Calculating Your Net Worth Is the First Step Towards Becoming Rich. Learn How to Do That Today.
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Just as a house must be built from its foundations, so must we first learn the basics of wealth to make sure we grow strong. Today, we’re looking at one of the most fundamental principles of wealth: NET WORTH, and how to calculate it.
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What’s Net Worth
Your net worth is a clear indicator of your financial health. It is the value of all assets minus the total of all liabilities. Put simple, is what you own minus what you owe. So the first step to learn what your net worth is, is to come up with a list of all your assets and one of all your liabilities.
List of Assets
Your assets is all that adds or can add value to your bank account. What you owe can go from the cash in your wallet to the furniture in your house. When you write down this list make sure to put in every single object that belongs to you. The list can include cash, savings and retirement accounts, the value of your home, car, boats, etc., insurance policies, business interests, and all personal belongings… yes, even the clothes you’re wearing!
Remember to consider the current market worth of your estates as well as of all those belongings which you could sell and not the price you paid them.
List of Liabilities
Be even more specific and precise here than you’ve been with your list of assets. Knowing exactly where your money goes is the first step to put your finances in order. Check out our video “10 Ways To Manage Your Money Better” if you need advice on this.
Here are some examples of what should appear in your list of liabilities: credit card balances, estimated tax owed, home mortgage loans, student loan, outstanding bills, etc.
The more detailed you are here, the easier it will be to understand how you are spending your money.
Do the Maths
Now that you have your lists ready, remember the formula to calculate your net worth:
ASSETS – LIABILITIES = NET WORTH
Add up all your assets and all your liabilities. Then, subtract your liabilities from your assets: that’s your net worth.
Let’s see a couple of examples:
a. You’re a new graduate with $1,000 in your savings, $10,000 in student loan debt and a part-time job that pays just enough to cover your monthly bills. You’re looking for a full-time gig so you can get on your feet. You have a student loan that has an APR of 4.65%.
Your assets: $1,000 cash savings
Your liabilities: $10,000 student loans
Net worth: -$9,000
b. You are a homeowner. Your home is worth $350,000 in the current market. You have $250,000 left to pay on your mortgage, and you have a credit card balance of $10,000. Your mortgage has an APR of 3.25% and your credit card charges 19.99%. You have $10,000 in cash savings and $30,000 in a 401(k). Your income is enough to pay all your bills, and you have $500 in discretionary cash left over each month.
Your assets: $10,000 cash savings; home valued at $350,000; $30,000 in retirement investments
Your liabilities: $10,000 credit card balance; $250,000 mortgage
Net worth: $130,000
If you want to know what some of the biggest liabilities of this century are, check out 15 Biggest Liabilities in the 21st Century.
Difference between Net Income and Net Worth
Do not confuse these two. Your net income is your what you’ve earned through your job after taxes and payroll deductions, such as social security and money you contribute to your 401(k). This is different from your net worth, which is the total value of everything you own, minus all your debts.
Liquid Net Worth
Liquid net worth is the portion of your net worth that could be easily converted to cash in a day if need be. Stock and bonds can be considered to be liquid assets. This is because you could dispose of the stock and bonds in your brokerage accounts and get paid within three days. Jewellery or property, on the other hand, are not considered to be liquid assets as they are harder to convert in immediately accessible money.
In an emergency or a situation where cash is needed quickly, liquid assets will be precious. Because liquid net worth only considers your liquid assets, your liquid net worth will be lower than your total net worth, which includes all assets.
Why Knowing Your Net Worth Is Important
As we said before, your net worth is the picture of how healthy your finances are. Let’s take Example A: it’s easy for a newly graduate to have a negative net worth. The school just finished and most likely you do not have a decent job yet. Still: knowing where you are today and where you need to put money in can help you create a budget to start paying off your debts and, if possible, start saving money.
Calculating your net worth is a useful exercise even if you are already well into your career. Perhaps you’ll find out you’re not saving enough for your retirement, or it’ll help you to decide what to invest in and how much you can invest.
Not knowing your net worth is like trying to get healthier without knowing how much junk food you’re ingesting. Assess your current situation first and decide how to move based on that.
How to Increase Your Net Worth
Many have calculated their net worth and come to the conclusion that it is in need of a revamp, yet improving it can seem very difficult. However, it only requires some willpower and a bit of patience.
Start by paying off your debts as soon as possible. Make extra payments where possible and work to reduce your overall debt burden.
Keep the money you have saved where it will grow. Your checking account should be lean enough for your regular spending and everything else should be in interest-bearing accounts. Even better, invest what you can. If you’re new to the investments world, we highly recommend J.C. Bogle’s “The Little Book of Common Sense Investing”. Thanks to our cooperation with Audible, you can get the audiobook for free. Just go to alux.com/freebook and sign up.
So, to wrap it up:
Knowing your net worth is like running a full check up of your finances. Not only will you know exactly what you owe and where you spend your money, you can use this knowledge to plan for the future and grow your net worth itself. Do not confuse net income with net worth, and make sure your liquid net worth is high enough to allow you to face unexpected expenses care-free.