Net Worth
When we listen to the news or read articles about celebrities, occasionally the phrase “net worth” comes up. It makes sense that someone who is popular and widely known would be worth a lot, but how is that number calculated? Can someone who isn’t a celebrity have a high net worth? This phrase actually speaks more to how an individual lives with the money he or she has, rather than a popularity contest. In simple terms, net worth is the difference between what you own and what you owe. It takes a look at your assets (what you own) and compares it to your liabilities (what you owe).
Your net worth helps you know where you stand financially at this moment. While this figure is helpful—for example, it can provide a wake-up call if you are completely off track, or a “job-well-done” confirmation, if you are doing well—tracking your net worth over time offers a more meaningful view of your finances. Think of it as a progress report; if you know what you’re doing well and what can improve, it can help you figure out what you need to do in order to reach your financial goals.
Assets include investments, bank accounts, brokerage accounts, retirement funds, real estate, and personal items like your car or jewelry; liabilities include your mortgage, loans, credit card debt, student loans, and any other debt.
One of the challenges in calculating your net worth is assigning accurate values to all of your assets. It’s important to make conservative estimates; we want to avoid having an unrealistic view of your actual wealth. Although homes are often considered a main financial asset, there is some debate about whether they should be included for the purpose of calculating net worth. Some financial experts believe that the equity in your home and the market value of your home should be considered assets because these values can be converted to cash in the event of a sale. However, other experts feel that even if the homeowner did receive cash from the sale of the home, that cash would have to go toward the purchase or rental of another home. This essentially means that the cash received becomes a new liability—the cost of replacement housing. Of course, if the home being sold has more value than the replacement residence, part of the former home’s value can be considered an asset.
Your net worth can tell you many things. If the figure is negative, it means you owe more than you own. If the number is positive, you own more than you owe. Like the stock market, your net worth will fluctuate, but it is the overall trend that is important. Ideally, your net worth continues to grow as you age—as you pay down debt, build equity in your home, acquire more assets, and so forth. At some point, it is normal for your net worth to fall, as you begin to tap into your savings and investments for retirement income.
Knowing your net worth is important because it can help you identify areas where you spend too much money. Just because you can afford something doesn’t mean you have to buy it. To keep debt from accumulating unnecessarily, consider if something is a need or a want before you make a purchase. To reduce unnecessary spending and debt, your needs should represent the majority of spending. It can also help you make plans to pay down debt. For instance, you might be earning 1% interest in a money market account while paying off credit card debt at 12% interest. Crunch the numbers to see if it makes financial sense to pay down a certain debt, taking into consideration the impact of no longer having access to that cash in case of an emergency.
Once you’ve set your own financial goal and made plans to get there, having the knowledge of your net worth will be the map you need to stay on track!
