How are you today? I mean how are you financially?
Knowing Your Net Worth:
- is a key benchmark and report card at a particular time.
- will allow you to set near term and long term goals.
- track its changes for better money management.
- highlight your liquid asset balances.
- helps you get a loan for a house, car, college tuition, or new business.
- pay down high-cost debt.
- refinance your mortgage loans.
- encourage you to save and invest more.
- buy your own home, rather than high rent.
- is your best road map to building your wealth.
You need to know the difference between net worth and net income.
What Is Your Net Income
Your net income is based on your gross or pre-tax income and reflects your annual salary or based on hourly wages times the number of hours you worked.
You may also earn commissions and interest income from investments that are added to your gross income.
That total gross income will be reduced by your tax deductions and deductions for pension and retirement accounts providing your net income for the year.
Using A Budget May Help You To Control Spending
Your net income is usually used to pay your monthly bills, your monthly loans, and other items in your budget.
For a better description of what goes into your budget plan, see our post, “How To Control Spending With A Simple Budget.”
Having a good budget plan and spending less than you earn will add to your net worth.
That is your roadmap to building wealth and greater financial flexibility. Take that road!
How To Calculate Net Worth
Your net worth is your personal balance sheet that provides a snapshot of your financial position at that time.
Net worth is all that you own less than all that you owe.
It is measured by total assets less total liabilities.
An excel spreadsheet of different assets/liabilities discussed below is an excellent tool for you to put all of your categories in one place that can be periodically updated. You should do it on at least a quarterly basis. However, if you are true to your monthly budgeting, reviewing your monthly net worth is better.
Try putting it on a spreadsheet first but you can use Personal Capital’s net worth app for tracking your investments. Frankly, any way you can keep on top of your net worth with an eye towards building the amount will work.
10 Key Reasons Why You Need To Know Your Net Worth:
- Your net worth is an important benchmark that measures your household’s successes and failures throughout your lives. Net worth is usually more than your net income.
- Knowing your net worth is important to set your near and long term goals and planning your family. Early in your career, your net income is likely at a lower level than the later years when your net income should rise from the potential upside coming from promotions, training, and better jobs. With careful planning and a budget plan in place, your net worth should increase over time.
- You should track changes in your net worth as early as possible to make sure you are making progress in managing your money properly.
- It is important that you have liquid or cash-like assets for the potential problems that are likely to arise. An ample emergency fund should provide some needed padding for unexpected events like a lost job. Liquidity can vary among different assets we own. A money market account are typically far more liquid than your car or your home.
- When you go for a loan to buy a house, a car, for college tuition, or to invest in a new business, you will want to review your net worth to make sure you can afford the incremental costs you will be taking on. Your bankers will want to review your financial statements, including an income statement with your earnings history and your net worth.
- Pay down your high yielding debt, typically your credit card debt which uses the magic of compounding interest against us if we only make the minimum interest payments. The Federal Reserve reported average credit card interest rates for 2018 of 14.22% for all card accounts and 16.04% for cards with assessed interest.
- You could pay off all or some of your mortgage debt if your interest rate is over 5%. If it is significantly above that, you should be seeking to refinance your mortgage. On the other hand, if you are benefiting from a lower mortgage rate, can handle the monthly mortgage payments, and continue to be able to write off your mortgage interest if your debt is below the $750,000 cap (lowered from $1 million in the 2017 tax reform bill), financially you may have better options for your windfall money.
- Add to your retirement accounts to the limit and increase investments in a low cost stock fund. While stocks can be volatile year-to-year as it was in 2018, longer-term, S& P 500 annual returns have averaged 9.9% since the 1920s. If you are not facing imminent retirement, stocks still remain a great place to invest your money.
- If you don’t own your home and are paying high rent in say New York City or San Francisco (most expensive cities to rent one bedroom apartments in the US), you may consider buying a home while mortgage rates are still relatively low at under 5%.
- Your road map to building wealth starts with knowing your net worth and making valuable changes like reduced spending, increased saving, and investing.
How do you calculate your net worth?
List all your the assets that have current monetary values in the following categories:
Cash and cash equivalent assets are those financial assets that quickly convert into cash. These assets include cash on hand, prepaid cards, savings accounts, checking accounts, money market accounts, certificates of deposit, savings bonds, and emergency funds. You can also include short term IOUs, money expected from tax refunds. You can get these amounts off your latest monthly statements. List these individually based on their current balances.
Other monetary assets include your taxable investment accounts, retirement accounts, real estate investment funds, pensions, and cash value of life insurance policies. List these at their current market value.
Monetary assets are more liquid, meaning they can more quickly be converted into cash with little to no loss in value.
Tangible assets would include your largest assets that are part of your lifestyle.
These real estate assets are your primary home and other real estate you own, including vacation or second home, timeshares, land, and rental property. Separate your primary home from the other real estate.
Use current conservative market values for real estate. Appraised values may not reflect actual sales or liquidated values. You should not be inflating your net worth unrealistically.
You would need to approximate the value of your home, cooperative, condominium, cars, boats, and any other large items. To approximate real estate values, you can look at Zillow, Chase Home Estimator, or real estate websites for your zip code.
If you own your business or businesses, it should be based on conservative market values. It can be a complex matter. A simple rule of thumb is to look at sales at simple businesses or a multiple of revenues, such as 0.6 times annual revenues.
Personal Property Is Tricky To Value
Unless you have a meaningful fleet of cars and boats, you should not add these to your assets even though there may be relating to those assets that should be included. These assets depreciate too fast and sell too slowly to add fairly to your net worth. If you do have that fleet, for cars, you can look at Kelly Blue Book, Edmunds, or AutoTrader. Similarly, for boats, you can consult Boat Trader.
What Else Goes Into Total Assets
Art, rare books, rugs, and antiques may be a large part of the net worth of many households. Unless they are highly desirable or rare, these assets tend to wildly low liquidated values to count on if you needed money in a pinch. Musical instruments have their value, but again, they are very difficult to peg and their sales are less predictable to raise capital.
This category has a lot of sentimentalities but its value may be very difficult to ascertain. In my opinion, these assets should not be counted on unless you work with an estate professional steeped in knowledge and has a terrific network to help you sell the items.
My own personal experience provides a valuable lesson
When I worked on Wall Street, I was restricted from making investments in financial securities. If on that rare occasion I was able to buy certain securities, I was often not allowed to sell that security when I wanted to. So, on either side of the trade, I was burned and finally abandoned investing until I left my career as an equity analyst.
So what did I invest in?
A large part of our assets was in art, rugs, rare books, and antiques.
These assets are on our walls (art), in our bookcases (rare books such as the first edition of the Federalist Papers), on the floors (ancient rugs), and antique furniture (signed in the mid-1760s by the cabinetmaker).
Ever try to sell an 18th-century Tiger Maplewood card table? We have! And we are still waiting for that sale.
Beautiful stuff, but they can’t pay the bills! So I don’t include these personal assets. The few pieces we have sold were at prices 70% below what we paid for them.
I digress but a worthwhile lesson for those who are collectors.
List all your liabilities according to their current balances.
Your mortgage loan balance is probably your largest liability.
The home equity loan balance
Separate mortgage loan balances for the other real estate property (listed above in assets)
Student loans at the current balance
Loans associated with the business(es)
credit card account balances (you should break these out individually)
Professional services unpaid
Total Assets minus Total Liabilities= Your Net Worth
How can you build your net worth? Start with writing out the ways.
You should look at your net worth statement with your budget to see what areas of growth and reduction in spending could build your net worth.
Look at your potential trade-offs.
Increasing your assets by increasing your savings could increase net worth.
Making more income at your job would boost net worth.
Cutting your spending in areas that you can allow you to put more money into interest-bearing bank accounts or stock investments.
Investing in financial securities can expand your wealth.
Choose to invest based on your appetite for risk and where you are in your life cycle.
Where should I invest my money to maximize my net worth?
Stocks are riskier but generate higher returns than keeping your savings in bank accounts at low returns.
According to Bankrate, the best annual percentage yield (APY) which is your effective annual return in April 2019 ranges from 2.35%- 2.50% for the top ten banks and may require a minimum balance from $1 to $25,000 and may incur monthly fees up to $15.
Having cash on hand is critical for your emergency fund. In 2016, 84% of families reported having at least $400 in liquid accounts according to the Federal Reserve Survey of Consumer Finances.
Your net worth will grow faster if you invest in a diversified basket of stocks, which will provide greater upside potential long term.
The younger you are, the more able you are to ride out the greater risk found in stock investing, with the benefits of compounding effects.
Homeownership remains a worthwhile investment despite the slide in property prices in 2008-2009 but is less liquid than financial securities
After household net worth plummeted in the great financial recession in 2008 to $58.996 trillion, having been impacted by declining home and stock market values, household net worth has improved to $109.0 trillion in the third quarter 2018 (the latest figures from the Federal Reserve), though consumer debt growth (up 5.4% in the last year) continues to dampen net worth for many families.
Savings and investments in financial securities will enhance your net worth.
Decreasing your loans or debt liabilities will increase your net worth.
Reducing your debt levels will also improve your net worth situation.
Your mortgage loan deserves your careful attention
Target carefully what you borrow, for how long, and at what rate. Look at taking our a 15-year mortgage loan versus 30-year mortgage loan. While your monthly payments will be higher for the 15-year loan, total borrowing costs will be lower.
Taking on a mortgage loan is a big cost but home prices have generally kept pace with inflation until 2008-2009 when subprime mortgages played a huge factor in declining home values.
Mortgage debt is actually growing at a slower pace of 3.1%. The median net worth for families in 2016 ranges from $11,100 where the head of the household is less than 35 years to more than $264,000 for those 75 years or older.
With the Fed holding off from raising the fed funds rate in 2019, mortgage loan rates have actually declined to the low 4% rate according to the latest Bankrate numbers. Since the coronavirus in Spring 2020 which caused an economic downturn, the fed funds rates were brought down to its lowest rates.
What if you are receiving a sizable tax refund this year, earned a higher bonus, inherited money, or experienced a sudden windfall, what would you do with the proceeds?
Lower your debt where possible
Pay off your credit card debt. It’s likely your highest cost debt so use your tax refund or bonus to lower this amount.
Pay off your student debt as soon as you are able.
Thank you for reading! If you found this of value, consider reading other articles on our blog, and join us by subscribing the The Cents of Money.
What are some of the things you are doing today to increase your assets, reduce your liabilities, and raise your net worth? Where can you reduce your spending to put more money into savings and investments? We would love to hear from you!
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.