Net worth is the most important number in personal finance and represents your financial scorecard.
What Exactly Is Net Worth?
Net worth is what you own minus what you owe. Or, you can think of net worth as everything you own less all that you owe. “Net worth is what’s yours, really yours. First, add up the value of everything you own, then subtract the total amount of any debts that you have. What’s left is your net worth”, explained Robert LeFevre Jr., a certified public accountant and certified financial planner.
Calculating your net worth requires you to take an inventory of what you own, as well as your outstanding debt. And when we say own, we include assets that you may still be paying for, such as a car or a house. Start with what you own (assets): cash, retirement accounts, investment accounts, cars, real estate and anything else that you could sell for cash. Then subtract what you owe ( liabilities]: credit card debt, student loans, mortgages, auto loans and anything else you owe money on. Then boom—you’ve got your net worth.
The average net worth for U.S. families is $748,800. The median — a more representative measure — is $121,700, according to the Federal Reserve Board’s Survey of Consumer Finances.
Financial planners point out that the actual value of your net worth is less important than its growth over time. Tallying up your net worth every three to six months can help keep you on track and alert to potential problems.
Assessing Your Assets
Start with what you own — your assets. The biggest ones might be your home and your car. You will want to write down your best estimates of what these items would sell for today rather than their original purchase prices. Add in other big-ticket items you own — a motorboat, shop machinery, musical instruments, jewelry, art and any other objects worth $500 or more. Next, add in your financial assets, such as cash, bank accounts, certificates of deposit, brokerage accounts, individual retirement accounts and any other investments. The tally represents your total assets.
Listing Your Liabilities
Liabilities are what you owe. Start with your biggest debts first. Your mortgage balance and remaining student loans might top the list. You also may be paying off one or more vehicles. Next, add in your current balances for credit cards, revolving home improvement loans and other types of consumer debt. Finish up with any medical bills, liens, court judgments or back taxes that you currently owe. Figure the sum of all your liabilities, and then subtract it from your assets, giving you your net worth.
What the Number Means
Net worth is the value of the assets a person owns minus the liabilities they owe.
When it comes to net worth, it’s not the number, but rather what you do with it that matters most. If you have a negative net worth, you’ve already taken a great first step by identifying the problem. Net worth is one way to check your financial well-being and spot strengths and weaknesses.
By inspecting your debts, you can develop ideas to modify your spending habits. Your list of assets will help show you if you need to increase your savings and investments. Most of all, be realistic with your numbers — an accurate number is a lot more valuable than a “feel good” one.
Examine the trend of your net worth over time. If it’s not growing as fast as you would like, consider putting together a budget that will help get you moving in the right direction. The payoff will come when you find you have enough net worth to do the things that are important to you, such as traveling or engaging in hobbies that were once too expensive to afford.
There are many tactics you can use to build net worth. Start with a few basic steps:
- Choose a debt payoff strategy. Create a plan for shedding burdensome liabilities. We recommend paying down debts with the highest interest rates first, an approach known as the debt avalanche. Another option you may consider is debt consolidation: rolling multiple debts into one payment.
- Grow your money. Set up automatic savings, take advantage of competitive account interest rates and explore other ways to build wealth.
- Be patient. The trend for most people is that net worth increases as they get older. Do your best to get on the right track and allow time for your efforts to pay off.
Your income is not included in a net worth calculation. Although, a drop in income can impact your net worth, which is essentially a calculation of all of a person’s assets — including cash in checking and savings accounts, minus liabilities.
A person can earn a big paycheck but have a low net worth if they spend most of the money they earn. On the other hand, even people with modest lifetime incomes can accumulate significant wealth and a high net worth if they buy appreciating or income producing assets and are prudent savers.
References:
- https://www.nerdwallet.com/article/finance/average-net-worth-by-age
- https://www.quicken.com/adding-it-all-determining-your-net-worth
- https://www.nerdwallet.com/article/finance/net-worth-calculator
- https://www.federalreserve.gov/publications/files/scf20.pdf