Does Your Net Worth Even Matter?

By Matt Bell on 17 May 2017 0 comments

Do you know your net worth? That's how much is left after subtracting your liabilities from the total value of your cash and assets.

At first glance, figuring out how much you're worth may seem pointless. You're probably not going to bump Warren Buffett or Bill Gates from their spots on any "World's Wealthiest People" list anytime soon. But no matter how much you earn, knowing your net worth is important.

Here are three reasons why monitoring your net worth can help you manage money better. (See also: 10 Ways to Increase Your Net Worth This Year)

1. Your net worth doesn't lie

In our culture, it's easy to convince ourselves that we're doing better with money than we actually are. We can finance nice cars, pay for the latest fashions with plastic, and even "buy" a more expensive home than we can realistically afford. But our net worth tells it like it is, and that can be a very helpful financial wake-up call.

In the personal finance classic, The Millionaire Next Door, authors Thomas Stanley and William Danko draw an important distinction between people who look wealthy but aren't (they call them "Big Hat, No Cattle"), and those who don't look wealthy but are (where the title of their book came from). If you're going to build wealth, it's far better to be in the latter group.

The concept of being unassumingly wealthy is also known as "stealth wealth," and it's a lifestyle worth striving for. People with "stealth wealth" maintain a high net worth by avoiding dumping their cash into shallow, depreciative purchases. Their modest approach to money management allows them to achieve such dreams as early retirement, entrepreneurship, traveling the world, and more.

After calculating your net worth, ask yourself: Do I look wealthier than I am, or am I wealthier than I look?

2. Your net worth shows whether you're making progress

To be sure, there are other ways to define your life and determine whether you're moving forward or backward. Tallying your net worth each year, however, and monitoring the trend that develops can be very helpful. If you're going to build a nest egg large enough to support your family in your later years, you need that trend to be moving in an upward direction.

Earning more each year and increasing your standard of living may make you feel like you're getting ahead, but an increase in your net worth will show if you actually are.

Of course, there will be occasional down years. The recession of 2007 to 2009 erased a lot of wealth, but those who didn't panic eventually recovered — and then some.

3. Your net worth helps you pinpoint financial issues

Each time you calculate your net worth (a natural time to do so is at the end of each year), don't just retain the bottom line number. Keep the components.

On the asset side, track the value of your home (Zillow will give you an estimate), your retirement savings, other savings, the value of your car(s), and other assets. Then look at changes within each asset.

With our household's retirement accounts, I don't just record the balance. I also record how much we contributed each year and how much our investments earned. How much we contribute is much more under our control than the returns we earn. I want to at least make sure we're doing our part. The earnings side is important as well. If you see year after year of meager returns, it's probably time to re-evaluate your investing process.

On the liabilities side, track how much you owe on your house and other debts, such as vehicle and student loans. This annual exercise will provide a helpful reminder to perhaps put more focus on getting out of debt or make sure you're on track to be mortgage-free at least by the time you retire.

The big picture

To a great degree, net worth is an "internal" metric. It's mostly about how you're doing now compared to how you were doing last year and the year before.

If you'd like more context, The Millionaire Next Door has an interesting way of defining "wealthy." Whereas many people think of someone who has a net worth of $1 million or more as wealthy, Stanley and Danko's definition created more of a level playing field for people across the spectra of age and income: multiply your age times your annual pretax household income, divide by 10, and then subtract any inherited wealth. That, they said, is what your net worth should be.

If you have significantly more than that, you have a low-consumption, high-wealth-building lifestyle and you're considered wealthy for someone of your age and income. If your net worth is significantly less than that, you're probably consuming too much of your income and investing too little. (See also: 6 Money Moves to Make If Your Net Worth Is Negative)

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