What is Net Worth? | Why It’s Important and How to Calculate Net Worth

Have you ever wondered how much wealth you have after looking at your banking accounts, debt statements and retirement investments? That is basically your net worth.

Specifically, it’s all of your assets minus your liabilities.

So, your next question may be what the hell are assets and liabilities.

Assets

Assets in finance are everything that you own that has monetary value.

Here is a list of some common personal assets:

• Cash
• Investments (Company Ownership, Stocks, Bonds and Derivatives)
• Home
• Vehicles

If you’re trying to figure out if something is an asset, ask yourself:

Could I sell this for an amount of money? 

If the answer is yes, then it is likely an asset. And, the value of the asset is the amount of money that you would receive when selling it. 

So, just because you bought your car for $10,000 doesn’t mean that it is still worth that amount.

Liabilities

Liabilities are everything for which you owe money on now or in the future.

Here is a list of common personal liabilities:

• Student Loans
• Credit Cards
• Future Lease Payments
• Mortgage

Calculating Net Worth

Now that you know the two components need to figure out your net worth you can figure out your wealth.

Create a list of all of you assets and liabilities and their associated monetary values. 

For your assets, you may have to make some estimates related to assets that are not easily sold.

For a stock you can simply pull up the current price quote to determine the value but how do you do this for your car or home?

Without obtaining an appraisal (which costs money), you can do some online searches to value your car, home or other asset. 

You can also just make an estimate based on how much you think you’d receive in a sale of the asset. It’s probably best to error on the conservative side.

Your debts (liabilities) are much easier because you can just take the current balance owed.

Once you have all of your asset values added up and all of your liability values added up subtract the liabilities from the assets.

Assets’ Total Value – Liabilities’ Total Value = Net Worth

Once you’ve done all of this you’ve essentially created a personal balance sheet.

For more on building a personal balance sheet and how you can use it, check out our posts:

• What is a Personal Balance Sheet? | 3 Steps to Create Your Own Balance Sheet
• 3 Reasons that a Personal Balance Sheet Will Keep You Motivated to Reach Your Financial Goals

Net Worth is a Measure of Your Financial Health

What is your net worth amount? Is negative, positive, or close to zero?

If it’s positive, that’s great! That means that at this point in time you have some wealth. 

The hope is that eventually you’ll build it big enough that you no longer have work. At least if you don’t want to.

If your net worth is close to zero, that is still good news. It means that you’ve built up enough assets to nearly cover or entirely cover all of your liabilities. 

If your it’s is negative, it’s not necessarily a bad thing it just means that you have some work to do.

Due to the astronomical rise in tuition costs (thanks inflation) many of us have to take out student loans to pay for college.

Typically, that automatically puts you at a negative net worth as soon as you secure that first loan. 

So, why is it a measure of financial health?

The lower your net worth or more negative it is, the more vulnerable you are to potential financial risks.

When it’s positive or even a close to zero, if a financial emergency were to happen like losing a job or some other type of incident where you lose a stream of income, you still have enough assets to cover your liabilities.

But, if you have a negative net worth and you experience a financial emergency it could cause financial ruin causing you to go further negative (taking out additional debt) or into bankruptcy. 

Why Is Net Worth Important?

In addition to being a good indicator of your financial health, there are other reasons why it is important.

Net worth is important because it can help you make financial decisions and help you stay motivated to reach your financial goals.

Net Worth = Wealth

Have you ever been to someone’s house and you think:

Wow! This is an amazing house you own, you must be rich.

In reality, you don’t know if there’s an offsetting mortgage liability on the home.

Your true wealth is all of your assets after subtracting all of your liabilities.

Think about it like this:

If you sold all of your assets and paid off all of your liabilities how much cash would you have?

That cash is your wealth and your net worth.

Making Financial Decisions Using Net Worth

If you know your financial health it’s much easier to feel confident about your financial decisions.

Not sure whether you should invest or pay off debt? What’s your net worth?

Investing involves risk and is not a sure thing while paying off debt is guaranteed to save you money by lowering your interest expense.

Every situation is unique but the higher your net worth the easier it is to digest the risk of investing. 

And, the more negative, the more beneficial it is to pay off debt.

Both, investing and paying off debt increase your wealth equally but one doesn’t involve risk. 

Knowing your net worth and thus your financial health can help you make a decision. 

Staying Motivated Using Net Worth

Your net worth is calculated at a certain point in time.

Today it’s one amount and tomorrow it may different amount.

If you have financial goals, which you should, you can use it as part of reaching your financial goals.

When you make your financial goals, make a goal for where you want your net worth to be by a certain time. 

If your goal is to be debt free and you have more liabilities than assets, you can have an intermediate goal of achieving a positive net worth.

If you’re on an extreme plan (like 50%+ of your income) to pay down debt, build investments, or both you could calculate your wealth every month to track your progress. 

Final Thoughts

The next time you’re wonder how wealthy you are, now you’ll have the tools and knowledge to calculate your net worth.

Remember the calculation:

Assets minus Liabilities equals Net Worth

You can use it as a proxy for you financial health. 

The lower or more negative your it is, the more vulnerable you are to financial adversity. 

The higher, the more secure you are to handle financial events like the loss of a job, an illness, or even the birth of a child or paying for college. 

It’s important to know your net worth because you can use it to make financial decisions and stay motivated to achieve your financial goals.