What Is Your Net Worth?
Net worth is one of those terms that gets tossed around a lot, but is often misunderstood. While many people assume that a big house, a nice car, and designer clothes are signs of wealth, they aren’t always signs of signs of net worth. This is because the net worth equation has two sides: one is assets, and the other is debt. The fact that many of us are so out of touch with this number is a shame, because unlike the external indicators of affluence that we tend to notice, net worth is probably the best indicator of how well we’re doing financially and the best way to track our progress over time. (See also: The First Step to Budgeting)
Want to learn how to calculate this magic number? It’s easy, and it all starts by adding up what you own and what you owe.
What You Own
This is the side of the net worth equation that everyone loves to add up — your mountain of gold. The assets side of your net worth includes everything of value that you own, including your home, your car, your savings and investments, and even valuable items such as jewelry. But in estimating the values of these items, remember that net worth is designed to provide a financial snapshot of your life right now. This means that you don’t enter how much you paid for your home when you bought it, but how much you could sell it for if you stuck a For Sale sign in the front lawn today. The same goes for your car. You might have paid $20,000 for it, but if that was a few years ago, pull out the Kelley Blue Book and find out what it’s worth now. When it comes to other assets like jewelry, be very conservative. After all, if you would never, ever sell grandma’s heirloom diamond wedding ring; its value is mostly sentimental.
So, for example, your assets might look like this:
- House: $375,000
- Car: $10,000
- Savings account: $5,000
- Retirement savings: $12,000
- Collection of Vintage Cookie Jars: $500
Add up the values of all the things you own. Tada! These are your assets. In this example, they add up to $402,500.
What You Owe
If you own a home and a car and have been doing some saving, perhaps you’ve added up what looks like a nice fat number. But here’s where things get a little tricky, because for many of us, there’s a still a mortgage on that house, a loan on your car, and a balance on your credit card. So, the next step in determining your net worth is to add up those debts. Remember how you had to calculate your assets based on what they’re worth today? Well, the same goes for your debts, except that you’ll be adding up how much you still owe. For the hypothetical person above, the debt side of the equation might look something like this:
- Balance Remaining on the Mortgage: $281,250
- Outstanding Car Loan: $6,000
- Credit Card Balance: $5,000
Now it’s time to add up your debts, or liabilities as they’re often called in the world of finance. In this example, they add up to $292,250.
The Bottom Line
Once you have your assets and liabilities, all that remains is to subtract what you owe from what you own. For our example here, this person’s net worth would be $110,250 ($402,500 - $292,250). The difference between your assets and your net worth should shift over time. When you’re starting out your career and buying your first car and home, your worth is likely to be very low. If you’re at this stage in your life, you should be looking to increase that number a little bit each year by saving, investing, and paying down your debts. I say should, because this isn’t the route a lot of people ultimately choose.
What If Your Net Worth’s Negative?
Having a negative net worth isn’t necessarily a bad thing. As I mentioned above, it’s fairly normal for a young person to have a negative ratio, especially if they’re working to pay down a mortgage, a car, and perhaps student loans. For most people, paying down those debts will be a huge factor in growing their net worth.
The big reason why net worth is considered important at all is that it’s a way to create financial security for retirement, when you may no longer be able to earn as much (or any) income. Retiring with a negative net worth is not a good scene, because when you’re living on a fixed (and probably limited income), that debt repayment will have to come right out of your lifestyle.
Have you ever heard that old story about Donald Trump? At one point in his career, he pointed out a homeless man on the street and claimed the man was wealthier than the real estate tycoon himself, who had fallen $1 billion into debt. Net worth is an excellent indicator of your financial position, but what many people fail to understand — and what Trump so clearly did — is that if you have $1 billion in assets and are $1 billion in debt, you essentially have nothing.