September 18, 2020
In the simplest terms, your net worth is everything you own minus everything you owe. This definition can help you frame the idea of personal net worth in your mind and is one that you can always come back to if you feel lost amidst all the financial nuances and rules that you might hear from financial experts.
In financial terms, net worth is assets minus liabilities (we’ll go over some of these definitions below). While not perfect, net worth can be a quick indicator of financial health. Having more assets than liabilities means that a business or individual has enough resources to pay off all their obligations and debt—it’s almost always better to have more assets than liabilities.
Let’s start by defining the terms: assets, liabilities, and net worth.
Your assets aren’t just what you have in the bank, they are everything you own that has a monetary value. This includes property, pensions, stocks and bonds, but also some less obvious stuff. Anything you own that you could sell for a fair value technically counts as an asset. A rare board game, comic book collection, a piece of art, or a signed classic could all be classified as assets.
We should note, however, that it is not a good idea to invest in “stuff” such as handbags or cars in hopes that they will pay off multiples in the future. No one can predict which brand or company will be a worthwhile investment in the future, and anyone saying otherwise may just be interested in making themselves money in the present.
Outside of traditional accounting, the definition of assets opens up quite a bit. It could be argued that skills, your time, and a personal brand are also assets. For a net worth calculation though, it’s best to stick to tangible assets that you already currently own.
Make a list of your largest assets. Most people include their home (if they don’t rent), vehicles like cars or boats, businesses, other real estate properties or land. When listing the values of the assets, try to err on the side of the conservative estimate. It might make you feel better to inflate the values a little bit, but doing so puts you in danger of making decisions based on inaccurate data. Most people use market or resale values to price their assets. For example, if you bought your car for $15,000 but you could only sell it tomorrow at a price of $11,000, you might be better off using $11,000 as the value of your car.
The next part might be easier or difficult based on your past record keeping. Log into all your banking, investment, and retirement accounts to download the latest statements. This would also be a good time to update your passwords and printed records as needed. Record your current balances as part of your assets.
Lastly, you might want to list other non-conventional assets. Fine jewelry, for example, and the realized value of any insurance policies that are available to you are some of the more common ones. Try listing assets that are worth $500 or more.
Now, take all of the assets you have listed and add them up. This number represents your total assets.
The word “liabilities” sounds a little scary, but odds are you have a pretty good idea what your liabilities are already. These are any enforceable debts and financial obligations you are responsible for. That said, the categories probably sound familiar: credit cards, student loans, mortgages, car loans, and rent payments.
For the purpose of calculating a net worth, only consider actual debt that you have (money that you have borrowed or money you haven’t paid for services/goods you have already bought). For example, even if you know you’re going to have to buy a new laptop next year and you even know how much it’ll cost, it’s technically not a liability because it’s not a present enforceable financial obligation. If you end up buying the laptop tomorrow instead and pay for it using your credit card, your credit card debt will be included in your liability calculation.
Again, start with the major outstanding liabilities such as the balance on your mortgage or car loans (wait, aren’t cars and houses assets? This might be a bit confusing, so do read the next section). List these loans and their most current balances.
Next, list all your personal debt such as any balance on your credit cards, student loans, medical debt, or any other debt you may owe.
Now, add up the balances on all the liabilities you have listed. This number represents your total liabilities.
Like we mentioned, there are a few things that could be an asset and a liability at the same time. The most common case of this is a mortgaged property, so let’s look at an example:
Let’s say you own a house that is valued at $500,000 and you have a mortgage on that house that is $400,000. In this example, you should add the full $500,000 to your assets calculation and the $400,000 to your liabilities calculation (each should be its own line item). The total impact to your net worth calculation will be $100,000.
It is worthwhile pointing out that sometimes you can be “upside down” on an investment, which means you owe more on the asset than the value of it. For example, say your car is valued at $15,000 currently. If you bought the car by financing it on monthly payments for 5 years, the total amount you’re responsible for paying back with interest could be $17,000. In this case, the total impact to your net worth would be -$2,000.
Now that you know the types of assets and liabilities that should be included in a net worth calculation, let’s go over what a net worth figure means and why calculating your net worth can be a good idea.
The word “net,” simply means “after subtracting expenses and debts.” In the financial world, net worth is synonymous with shareholders’ equity—what the shareholders of a company are left with after all the debts and liabilities are accounted for. Taking a financial term meant for the corporate world and applying it to your finances can be a little tricky, so its best to consider your financial picture holistically.
To calculate your net worth, simply subtract the total liabilities from the total assets. For individuals, it doesn’t matter how big or how small the number. The number can even be negative, depending on where someone is in their financial journey. Your net worth is just a starting point to have something to compare against in the future.
You might have a negative net worth because you invested in yourself by going for higher education or starting a business that will significantly increase your income over the course of your life. That doesn’t mean your financial health is bad—if this was the case no one would use their money to better their life. This just means your investment in yourself hasn’t yet paid off in a way that’s easily quantifiable.
Comparing your number to others will most likely not yield any useful or actionable conclusions. But if you repeat this process at least once a year and compare your progress year over year, you can track your financial journey over time. A consistent increase in net worth indicates that your assets are increasing at a greater rate than your debts, indicating progress on your financial goals.