of your goals.