What is Your Net Worth and Why is It Important?
Net worth is a commonly-used measurement of wealth, but what does it really measure and why should you care? There is no one “right” net worth. Even the idea of a “good” net worth varies widely from person to person. But, tracking your net worth over time can be a powerful method for evaluating your financial health.
What does my net worth include?
The calculation of your net worth includes both your assets and your liabilities. Your assets are anything owned that has monetary value. This includes checking and savings account balances, property values for real estate (including your home), and the market value of any cars, boats, collectibles, or other valuable possessions. Also included in your assets are the value of your investment accounts, including taxable accounts and retirement accounts, such as Individual Retirement Accounts (IRAs) and 401(k)s.
Also included in your net worth are liabilities. Liabilities are also known as debts. Your liabilities include any amount you owe on mortgages, car loans, student loans, and personal loans. Your liabilities also include any outstanding credit card balances.
How do I calculate my net worth?
You calculate your net worth by adding the dollar amount of all of your assets and subtracting the dollar amount of any liabilities. When you have more assets than liabilities, you have a positive net worth. When you have more liabilities than assets, you have a negative net worth.
Having a negative net worth sounds like a major problem. But it is a natural and expected stage for many people just starting their financial journey. Not all debt is bad. If your net worth is negative because of student loans or a mortgage (with monthly payments that are within your means), then having a negative net worth is not necessarily a sign of poor financial health. However, if you have a negative net worth due to credit card debt, or if you have a negative net worth as you are nearing retirement, it may be cause for concern.
What does my net worth mean?
Because everyone’s financial situation is unique, your net worth doesn’t mean much on its own. But, tracking your net worth over time can be a useful indication of your financial health. The rate at which your net worth is increasing can be a good hint of the pace at which you are working toward your financial goals, and can help give you a clue as to whether or not your goals are realistically achievable.
If your net worth is decreasing, you may need to make changes in order to make your financial plan work. A decreasing net worth may indicate that you need to reevaluate your savings rate, spending habits, investment choices, or all three.
What is liquid net worth?
One common type of net worth is liquid net worth. Liquid net worth is a measurement of the amount of wealth you can access quickly, if needed. You calculate your liquid net worth by adding the dollar amount of all of your cash and cash equivalents and subtracting the dollar amount of any liabilities. Cash equivalents are assets that can be easily converted into cash, such as treasury bills or notes, certificates of deposit (CDs), money market funds, and investments held in taxable accounts. The value of real estate holdings, automobiles, boats, or other valuable possessions, and retirement accounts, are excluded when calculating your liquid net worth.
What does my liquid net worth mean?
Liquid net worth is an important measurement of your current financial stability, because it shows how much money you have available for unexpected events, such as the loss of a job, an unanticipated home or auto repair, or a medical emergency.
Even financially savvy individuals can be surprised by how much lower their liquid net worth is than their net worth. Individuals who use their assets to save for retirement, pay off their debts, or purchase valuable property are improving their net worth, but not their liquid net worth. In fact, using extra cash flow in these ways can decrease your liquid net worth.
The tendency to confuse net worth and liquid net worth, or to prioritize building your net worth at the expense of your liquid net worth, is one of the reasons that it is critical to have a dedicated emergency fund. After you are properly prepared for life’s unexpected expenses, you can confidently work to increase your net worth, with less concern for your liquid net worth.
Why is it important to know my net worth?
Your net worth provides a high-level overview of your present financial situation. Put simply, it tells you how much you own minus how much you owe. Without any context, the calculation of your net worth really isn’t important - it’s just number. But, when your net worth is calculated and recorded through time, it becomes a valuable measurement of progress. Aside from the early years of adulthood, when you are likely to take on student loans or your first mortgage, your net worth should increase over time. After those early years, a decreasing net worth is a red flag, indicating that your finances need a closer look.
Final Thoughts
We can’t tell you what your net worth should be – because a “good” net worth will be different to everyone reading this article. But, we can tell you that it’s important to understand your net worth, as well as your liquid net worth. Tracking your net worth year-over-year, can help paint a picture of your financial health over time. It can help assure you that you are on the right track, or persuade you to make necessary changes. Knowing your liquid net worth can help you be confident that you are ready to face life’s unknowns.
If you’d like help calculating and evaluating your net worth, reach out to your Affiance Financial Planner today.
Please remember, there can be no assurance that the content made reference to directly or indirectly in this article will be profitable, or suitable for your individual situation, or prove successful. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized advice from Affiance Financial. Please remember to contact Affiance Financial if there are any changes in your personal/financial situation or investment objectives.
Sources: https://www.investopedia.com/articles/pf/13/importance-of-knowing-your-net-worth.asp
