If you follow the news whether it is politics, business, sports, or even celebrities, you will often hear the term “net worth” mentioned.
A quick look at the headlines for the past month reveals articles about President Trump inflating his wealth by billions, Jeff Bezos being worth $150 billion, to Kylie Jenner being the youngest billionaire. Forbes Magazine’s Forbes 400 list of the wealthiest Americans is enormously popular and often referenced.
This brings up the question what exactly is net worth anyways?
If you aren’t a business owner, sports figure, or celebrity, why is it important that you know your net worth?
In this article, I’m going to explain what net worth is and why you’d want to calculate and keep track of it.
What Is Net Worth?
To put it simply, net worth is a really easy formula:
Net worth = Assets (what you own) – Liabilities (what you owe)
It is basically the total value of everything that you own:
- investments such as stocks and bonds
- cash in your bank accounts
Then you subtract your liabilities. These are total debts that you owe, such as:
- car loans
- student loans
- credit card debt
- personal loans
To put it another way, if you were to have a massive garage sale and sell everything that you own and used all the proceeds to pay off all your debts, your net worth is the amount of money you have left.
When adding up your assets, it is important to make conservative estimates on the value of your assets. For many people, their home is their biggest asset and its value could be different depending on which figures you go with. The most accurate determination might be to use comparables from similar nearby homes that were recently sold.
Notice how there is no mention of your income. If you earn a million dollars a year but spend it all on donuts, you will have a net worth of zero and a rapidly expanding waistline.
Your net worth is determined not by how much money you make, but how much money you keep.
Net Worth Example Calculations
To get an idea of how appearances may not be everything, lets consider two families.
The Jones Family
The Jones look to be doing extremely well. They are working professionals in their 30s who have MBAs and have two kids. The Jones own a house in a good neighborhood, have two nice newer cars in the driveway, and they go on a vacation to Disney World every year. Someone who meets them for the first time would think they’ve got their financial lives together.
Here is how their assets stack up:
- $300,000 – House
- $25,200 – Car 1
- $18,300 – Car 2
- $2,100 – Checking account
- $5,500 – Retirement savings
- $7,000 – Furnishings, jewelry, and misc items
Their assets add up to $358,100. That’s over a third of a million dollars. Sounds awesome, right? But what about their liabilities?
- $280,000 – Mortgage
- $23,100 – Car loan 1
- $15,000 – Car loan 2
- $75,000 – Student loans
- $8,900 – Credit card balances
Their liabilities come out to $402,000. That’s not quite so awesome.
Jones Family Net worth
Lets calculate their net worth using the formula from above.
$358,100 in assets – $402,000 in liabilities = -$43,900 net worth.
This means they have a negative net worth and owe more in liabilities than their total assets. The Jones in this example have a big hole to dig out of.
The Jackson Family
The Jacksons don’t very high earning jobs, but they are happy. The wife is a teacher who has access to a 403b that she has been contributing to regularly. Mr. Jackson works in construction but makes it a point to contribute yearly to his Roth IRA.
They drive older cars that they’ve paid off 5 years ago and they rent an apartment instead of owning a home. Their vacation is taking the kids to the local lake.
Here is how their finances look:
- $5,400 – Car 1
- $6,300 – Car 2
- $1,100 – Checking account
- $3,500 – Savings account
- $45,500 – 403b
- $36,300 – Roth IRA
- $4,000 – Furnishings, and misc knick knacks
Their total assets add up to $102,100. That is less than a quarter of the Jones’ assets.
But what about their liabilities?
- $3,400 – Credit cards
- $5,600 – Mr. Jackson’s medical bills
Their total liabilities come up to $9,000. That’s a big difference from the Jones.
Jackson Family Net worth
Using the net worth formula, we get for the Jacksons:
$102,100 in assets – $9,000 in liabilities = $93,100
This means the Jacksons have a positive net worth.
What These Examples Show
In summary, when you look at the things each family owns and does, you would think the Jones are much wealthier. They own a home whereas the Jacksons are living in an apartment. The Jones drive more expensive cars and take fancier vacations.
But appearances are meaningless when calculating wealth. A noteworthy saying is “big hat, no cattle” from the book The Millionaire Next Door. Many people are bedazzled by the shiny status symbols like driving expensive cars, wearing designer clothing, and owning fancy watches as examples of someone who is wealthy.
You must take everything into consideration, which means accounting for all assets and liabilities.
A negative net worth doesn’t necessarily mean you are irresponsible with money. As you pay down your debts like student loans and mortgages, your net worth will naturally rise.
Reasons You Should Know Your Net Worth
Like everything else in life, if you want to improve on something you need to keep track of it.
You want to lose weight? You need to keep count of your calories and weigh yourself regularly. You want to be stronger? You need to track how much weight you are lifting and gradually increase it. You want to be rich or get out of debt? Yup, you guessed it. You need to track your savings and net worth.
Here is why it’s important to know what you net worth is and how it can help you with your financial goals:
1. Shows Your Financial Progress
Are you spending too much money or is your debt increasing faster than your assets? By comparing the value of your assets and liabilities from each month or year, you can get an idea of how you are doing financially. If your net worth is going up, you are moving in the right direction. If it is declining, you have more work to do.
Not knowing where your finances stand is like a car stuck in the snow. Your tires are spinning fast, but you are not going anywhere.
2. Knowing Your Net Worth Can Provide Motivation
One of the best ways to improve on something is to set goals. By setting a financial goal for yourself whether it is getting out of debt or saving a million dollars for retirement, tracking your net worth lets you will know how close you are to your goal.
If your net worth numbers shows that you are on track to hit your financial goals, it can encourage you to keep doing what you are doing. Or if your debts are going up faster than you can pay them down, it is a sign you need to change your habits and focus more on saving, investing, and earning more money.
3. It De-emphasizes the Value of Assets Alone
Some people might feel proud to proclaim they own a house worth $500,000. But that is all meaningless if they have a mortgage where they owe more than the house is worth because its value has fallen such as during the last recession.
It is not the value of the asset that matters, but how much of that asset you’ve paid off. Owning something free and clear is the true definition of freedom.
4. Helps You Make Better Financial Decisions
Each time you check your net worth you are looking at how much debt you are holding. By having an idea of what your assets and liabilities are, you are able to focus on what area is important – spending on things that increase the size of your assets column while decreasing spending on things that put you deeper into debt.
To keep from overspending you should consider whether something is a need or a want when making a purchase. Is that $200 pair of jeans eight times better than the pair of Levi’s that would do just as well?
How to Track Your Net Worth
Tracking your finances is easier than you think. To track your net worth, you need to account for your assets and your liabilities.
There are two ways you can do this: manually and with online services.
Tracking Your Finances Manually
The old-fashioned way of tracking is using a simple spreadsheet such as Excel or Google Sheets. You need two columns – one for assets and one for liabilities.
You will need to find all your various accounts and add a new row for each. After that it is only a matter of totaling both columns and subtracting your liabilities from your assets to get your net worth number.
The benefit of this method is that it is free. By using a spreadsheet, you can keep all your logins private and not with yet another online company.
The downside of using a spreadsheet is it a lot more labor and time intensive. Each time you want to see how you are doing financially you will need to login to each account and look up your numbers. If you have a large number of accounts, it could make you check your finances less frequently.
Using Online Services to Track Your Finances
In addition to making it easier to keep in contact with friends, the internet has also made it much simpler to track your net worth with free online services like Mint.com, which is owned by Intuit, the makers of TurboTax and Quicken. I’ve also heard good things about Personal Capital.
With online financial tracking platforms, you set up your account on their website and enter information from almost any U.S-based financial institution. Then the service will download and aggregate all your financial data automatically and display it in one place. As you can imagine this will save you a ton of time once you’ve gone through the initial sign-up process. All you need to do then is login whenever you want to check your finances and your info will be waiting for you.
You will get reports on everything from bills, debt, income, spending, credit scores, net worth, and more all with categories, graphs, and charts letting you know where your money is going and how you are doing.
Don’t know which one to choose? My recommendation is to try the spreadsheet method at first or if you plan to compile your financial stats less frequently. If you find that is not working or it is taking too long, switch to the online option.
Knowing exactly where you stand by evaluating your financial health and how you are progressing towards your goals is important if you are trying to achieve a life free of financial stress. Before you can improve on anything you need to get a baseline. That is the only way to know if you are making progress.
Before you spend a bunch of money going to seminars, buying courses or personal finance books trying to improve your money situation, the first thing you should is tabulate and find out your net worth.
Do you track your net worth? What do you use to do it? Do you do it manually or do you use an online service like Personal Capital, Mint, or something else? What do you recommend?