I wanted to take a step back from the credit discussions that were recently posted, to be able to start at the basics. This will be a series of conversations for beginners, or those who wants to review their knowledge from a different perspective. Let’s talk about calculating your net worth, and why it even matters.
What is a Net Worth?
Simply speaking, your net worth is what you were to own financially if you were to sell everything today. The formula for calculating your net worth is simple: Assets-Liabilities=Net Worth.
Great, But What Are Assets and Liabilities?
Lets start with assets. Assets are what you currently own. They include: Cash, Investments, Real Estate, Cars, Furniture, Jewelry, etc.
Liabilities are the opposite, these are what you owe. They can include short term debt; such as credit cards, and long term debt; such as real estate, car notes, student loans, etc.
So How Do I Value My Favorite Rocking Chair?
Not so fast! While technically, these could be included in your net worth, I would advise against it. Items such as these are very hard to price in the market, and most times, not very easy to sell.
Always try to focus on the bigger categories, which are cash and investments.
Lets Start With Assets
Look at all your bank accounts, and separate them into four categories which can be itemized for further organization: Liquid Assets, Investments, Real Estate, and Other.
- Liquid Assets are any assets that can be easily withdrawn from your account. These normally include Checking and Savings accounts.
- Investments can include IRA’s 401k’s, and any other non retirement investment that you might own. These fluctuate all the time, so pick intervals in when you want to update them (Weekly, Monthly, Quarterly, Yearly)
- Real Estate includes any property that you own. These normally (but not always) go up in prices. The national average in the United States is about 4% increase in a year, but your city has a huge impact on this. My rule of thumb is to either be extremely conservative with this value, or speak to a realtor about property values in your neighborhood.
Also keep in mind, that if you were ever to sell a property, a realtor will charge about 6% of the value, so factor that in to get a more realistic view of your net worth.
- Other category can include your car, and anything else you think might be of value. Remember a lot of these items go down in value over time, so set up intervals on when to update these as well.
Now on to Liabilities
Like I stated earlier, liabilities are normally broken down into two categories; long term debt & short term debt.
- Long Term Debt includes anything that will usually take more than 1 year to pay off. Common examples are student loans, real estate, and the remaining balance of a car loan.
- Short Term Debt can include everything else, from the $20 you owe your uncle, to the various outstanding Credit Card Debt you have.
Now that you have your assets and liabilities on a spreadsheet, just subtract the liabilities from your assets and you have your net worth!
Don’t worry if this number is small or even negative, its more common than you think! But now that you know where you stand, you can put together a plan for increasing it. A good practice is to update your net worth monthly to see where you stand. Fluctuations, especially when you have investments, are bound to happen, but the goal is to see that spreadsheet graph move up!
Great, But Why Is This Important?
For many reason! Not only does your net worth let you know where you stand, it also lets you create a plan for financial freedom. Whatever that number is, if you were to sell everything, cash everything in, etc., this is a rough estimate of what would be left over! So if you wanted to retire today, and you had that much money, how long could you survive for without working? If the answer isn’t until you’re 100 years old, then let’s keep moving up!
Also remember if you sell your primary house, you would need to find a new place to live, so don’t get too cocky just yet! The goal here to keep increasing your assets, while lowering your liabilities… You don’t want to be too deep into debt!
So Where Do You Stand?
I will be posting my own net worth monthly here at The Shiny Dollar, as I did in My Instagram, with the goal being to just move forward little by little. Hopefully seeing that forward motion can motivate others to join in and take their finances more serious. But after this exercise, I’d love to know where you stand in the comments!
Already figured this step out? Move on to Step 2: Finding Your Financial Freedom Number.