Net worth is simply what you have minus what you owe. Let’s use a house as an example. If someone owns a house worth $200,00 and they owe $150,00 on the mortgage then the net worth (or equity) of the house is $50,000. (200,000 – 150,00 = 50,000) Or if they own a house worth $200,000 and they owe $225,000 on the mortgage then the house has a net worth of negative $25,000. (200,000 – 225,000 = -25,000) Easy right?
To calculate your net worth you take the value of everything you own and subtract everything that you owe. What you have left is your net worth. I think of it as if I was going to gather as much cash I could, pay off everything I owe, and then disappear into the wind. How much money would I have to take with me? That would be my net worth. (For the record, I don’t ever plan on doing that. If I go missing someday don’t point to this article as evidence that I ran away. I didn’t. Come look for me.)
That said most people don’t really calculate their net worth by including every single thing they own. That’s not very practical. It would take a very long time to assess the value of every thing you own, and still at the end of the day it would only be a guess. So if you want to include your personal belonging then just take a guess at what they would be worth as a group, but most leave this out.
In my net worth I include things that I would sell in an emergency. So I do include cars but don’t include anything inside my house. If I needed money to live on I would sell my car to put food on the table. Would I sell my couch, my computer, my clothing? Probably not. If I had a collection of something valuable, like Rolex watches I would probably include that. But I don’t have anything of extreme value. Used household items don’t sell for very much so I don’t bother with it.
Assets to consider when calculating your net worth:
- Balances in all bank accounts (Some people leave out the balance in their checking account since it can fluctuate so much)
- Cash value of Life Insurance
- Investment balances (stocks, bonds, gold, etc.)
- Retirement account values
- Real Estate values (Market value, not equity only. For simplicity I use Zillow.com)
- Car values (I use private party sale)
- Accounts Receivable (does anyone owe you money that you have a reasonable chance of collecting?)
- Other property (Anyting else you have of value)
Libilities to consider:
- Car loans
- Credit card debt
- Consumer Loans or Installments (Zero interest, zero payments til 2013! Don’t forget those.)
- Student loans
- Taxes owed (Don’t forget Uncle Sam!)
- Accounts Payable (Do you owe money to anyone? Drs, friends, relatives, etc.)
- Other liabilites
Add up your total assets and subtract your total liabilites. What you get is your net worth. Hopefully it’s positive. If it isn’t don’t worry, stick around and we will get you on the right track. If you want to use a spreadsheet there are lots online.
Why bother with this?
It’s an information metric for sure. You aren’t going to use your net worth to make daily decisions. It’s used more as a yardstick to track progress. You want to see your net worth rising over time. That means you are getting richer.
I find the concept of networth interesting. When you get paid your networth goes up by the amount of your paycheck (an increased bank balance). Then you pay your mortgage. Your networth goes down the amount of your payment (decreased bank balance) but then when it is applied to your mortgage it goes up a little bit (decreased liabiltiy, you owe a little less on your mortgage.) The amount you paid in interest is taken out of your networth forever. Maybe I’m a dork (ok, not maybe) but I think about stuff like this.
If you take money out of savings to pay a loan off your networth isn’t affected. Less in the bank but the same amount less in debt. Even Steven. But the amount you were paying in interest every month is no longer eating up your cash. So the long term affect is positive on your networth.
When you buy something you net worth is affected one of three ways:
- Your net worth goes down: If you buy a consumable item your net worth will go down by the amount you spent on said item. If you spend $5 on lunch your net worth goes down $5. You ate it. You paid $5 and have nothing to show for it, other than a full belly. If you buy a car your net worth goes down more slowly. If you buy a new car it takes a big hit right as you drive it off the lot and then drops a little more every day afterwards. This is why frugal folk say to buy used cars. If you buy a used car the impact on your net worth is slower and less. It will still depreciate but not as fast. Your net worth takes less of a hit. In the end you sell the used car for much closer to what you paid for it than you do the new car.
- Your net worth goes up: You can also buy things that rise in value. If you buy a stock for $25 and the price rises to $30 your net worth went up $5. Anything that you can sell for more than you paid causes your net worth to rise.
- Your net worth stays the same: There are things that retain their value very well. You can pretty much always sell them for what you paid, inflation included. Used items quite often fall into this category. If I buy a used washing machine for $75 on craigslist and use it for two years I can probably sell it again for $75.
To increase your networth you want to minimize those things that decrease it and maximize those things that increase it. Spend less on consumables, buy used, buy appreciting assets, and pay off debt so interest isn’t eating up your cash. Over time you will see your net worth rising.