What is your net worth?
Simply put, the net worth of a person is how much that person is worth in a single number, a dollar amount. This might sound harsh and cold, and it can be… Net worth shouldn’t be used to judge or compare two persons to one another. The net worth is just one more financial tool, and like most financial tools can be extremely useful if used right.
How to calculate your net worth
Calculating your net worth does not require any special skill. The formula is very simple. What might take a bit of time is to actually gather all the information you’ll need, but once you have that calculating your net worth will only be a matter of minutes.
The simplest way to calculate your net worth is:
Net worth = Assets – Liabilities
So you basically need to add up all your assets on one side, add all your liabilities on the other and subtract your liabilities from your assets. Easy right?
What is an asset?
An asset is anything you own which has a monetary value, or in other words anything you own that you could sell for money. Your house is an asset (if you own it), your can is an asset, your business is an asset if you are your own boss, even your furniture is an asset. As you can see just making a list of all your assets can be challenge by itself.
Once you’ve made a list of all your assets, calculating their value can be even harder. You need to remember the value of an asset is how much money you could get for it if you sold it right now, so its not you who sets the value of your assets, it’s the market who does. Try to be realistic. Most people tend to lie to themselves here factoring in sentimental value. Unfortunately sentimental value does not count towards your net worth. Even if you paid $3,000 for your couch a few years ago and you think it’s the best and it should still be worth at least $1,500 the truth is its only worth $300 if that’s what the market would be willing to pay for it.
With that in mind, there is not need to go crazy here if you are just calculating your net worth for personal use. If you want to know how much your house is worth g online and find a similar house for sale in the same neighborhood. If you want to know how much your car is worth, go online and look for your same car with similar mileage and see how much it sells for. If you have doubts about the value of a certain asset, try to stay on the conservative side.
What is a liability?
A liability is anything that would require you to pay money in order to liquidate. These are basically loans, which might come in the form of a mortgage, student loans, credit cards…
Liabilities are easy to calculate as somebody else has already done that for your, in most cases your bank.
How to use your net worth
After you listed all your assets and all your liabilities, calculated their value and applied the formula above you’ll get a number, this is your net worth.
Most people are surprised to find out their net worth is actually negative, which means they have more liabilities than assets. This can be worrying if you have been working for a few years now or if you have kids or other people depending on you, but it can be quite common for students who just graduated with sizable student loans to pay for.
We started this article saying the net worth is just a tool, not a ranking, and it’s important to remember that. There is no specific number above or below which your net worth is ok or not.
Your net worth can be a great tool to track your financial progress. Calculate your net worth every 6-12 months and see how you are doing compared to the previous calculation. If your net worth is growing every time you calculate it that’s a good sign. If it’s not you should ask yourself if there is a good reason for that (a medical emergency for example) and act accordingly if there isn’t.
Knowing your net worth, even if roughly, can also be useful to apply some common rules of thumb or make quick calculations. Imagine your net worth is $100K and you want to buy a car that’s $40K. Even if they offer you to pay it over a few years, do you really want to spend 40% of your net worth on a car? The final decision is up to you, but knowing your net worth can definitely help put that decision into perspective.