What Does Net Worth Mean?
The term net worth may envision thoughts of multi-millionaires or real estate moguls — bigwigs rolling in big money. However, net worth applies to everyone, whether you have millions or much less. You may own a home or car or have some savings in your bank. You may even arrive at a substantial figure when you add it all up. But to truly understand your net worth, you must deduct what you owe. Net worth is the bigger picture of your overall financial health.
Learn what net worth means, how to calculate it, why it’s important, and how you can track it.
What Does Net Worth Mean?
Net worth is the dollar amount you’ll have left if you sell all of your assets for their current market value and settle all of your debts in full. Individuals, businesses, corporations, and even countries can have a net worth as long as they bring in money.
Net worth could either be positive or negative. Positive net worth is the most common scenario for individuals. It means that your assets are more than you owe, which could be in the form of real estate investments, retirement accounts, and high-value possessions like jewelry. On the flip side, negative net worth results if you owe more than the value of what you own. For example, if your utility bills, mortgage payments, auto loans, and student loans exceed what you own in cash and investments.
While negative net worth could signal a road to bankruptcy, this situation isn’t uncommon early in life when people have to juggle between student loans and maxed-out credit cards.
How to Calculate Net Worth
To calculate your net worth, you’ll need to piece together information regarding your assets and liabilities. Assets are the things you own that bear some monetary value, while liabilities are financial obligations to others, often in the form of debt.
Calculate your assets
To obtain your net worth, you’ll need to first determine the value of your assets. Here are the types of assets to consider.
- Large assets: Large assets often carry a higher monetary value. These include a home, real estate properties, vehicles, or boats. Business owners will need to conduct a valuation of their business, which may be more complicated. Value these large assets for their current market price.
- Liquid assets: Liquid assets are those that you can turn into cash quickly. These include savings accounts, checking accounts, certificates of deposit (CDs), cash, retirement accounts, or investments in brokerage accounts.
- Valuable possessions: Valuable personal items like jewelry, heirlooms, art, or coin collections also make up your net worth.
Once you list and value all items above, add them to obtain your total assets.
Calculate your liabilities
Liabilities are your financial obligations to others. These include:
- Major debt: Huge outstanding liabilities like a mortgage or auto loan make up your major debt. List them and provide their most current balances.
- Personal debt: Personal debt includes smaller financial obligations, such as credit card loans, student loans, or other forms of personal loans.
Add these balances to obtain your total liabilities.
To calculate your net worth, you’ll need to add your total assets and subtract your liabilities. The formula for computing net worth is:
Net Worth = Assets – Liabilities
If your computation returns a negative value, it means you owe more than you actually own. A positive result means your debt obligations are less, putting you in a decent financial position. For instance, if you have $306,000 worth of assets and owe $105,000 in debt, your current net worth is $201,000.
Why Is Net Worth Important?
Net worth is a crucial financial indicator in tracking your financial health and progress. Knowing it is important for two main reasons:
- It helps you understand your current financial situation.
- It provides a benchmark for assessing the progress toward your financial goals.
Knowing your net worth is important for determining whether you’re saving enough for your retirement, emergencies, or other financial goals. You’ll know whether you’re making progress, at a standstill, or falling behind your goals.
Ideally, your net worth will continue to grow as you earn and save. If you’re in the red, you may implement strategies to ensure you’re not lagging financially.
How to Track Your Net Worth
Your net worth will constantly change, so you’ll need to periodically review your assets and liabilities. A net worth statement is one of the tools that may help you track your net worth. It could be compared to a personal balance sheet that provides a snapshot of the dollar value of everything you own and owe.
You may prepare your net worth statement on a quarterly or annual basis, depending on what you feel will suffice. Ultimately, the goal is to know where you stand financially and be realistic with your expectations.
Keep Tabs on Your Net Worth
Ultimately, knowing your net worth may help complement your financial planning efforts. You can easily compute your net worth on your own or enlist a financial advisor for a more comprehensive snapshot of your financial health. Remember, your net worth differs from income since we don’t necessarily retain every dollar we earn.