“Liquidity is a good proxy for relative net worth. You can’t lie about cash, stocks, and bond values.
Understanding your net worth and how to calculate it is hugely important for measuring your financial health at a particular point in time. It is simply the difference between assets and liabilities. However, it doesn’t consider the liquid nature of your assets. Liquid net worth matters.
For example, stocks and bonds tend to be more liquid than other assets as they can be quickly and easily converted into cash. Other assets like your house or car take time and negotiation to sell if you need money. Net worth remains a helpful benchmark but depending on the type of assets you have it may be a less accurate picture.
Liquid Net Worth Is A Realistic Snapshot Of Your Financial Condition
Liquid net worth is what really matters. It is a far more realistic reflection of your financial condition should you face an immediate need for money such as a medical crisis or a business opportunity. While liabilities remain the same for both calculations, your liquid assets have more significance when unforeseen events occur.
Those assets for readily available as cash with little or no loss of value to be counted in liquid net worth. Having liquid money provides a sense of financial security for disasters and opportunities alike.
Asset Rich Cash Poor Can Be Uncomfortable
To a great degree, when you need to take money out to pay for an unforeseen event, would it be easier to take $15,000 out of your savings account or sell your land? Depends if you have $15,000 in the bank. The expression “asset rich cash poor” comes to mind. Often, people have economic assets like land or other economic interests but are not able to easily liquidate them for money.
Land and antiques are assets we have owned and enjoyed. However, you can’t count on those assets to pay for a costly emergency in your life. When I think about mistakes I have made, those purchases stand as major regrets. You sleep easier with access to liquid assets.
What Is 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. For an expanded explanation, see 10 Reasons Why You Need To Know Net Worth.
The Formula: Net Worth = Total Assets less Total Liabilities
Using an excel spreadsheet with different assets/liabilities 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. 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.
Knowing Your Net Worth:
- is a crucial 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 to 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 pay high rent.
- is a great road map to building your wealth.
What Is Liquid Net Worth?
Although net worth provides a view of your current financial condition, it doesn’t differentiate the assets that can provide you with liquidity quickly and easily. When facing a medical crisis or an opportunity to buy a business, getting access to your money matters. Sure, you can sell your car quickly but likely for less than the estimated value. Understanding what assets are more liquid means they can be readily converted into cash with little or no loss in value.
The Formula = Liquid Assets Less Total Liabilities
You can either remove non-liquid assets from your total assets or discount their values from their appraisals. Additionally, you need to recognize that tapping certain assets too early such as retirement accounts could result in paying penalties and taxes. More than that, you lose momentum when you withdraw assets that were benefiting from compounding growth.
Your Liquid Net Worth:
- Understand the differences between your net worth and liquid net worth. Liquid net worth is what you need to count on for immediate funds.
- Liquidity varies among our assets which have different growth rates. Money market accounts are liquid but typically have lower returns than stock investments long term.
- Consider costs involved in the transactions such as penalties, taxes, fees, and such
How To Calculate Your Liquid Net Worth?
- Cash-Equivalent Securities
- Brokerage/Investment Accounts
The most liquid assets are cash, cash-equivalent (or money market) securities, and investment or brokerage accounts. These are either already in cash or are those financial or monetary assets that can easily turn into cash with little or no loss in value.
Cash is the best form of liquidity but of course, doesn’t grow unless it is invested. This category broadly consists of cash on hand, prepaid cards, savings accounts, checking accounts, money market accounts, certificates of deposit (CD), savings bonds, and emergency funds. If your CDs are in a fixed term like 6 months or a year, you may need to pay a small prepayment penalty but this is fairly accessible money. Separately, you need to have an emergency fund earmarked for unforeseen expenses.
All types of financial securities can be bought or sold in your brokerage account. Typically, they are stocks, bonds, REITs, mutual funds, and ETFs that are in these taxable investment accounts. While these accounts are liquid in a matter of three business days, you do pay taxes on price appreciation based on the time you held the security. Holding the securities for over one year is taxed at a lower 15% capital gains rate. Otherwise, you pay taxes at the same rate as ordinary income.
Less Liquid Assets
The cash value of your life insurance policy is fairly liquid but you may have to absorb small fees. Depending on the company, it can take more time (eg. 10-20 days) than access to financial securities. On the other hand, access to pensions and investments in real estate such as multifamily homes are less liquid.
When withdrawing money from your retirement accounts before you turn 59.5 years, you will likely be hit with a 10% penalty and immediate payment of taxes, losing the deferred benefit on that amount. Generally, if you withdraw early from a 401K plan or IRA account you will pay taxes at your marginal tax rate. The marginal tax rate is the tax rate paid on the dollar of earnings (eg 22%-24%). On the other hand, Roth IRAs are treated differently. For those accounts, so long as you have had this account five years or more, you may withdraw contributions you made to your Roth IRA anytime tax-free and without penalty.
While you may have access to your retirement savings, these are not considered to be liquid. You should not dip into your retirement accounts unless needed as a last resort. By withdrawing these funds, you lose the compound benefit on this money for your future when you are less likely to earn money at your job.
A Temporary Exception
The federal government had waived the 10% penalty if you made a withdrawal between January 1 and December 31, 2020, for those impacted by COVID. Qualified individuals that put back this withdrawn money within a three-year time frame will be excused from paying taxes on the money.
If you are including retirement accounts in your liquid net worth, you should discount your retirement balances by 25% to be conservative.
529 College Savings Accounts
Like retirement accounts, withdrawal of money saved in a 529 college savings plan may be subject to a 10% penalty and you will have to pay taxes. The exception to this rule for 529 savings is withdrawals made for qualified education expenses such as tuition, fees, books, computer, and related costs.
If you are including 529 accounts into the liquid net worth, I would use a similar discount of 25% off the account balance.
The cash value of your life insurance policy is fairly liquid but you may have to absorb small fees. Depending on the company, it can take more time (eg. 10-20 days) than access to financial securities. On the other hand, access to pensions and investments in real estate such as multifamily homes is less liquid.
These assets are real and personal property that reflects your lifestyle and is harder to liquidate for funds.
Your Primary Home
If you own the primary home you live in, this may be your largest asset. While the home is an investment, it is not a liquid asset like financial securities you invest in. You cannot count on liquidating real property for quick conversion to cash. You need to figure out how the real estate market is faring in your area using Zillow Zestimate and other sources.
Selling your home is a complex process that can take several months or more to accomplish. An appraisal value is not necessarily your sales price which is often lower. Also, to complete your sale, you are responsible for fees and costs including broker fees of 5%-6% on the sales price, closing costs of 1%-2%, and attorney costs.
Most likely you are carrying a mortgage that is picked up in total liabilities. Upon the sale of your home, you will pay off your mortgage in full from the proceeds of the sale of your home, reducing your liabilities.
Your primary home as an asset should be discounted about 25%-30% off its estimated value for purposes of liquid net worth.
Other Real Estate
Besides your primary home, you may own other types of real estate, including vacation or second home, timeshares, land, and rental property. Having just sold a plot of land, I can tell you that we took a 30%-35% hit from our cost basis in an ugly market after putting it on the market over a year ago.
Use current conservative market values for real estate. Appraised values may not reflect actual sales or liquidated values. You should not be inflating your liquid or 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 Zestimate, Redfin, Chase Home Estimator, or real estate websites for your zip code.
If you own businesses outside of your primary income, it is tricky to calculate a value let alone consider it to be a liquid asset. While you may want to include in your net worth statement a discounted multiple of annual revenues, it doesn’t make sense to include for purposes of liquid net worth unless you had the business appraised and a ready buyer.
Personal Property Is Tricky To Value
Unless you have a meaningful fleet of cars and boats, you should not add these to your assets for your net worth or liquid net worth. These assets depreciate too fast and sell too slowly to add fairly to your liquid 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 wealthy households handed down to the next generation. Unless they are highly desirable or rare, these assets tend to be 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 who 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. What was I thinking?
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 By 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) even though you aren’t including the value of the businesses.
- Personal loans
- Credit card account balances (you should break these out individually).
Related Post: Pros And Cons of Credit Cards
As mentioned earlier, the formula is fairly easy:
Total Liquid Assets minus Total Liabilities = Your Liquid Net Worth
Depending on the composition of your assets, it is possible that your liquid net worth may be negative, especially when you are conservatively discounting large assets like your home but including the full mortgage balance. It is important for you to consider whether you need to adjust your investment strategies, spend less, save more, and make sure you have money for emergency purposes.
How Can You Build Up Your Liquid Net Worth: Make Good Trade-Offs
Track changes in your liquid net worth statement as early as possible to make sure you are making progress towards your goals.
Track your spending, review for areas you can reduce and produce savings
Have an ample emergency fund of 6-12 months for unexpected events like a lost job. Invest this fund in a liquid account like money markets.
Put more of your money into investment assets like stocks that can expand wealth rather than in personal possessions.
Add to your retirement accounts to the contribution limit. Avoid withdrawing money from these accounts which trigger penalties and taxes. The same goes for 529 plans.
Making more money at your job or a side gig to boost income.
Consider buying recently used cars than luxury fast-depreciating vehicles.
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 Liquid 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 as of August 28, 2020 ranges from 0.60%- 0.91% for the top ten banks. Those paltry rates which do not provide much in the way of income. Typically, banks may require a minimum balance from $1 to $25,000 and have monthly fees up to $15.
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 with currently low mortgage rates. But your home is less liquid than financial securities.
Decreasing your loans or debt liabilities will increase your liquid net worth.
Your Mortgage Loan Deserves Your Careful Attention
Look into refinancing your mortgage if you carrying a mortgage with more than 5% loan rates. You may realize savings.
Target carefully what you borrow, for how long, and at what rate. Look at taking out a 15-year mortgage loan versus a 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.
Lower Your Debt Where Possible
Pay off your credit card debt in full. It’s likely your highest cost debt so use extra savings, bonus, or tax refund to lower this amount. Otherwise, slow your spending.
Pay off your student debt as soon as you are able.
While net worth is a more common benchmark, refining your assets for liquidation purposes gives you a more realistic picture. Tracking liquid net worth helps you to understand your ability to deal with a crisis or an unexpected opportunity. When facing an immediate need for cash, you don’t want to withdraw funds that are earmarked for retirement.
Thank you for reading! If you found this of value, consider reading other articles on our blog, and join us by subscribing to The Cents of Money. Please let us know your thoughts!
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.