You hear about net worth all the time, but do you know yours? It's a simple calculation. And once you know the number, it's important to know why it matters, what affects it and how it will be used in your financial life.
What Is Net Worth?
Personal net worth is a straightforward calculation: add up what you own (assets) and subtract what you owe (liabilities). Easy, right? Sure, it is, but first, you have to know exactly what you've got out there. Then, you can add it up and see if you have a negative net worth or a positive net worth.
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Adding Up Your Assets
The only way to get an accurate picture of your total assets is to make a detailed list of what you have and how much it is worth. There are several categories to consider:
- savings accounts
- checking accounts
- real estate
- home equity
- retirement savings and IRAs
- life insurance (whole life insurance)
- investment accounts
- mutual funds
Some of these are tricky. For instance, term life insurance, the type that only pays out after death, is not considered an asset. Whole life insurance, however, is an asset.
Consider also: Does Life Insurance Count in Net Worth Values?
Some of the things you own are considered "liquid assets" because they can be readily exchanged for their cash value. This includes things like savings and checking accounts, mutual funds, stocks and bonds, CDs and money market accounts.
Real estate, while a solid asset to have, is not considered liquid because the sale takes time and relies on market value. Collectibles, vehicles, jewelry and other personal property are also considered illiquid.
All of your assets count when adding up your personal net worth. Liquidity just gives you an idea of how much of your assets are quickly accessible, if needed.
Consider also: Examples of Personal Assets
Tallying Your Liabilities
Liabilities are your debts. When determining net worth, you'll need a detailed list of everything you owe every lender:
- credit card balances
- student loans
- auto loans
- personal loans
Add up the balances for all credit balances and loans to determine your total liability. If you need help tracking all of this, you can use a net worth calculator to help you put it all together.
While net worth doesn't directly impact your credit score, improving your net worth over time will also boost your credit score.
Calculating Your Personal Net Worth
Now you can put this all together on a balance sheet and subtract your total liabilities from the total value of your assets. This is your net worth. If it's a positive number, you have a positive net worth. If it's negative, you have a negative net worth.
This number isn't going to remain static, however. Net worth fluctuates over time as you pay down balances and take on new financial responsibilities. Your total net worth is a snapshot of your financial health at that moment in time. And it can help you see into – and plan for – your financial future.
Consider also: This Is Our Average Net Worth - And It's Grim
What Net Worth Means to You
Because your net worth gives insight into the health of your personal finances, you can guess who will use this information: lenders and financial planners.
If you want to take out a loan or mortgage, your lender is going to want as clear a picture of your financial situation as possible to figure out how much you can afford to pay back. If you are applying for a new credit card, the financial institution will use your net worth to determine your credit limit.
You can also use your net worth to help achieve financial goals. Putting together the balance sheet of assets and liabilities will help you see where you spend your money and help you plan to lower your debt.
Changing Your Net Worth
Your net worth will fluctuate over time, based on your financial activity. If you are paying into your retirement savings or emergency fund, while that may not be money on-hand, it is going toward a future goal of increasing your net worth.
Paying down a loan may shrink your savings for a time, but over time, you are limiting a liability. And, while net worth doesn't directly impact your credit score, improving your net worth over time will also boost your credit score.
Don't be afraid to sit down and do the calculations. Net worth is a tool for you. It is a metric you can use to monitor – and improve – your financial health.