Content of the material
- What Does Net Worth Mean?
- Deeper definition
- Closing Thoughts
- How your net worth changes over time
- How To Increase Your Net Worth
- Increase the Value of Your Assets
- Decrease Your Liabilities
- How to Calculate Your Net Worth
- Step 1: Add Up Your Assets (What You Own)
- Step 2: Add Up Your Liabilities (What You Owe)
- Step 3: Subtract Your Liabilities From Your Assets
- Evaluating Your Net Worth
- Average Net Worth Examples
- Understanding Net Worth
- Sending you timely financial stories that you can bank on
What Does Net Worth Mean?
At its most basic, net worth is your personal balance sheet, according to Elizabeth Keatinge, a Certified Personal Finance Counselor and the founder of FundsSavvy.com. “Simply put, it’s what you own minus what you owe,” Keatinge says.
A positive net worth indicates your assets outweigh your liabilities, meaning you’re on track to building wealth. A negative net worth suggests there are parts of your financial life you need to improve.
When it comes to your net worth, the goal is to be “in the black,” says Keatinge. While some amount of debt is inevitable for most people, the higher your net worth, the more potential stability you have during times of economic upheaval, and the better positioned you are to take advantage of any opportunities that come your way.
In order to understand and calculate your net worth, you need to start by taking stock of all of your assets and liabilities.
There are slightly differing methods for calculating the net worth of an individual and the net worth of a company. Both figures are the total of all assets minus all liabilities. For calculating individual net worth, the value of assets is based on their current market value rather than original purchase prices. For company net worth, the value of assets is based on their original purchase prices instead of their current market value.
When an individual passes away, her net worth is equivalent to the value of her estate. In probate, any liabilities of the deceased are met, and the rest belongs to heirs. Any inheritance then becomes a part of the inheritor’s net worth.
For businesses, the value of an asset is referred to as its carrying value or open market value. This is understood as the price an asset would get in a competitive auction. Other concepts used interchangeably with carrying value are mark to market, fair value, and fair market value, although they can have different meanings depending on the context.
Negative net worth happens when the liabilities of a company or an individual exceed the assets held. This happens in one of two ways: either the liabilities increase over time as more debt is taken on, or assets owned decline in value.
Check out our loan repayment calculator to help you figure out your net worth.
Net worth is a measure of your wealth. It is the difference between your total assets and total liabilities. Fundamentally, the measurement informs creditors and other parties of your financial strength.
While the calculation of net worth is simple on paper (total assets minus total liabilities), establishing an accurate figure for your finances can be very complex. This is because (1) the calculation requires a detailed awareness of all assets and liabilities, and (2) it entails the establishment of fair market values, which are often estimated.
To address these challenges, most financial experts recommend you keep a secure folder or electronic file with information about your financial assets and liabilities and update this file at least once a year. Furthermore, it’s recommended that you maintain a conservative stance with any estimates. Valuations can be tricky and unrealistic; low-end measures for assets and high-end measures for liabilities are best.
Gathering and organizing this information can be cumbersome, but it’s a wise move. Knowing your net worth and tracking it over time is essential to understanding your financial condition and planning for the future.
How your net worth changes over time
Your personal net worth will go through fluctuations over time. For example, if you pay off a student loan or the market value of your home increases and everything else stays the same, your net worth will improve. In contrast, if you acquire new debt or spend some of your savings on a vacation, your net worth will decrease.
Net worth can even vary from day to day if you have investments such as stocks that naturally fluctuate. These types of fluctuations are normal and shouldn’t be cause for concern. Over time, however, a personal financial advisor can help you determine if you have the right mix of investments.
How To Increase Your Net Worth
Net worth has just two variables: assets and liabilities. You can increase your net worth by increasing the value of your assets or reducing your liabilities.
Increase the Value of Your Assets
- Review your budget to see if you can free up more money to save and invest.
- Increase your income with a side gig so you have more money to save, invest or pay down debt.
- Devote more savings to tax-advantaged assets.
- Invest some money in index funds, which are likely to appreciate much faster than savings accounts.
- Increase your home equity with improvements that provide a positive return on your investment.
Decrease Your Liabilities
- Reduce your spending.
- Pay down credit card debt.
- Make extra principal payments on your mortgage.
- Avoid deferring student loan payments even if you’re eligible
How to Calculate Your Net Worth
Let’s say Joe wakes up one day and realizes he’s completely lost financially. He’s not exactly struggling to pay his bills, but deep down inside he knows he could be doing a lot better with his money. First, he needs to figure out where he is by calculating his net worth.
He can do that in three easy steps.
Step 1: Add Up Your Assets (What You Own)
Again, your assets include the stuff you own that has monetary value.
There are two types of assets: liquid and illiquid. A liquid asset is basically cash that’s easy to get to—like money in a money market account. An illiquid asset, on the other hand, can’t be converted to cash quickly. That would be something like a piece of land or a car you’d have to sell to turn into cash. Both types of assets are part of your net-worth equation and can include:
- Cash: savings and checking accounts
- Retirement accounts and other investments: 401(k), 403(b) and IRAs
- Real estate: the current value of your house and rental properties
- Vehicles: cars, trucks and boats
- Contents of your home: jewelry, art, collector’s items, etc.
So, Joe makes a list of his assets. Remember, this is what he owns:
- Home valued at $210,000
- 401(k) with $60,000
- Car worth $15,000
- Savings account balance of $7,000
- Checking account balance of $2,000
Add it all up and Joe has $294,000 in total assets.
Step 2: Add Up Your Liabilities (What You Owe)
Here comes the not-so-fun part: adding up all your liabilities. These are all the debts and outstanding payments you still have lying around. Of course, it’s best if your debt equals zero. But if that’s not the case (yet), get them all down on paper. Things like:
- Credit cards
- Student loans
- Car loans
- Medical bills
Unfortunately, Joe has done some “stupid” with money (haven’t we all?) and piled up some debt over the years. Here’s what he owes:
- Credit card debt totaling $12,000
- Student loan debt of $35,000
- Mortgage balance of $175,000
- Car loan of $10,000
- Medical bills equaling $1,000
That list is painful to look at. Joe’s liabilities add up to $233,000.
Now Joe’s ready for the final step.
Step 3: Subtract Your Liabilities From Your Assets
Now all Joe has to do is subtract using this formula:
Total Assets – Total Liabilities Net Worth
So Joe’s total net worth is $61,000.
$294,000 (Assets) – $233,000 (Liabilities) $61,000 (Net Worth)
Evaluating Your Net Worth
Net worth is not a concept reserved for tech stock founders and real estate tycoons. Everyone has a net worth figure, and it’s a measurement we should all be familiar with.
That said, there is no magic net worth number to target. Rather, net worth should be monitored over time — with an understanding that a positive trend is more important than any one single measurement.
Ideally, your net worth should grow over time, assuming you can maintain or increase your gross income, reduce your debts and prudently invest discretionary income. The best way to drive growth is to maintain a disciplined budget, avoid unnecessary debt and implement a long-term investment program that reflects your risk-return profile.
Average Net Worth Examples
According to the Federal Reserve the average net worth for an American household in 2019 was $748,800. Broken down by age of the head of household, the average net worth is:
|Age (head of household)||Average net worth|
It’s important to keep in mind that these are averages which may be strongly influenced by small numbers of high-dollar outliers. The median net worth for an American household, for example, was only $121,700. A substantially lower median than mean (average) value suggests that many, many more people have substantially lower than average net worths.
Consider these five hypothetical net worths: $0, $100, $100, $100, $10,000. In this list, the average net worth would be $2,060, a number far greater than all but one of the actual net worths. That’s why looking at the median ($100) may better illustrate the reality many face.
Regardless of whether your net worth is closer to the mean, median or neither, remember your net worth isn’t a reflection of your personal value. Most people end up with a negative net worth at some point, and it doesn’t necessarily reflect poor financial habits. You may have to take out student loans to cover your education, for instance. And depending on the size of your loan, even if you’re making on-time payments, your net worth may be negative for a time.
Understanding Net Worth
Net worth is calculated by subtracting all liabilities from assets. An asset is anything owned that has monetary value, while liabilities are obligations that deplete resources, such as loans, accounts payable (AP), and mortgages.
Net worth can be described as either positive or negative, with the former meaning that assets exceed liabilities and the latter that liabilities exceed assets. Positive and increasing net worth indicates good financial health. Decreasing net worth, on the other hand, is cause for concern as it might signal a decrease in assets relative to liabilities.
The best way to improve net worth is to either reduce liabilities while assets stay constant or rise, or increase assets while liabilities either stay constant or fall.
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