Calculating your net worth can provide you with a personal financial report card for how you are doing at this point.
Net worth is calculated by subtracting all of your liabilities (what you owe) from your total assets (what you own). If your assets exceed your liabilities you have a positive net worth. If your liabilities are greater than your assets, you have a negative net worth.
Keep in mind, your net worth fluctuates throughout your adult life, responding to changes in your income, your saving and spending habits, and your family responsibilities.
It is helpful to calculate your net worth to figure out how you are doing financially today. But it's even more informative when you calculate it regularly and track it over time. You'll see trends in your financial situation, make better financial decisions, and figure out what you need to do to reach your short-term and long-term financial goals.
Key Takeaways
- Net worth is a measure of what you own minus what you owe.
- It's calculated by subtracting all of your liabilities from all of your assets.
- In addition to your home, key assets include investments, automobiles, collectibles, and jewelry.
- Tracking your net worth over time can help you adjust your saving and spending habits to stay on track to meet your long-term financial goals.
You can improve your net worth by increasing your assets, reducing your liabilities or a combination of the two.
Understanding Net Worth
Net worth is the difference between your assets and liabilities, calculated as:
Net Worth = Total Assets - Total Liabilities
Your liabilities are easy to quantify. You probably receive a reminder each month that states the exact amount of money you owe to each creditor.
It can be more challenging to determine accurate values for some of your assets. It is best to make conservative estimates to avoid inflating your net worth and giving yourself a false sense of financial security.
Your home is likely your most valuable asset and the value that you assign to it will have a great impact on your net worth calculation. A qualified real estate professional can give you an estimate of your home's value, or you can do your research using online real estate aggregators such as Trulia or Zillow. Look at the sales prices for recently sold, similar properties in your area. To be realistic, subtract the going commission, about 5%, to cover the future cost of selling the home.
Valuing Your Possessions
When in doubt, be honest and conservative in estimating the market value of any of your assets—including your home, vehicles, collectibles, furnishings, and jewelry. Be realistic about the condition of your assets, and try to base these figures on what you could sell each asset for now, rather than:
- How much you paid for it
- How much you wish it were worth
While any asset can boost your net worth, several large assets are likely to have a greater positive effect on your bottom line. These include your primary residence, vacation homes, rental properties, investments, and collectibles.
Your Primary Residence
Your house is probably your most valuable asset, and may simultaneously be your biggest liability. The more equity you have in your home, the more it will increase your net worth.
Keep in mind that when you determine your net worth, you must subtract your liabilities—including your mortgage. If your home is valued at $300,000 and you owe $200,000 on your mortgage, your home will effectively add $100,000 to your net worth ($300,000 - $200,000 = $100,000 equity). If you owe only $50,000 on that same home, the house will add $250,000 to your net worth ($300,000 - $50,000).
There is some controversy over the appropriateness of including your home in your net worth calculation. Proponents believe that your home is your most valuable asset and should be included. Opponents argue that your home is not part of your net worth because you're living in it rather than realizing its cash value, and even if you sold it you would have to replace it.
To appease both schools of thought, some individuals choose to create two net worth statements: one that includes the house, as both an asset and a liability if there is a mortgage, and one that leaves it out as an asset while still including it on the liability side of the equation if there is a mortgage.
Vacation Homes and Rental Properties
Second homes or rental properties can contribute substantially to net worth, ironically because they tend to be less expensive than primary homes. Buyers often pay all cash or take on a relatively small mortgage. If you rent out the property, it can even add a steady source of income on the plus side.
You won't have that income if you plan to use the property exclusively, but your net worth can still increase over time as you build equity in the home and, hopefully, it appreciates in value.
Because you will still have a place to live if you sell your vacation home or rental property, you can safely count it as an asset without worrying about the don't-count-your-home-as-an-asset school of thought.
Investments
The value of your investments in any tax-deferred retirement plan such as a 401(k), 403(b), or individual retirement account (IRA) can significantly increase your net worth over time.
Any other savings or investment accounts go on the plus side as well.
Most investments fluctuate in value over time, so it is important to reflect these changes in your periodic net worth calculations.
Note: taxes on these assets are contingent liabilities that should be included in the liability side of your net worth statement to provide a realistic view of your financial situation.
Art and Other Collectibles
The values of art and collectibles are fickle, to say the least. They also are hard to pin down.
If you own art or collectibles that may be valuable, it pays to seek professional appraisals. In fact, getting a new appraisal every few years is a good idea since values change so radically.
The appraisal also will alert you to the need for adequate insurance against losses. Your homeowner's insurance policy may not cover art and other collectibles without a specific rider.
Should I Include My Car in My Net Worth?
Your car is definitely an asset. Don't forget, any money you owe on it is a liability.
If you're tracking your net worth over time, make sure you reduce your car's value every year to account for depreciation. A source like Kelley's Blue Book can pinpoint the current market price of the vehicle.
What Is Liquid Net Worth?
Your liquid net worth is the amount of cash that you would have if you sold every asset that you could sell and paid off any debts.
Your liquid net worth is probably less than your net worth. For instance, your home is not a liquid asset because you need it to live in. Your retirement account balance is not a liquid asset, at least until you're at least 59.5 years old.
How Often Should I Calculate My Net Worth?
A yearly calculation of your net worth is a good idea.
Tracking the numbers from year to year can give you the satisfaction of seeing your long-term savings grow over time. Hopefully, you'll see your home's value appreciate and the amount on your mortgage decline.
You'll also see where you would be wise to make some adjustments. If you see your liabilities growing from year to year, you might consider making some changes.
The Bottom Line
Your net worth is simply the sum total of all of your assets minus your liabilities. It's a useful figure to know. It's even more useful to track it from year to year to see whether you're on the road to achieving your long-term financial goals.
