As I’ve written before, there are a number of different ways that people will define financial success– right or wrong. The best measurement that is a true indication of your financial success is net worth.
What is Net Worth?
Net worth is the metric that reflects your level of wealth and financial success, and it’s calculated by taking the total of all of your assets minus the total of all of your liabilities.
So, ASSETS – LIABILITIES = NET WORTH
What are “assets”?
Everything you own, including home(s), car(s), cash in the bank, retirement accounts, etc. Generally, most consumer goods (clothes, electronics, other miscellaneous things you own) aren’t counted toward the assets because it isn’t worth the trouble of documenting them all and trying to figure out how much they’re worth (which can change daily based on a variety of factors). Plus, these types of products tend to depreciate in value, often rapidly, so adding them all up isn’t worth the effort.
What are “liabilities”?
Everything you owe, to anyone for any reason. Mortgages, car loans, credit card balances, personal loans from friends or family, etc. Every penny that you owe to any person or business is a liability – no exceptions. As a fee-only financial advisor and money coach, often hear people say things like “I don’t have any debt… except my student loans” or “I’m debt-free because I don’t have any credit card balances” but they have mortgages, car loans, and/or other liabilities beyond credit cards. So when running this total make sure you include everything.
What does a Statement of Net Worth look like?
A statement of Net Worth sometimes referred to as a Personal Financial Statement by financial planners, is a simple document to put together. You’ll have two columns on a piece of paper: A column on the left-hand side for all of your assets and a column on the right-hand side for all of your liabilities. Then you will total each column and at the bottom, you’ll show the net worth total using the two column totals.
Here is a sample:
|Car Loan #1:
|Car Loan #2:
In this example, we show a total of $285,000 worth of assets, and then a total of $176,900 in liabilities. That gives a total net worth in this case of $108,100.
When you use a tool like Mint it calculates all this for you. It even puts the display into nice graphs to help you track your progress over time.
About YOUR Net Worth
Understand in advance that when you initially calculate your net worth, the results may surprise you. There are many people that we talk to regularly who have a negative net worth. While this isn’t a great situation to be in, it isn’t an impossible situation to get out of. So don’t avoid creating the statement for fear of what you’ll find, and also don’t worry if the numbers don’t look as good as you hope.
A few common reasons that we see people having a negative Net Worth:
1. Big student loans
Student loans are liabilities that aren’t offset directly by an asset, so these are a direct hit against the total net worth. Hopefully, the college degree is marketable that will more than offset the cost of the education by providing higher earning potential, but while that loan is hanging out, it’s just a liability dragging down the Net Worth total.
2. Car loans – especially on new cars
The average new car depreciates 11% the moment it is purchased and driven off the lot. And in the first three years, the car will further depreciate an average between 10% and 25% annually. Many people purchase cars and only pay attention to the monthly payment and not the total cost. In those cases, it is often “overlooked” (or not even considered) what the total cost of the car will be versus the fair market value of the car. It is unfortunately very common for people to owe more on their car than what the car is actually worth.
3. Mortgage “deals”
Saving for a nice-size down payment is hard and can take a long time; generally measured in years. What some people have done, rather than waiting to save for a nice down payment, is to opt for a very low down payment option. We see this especially with first-time homebuyers because it is easier for many of them to qualify for as little as 3% down. Three percent isn’t much equity and home values can easily fluctuate that much in a single year in many markets. Small down payments on houses can turn into “negative equity” (owe more than the home is worth) very easily with changing market conditions.
4. Credit card debt
Credit cards are almost always used to purchase items that are either a) consumed immediately so don’t show up as an asset or b) are quickly depreciating assets, so the value is instantly lower than the amount paid and owed. And because so many people carry balances on their credit cards rather than paying them off each month, their use creates a huge hit to people’s Net Worth.
Improving your Net Worth
Since the Net Worth calculation has two sides to it, an adjustment to either side impacts the bottom-line result. That means there are two main ways to increase your Net Worth:
1. Acquire more assets
As mentioned, and shown in the example, cash and investments are assets. So “acquire more assets” does not mean go out and buy more stuff. Saving more money each month and putting it in a bank or investment account is a great way to increase the assets total and increase your Net Worth.
2. Reduce liabilities
While it may not make you feel wealthy, because it doesn’t show as an increase in assets, paying down debt does directly impact your Net Worth level. The faster you can pay off debts, the faster your wealth (measured by Net Worth) will grow. A great thing about tackling this side of the equation is that once a certain debt is paid off, the amount previously paid toward it can be put toward another debt, allowing you to pay it off even faster. And once all debts are gone, what had been paid against them in the past can now go directly into savings or investments — really accelerating your Net Worth growth!
Track Your Net Worth
Do you know what your Net Worth is already? If not, take a little time and calculate it now. Either do it manually or use something link Mint. Then I’d recommend updating it at least twice a year so that you can monitor your progress. Hopefully, you will make steady positive progress and not see any decreases in Net Worth, but whatever direction it moves – you should be aware so that you can celebrate the wins and also tackle any setbacks that come up.
As Robin Sharma said, “what gets measured, gets improved.” This is true and why wealthy people often have a pretty good idea of their Net Worth level at any point in time. It is also why it is so important to understand this metric, calculate it, and track it over time.
Helping you track financial metrics like these are just one of MANY things covered when you work with a fee-only financial planner. If you’re ready to get started maximizing your financial plan just click here and let’s chat.