Net worth is defined as the difference between assets and liabilities. If you have more assets than liabilities, you have what’s referred to as positive net worth. But if your liabilities exceed your assets, you have a negative net worth. In a perfect world, if you sold off all your assets, you’d have that amount in cash at your disposal. And this figure would be indicative of your true net worth if you also paid off all your liabilities.
While this formula is often used to gauge financial health, it doesn’t always tell the full story. So before you crunch your numbers and turn into a ball of sorrow because your net worth isn’t pretty, take a step back and ponder a few things.
For starters, if you happen to own a home, car, boat, or any other big-ticket item, your net worth may not be an actual reflection of how you’re doing financially, particularly if you borrowed to make the purchases. Furthermore, student loans have their way of placing a huge dent in someone’s net worth or even making it negative, even if they’re earning a nice salary and making responsible financial decisions.
Why Your Net Worth Matters
So what’s the big deal about net worth? Regardless of where you are on your journey, taking the time to calculate your net worth can provide insight into what areas of your finances need the most attention to attain your goals. Analyzing your net worth can also help you prioritize financial goals by addressing issues that are most pressing and could have detrimental consequences for your finances if not resolved sooner than later.
In essence, you should be monitoring your net worth over time for fluctuations. Did it go up or down, and if so, why? Was it for a valid reason or did you get in over your head with consumer debt?
How to Calculate Your Net Worth
As mentioned earlier, your net worth is the monetary value of your assets minus liabilities. So, if the aggregate value of your assets is $150,000 and your liabilities are $50,000, you have a positive net worth of $100,000. But if the numbers are swapped, you have a negative net worth of $100,000.
Below is a breakdown of what items are classified as assets and liabilities:
Assets
These include:
- The market value of your home
- The market value of other properties you own
- The market value of automobiles or other motor vehicles you own
- Checking account balances
- Money market account balances
- Savings account balances
- Insurance policies that have a cash value
- Value of retirement accounts, including IRAs, Roth IRAs, 401(k)s, 403(b)s, and 457 plans
- Value of other investments, including stocks, bonds, commodities, and mutual funds
- Business assets and investments
- Other assets, including valuable personal property and collectibles (i.e. artwork, antiques, jewelry, furniture, and other household items)
Liabilities
- Mortgages (the aggregate sum of outstanding balances)
- Credit card balances
- Auto loan balances
- Student loan balances
- Personal loan balances
- Any other debts you may owe
How to Boost Your Net Worth
Ultimately, you want to continue climbing the income ladder while eliminating debt. Doing so will enable you to stash away more cash once the balances are eradicated and invest in income-producing assets. A combination of these actions will ensure your net worth continues to grow. Some additional tips:
- Ask for a raise at work and maintain the same lifestyle while using the extra cash to invest or eliminate high-interest debt.
- Reduce your expenditures so you can save more and steer clear of debt.
- Launch a business and continuously reinvest the profits until you earn enough to pay yourself a salary and have the disposable income to invest in securities or real estate.
- Open an Individual or Roth IRA if you don’t yet have one
- Maximize your 401(k) contributions to take full advantage of your company’s match (or you’ll be leaving free money on the table).
This is not meant to be a comprehensive list but a few ideas to get you started on your journey towards increasing your net worth.
It’s important to understand that fluctuations in your net worth are not the end of the world, and could be an indicator of improvements in your financial health. Below are a few scenarios to illustrate why:
Scenario 1
You build your cash stash to cover 12 months of your expenses in the event you become unemployed. The next month, you get a 20 percent raise at work and decide to use half of your cushion to pay down your student loan balances. Furthermore, you will allocate all the money from your raise to the balances until the loans are paid in full. Initially, your net worth will take a hit but will bounce back nicely once the loans are gone and you start to rebuild your emergency fund.
Scenario 2
You turn your passion into a profit by selling handmade jewelry. Profits are around $1,000 each month but instead of saving the money, you use it to pay off credit card debt. And to ramp up your efforts, you decide to withdraw some money from your emergency fund, cut off a large chunk of retirement contributions, and use any disposable income from your job to put towards the credit card balances. While your assets may appear to have decreased for a bit, the change will be offset by the dwindling credit card balances.
The Bottom Line
Once you’ve computed an estimate of your net worth, sit down with a financial adviser to brainstorm the best course of action when moving forward. It’s also a good idea to monitor your net worth over time to gauge your financial progress.
