You're probably aware of the importance of your credit score and the effect it can have on interest rates for loans and premiums for insurance. And you are also aware that it's a good idea to keep your credit card debt at a low amount to avoid paying high interest charges. But these financial concerns are only a few of the factors that determine your overall financial health.
The metric that brings everything together is your personal net worth. Here's how to find your personal net worth and how to use it to improve your personal finances.
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What Is Net Worth?
Your net worth is a financial gauge of your success. It shows how well you have managed your finances and if you are improving your financial health. If you're managing your finances properly, your net worth should be increasing each year. The more net worth you have, the wealthier you are. Net worth is a picture of your financial condition.
Net worth is simply the figure that remains after subtracting all your liabilities from the total value of your assets. If the value of your assets exceeds your total liabilities, you have a positive net worth. That's good. However, if your total liabilities exceed the value of your assets, you will have a negative net worth. That's not good, and you need to have a plan to make improvements. You need to know your net worth to understand what kind of financial situation you're in so you can plan for the future.
Wealth is not measured by how much money you make; it's how much money you keep. Having a positive net worth is something you can be proud of.
What’s Included in Assets?
The following are examples of personal assets:
- Bank accounts – checking account and savings
- Investments – stocks, bonds, mutual funds and brokerage accounts
- Retirement funds – traditional IRAs, Roth IRAs and 401(k) plan
- Real estate – market value of your personal residence and rental properties
- Emergency fund
- Personal items – cars, jewelry, art and collectibles
- Life insurance – whole life insurance policy that builds up cash value
Consider also: Investing in Stocks for Beginners: How to Start Investing
What Are Liabilities?
Liabilities are debts and obligations such as:
- Loans – car loans and personal loans
- Credit cards – revolving credit lines
- Mortgages – loans on personal residence and other investment real estate properties
- Student loan debt
Consider also: First Steps for Getting Out of Debt
Your personal net worth is an indication of how well you've managed your finances and how wealthy you are.
How Can You Improve Your Net Worth?
You should do a net worth calculation on a quarterly or annual basis to make sure you're headed in the right direction and are building wealth. Develop a plan to increase your net worth every year by concentrating on the following areas.
Pay off debts – Make a plan to start paying down your debts, beginning with your credit cards with the highest interest rates. Each dollar you pay down on your debt will increase your net worth by a dollar.
Control your spending – Always spend less than you make. Review your expenses and make a budget to find areas to cut back wherever you can. Use the savings to pay down debt and add to your investments and savings accounts.
Invest in assets that will increase in value – Put your money in investments that will grow and where you can take advantage of compound interest returns. Cars are depreciating assets and lose value over time.
Contribute the maximum to retirement accounts – Return on investments in retirement plans accumulate tax-free and postpone taxable income until your retirement years when you may be in a lower tax bracket. You should contribute the maximum to these plans. In addition, many employers offer matching funds in their 401(k) plans, and it makes sense to take full advantage of this opportunity.