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When assessing your overall financial health, it’s helpful to have a few key performance indicators to turn to. Ambiguity is rarely a recipe for success when it comes to finances.
One of the most common measurements people use is net worth.
While you’ve probably heard the term net worth several times, you may not know what it actually means.
The term is often thrown around when we talk about the ultrawealthy, but rarely is it ever accurately defined.
So, what is net worth? How does knowing your net worth impact your overall financial wellbeing?
This article will explore these questions so you can better understand your financial standing.
What Is Net Worth?
To start, let’s define net worth.
Your net worth is the total value of your assets minus the sum of your outstanding liabilities.
In other words, your net worth is how much all the things you own are worth minus how much debt you have.
Conceptually, net worth is simple. It gets a bit more complicated when you try to account for the worth of everything you own.
How Does Net Worth Work?
Theoretically, your net worth is the money you would have if you liquidated everything you owned and then paid off all your debts. If the world were simple, this is how net worth would work.
Unfortunately, the world is not so simple. There is no decidedly perfect estimate for the value of all your stuff.
If you were trying to sell everything, you would probably have somewhat varied price ranges for each item.
This doesn’t mean that net worth isn’t a valuable concept, though. While there may be no perfect way to measure it, the reality is that you probably don’t want to sell everything you own.
Net worth is more valuable as an indicator of progress or movement for your finances than it is as a measure of absolute truth.
So long as you are somewhat consistent in how you measure your net worth, the number you get after running your calculations can tell you if you’re increasing, decreasing, or staying the same with your financial health.
Net Worth Formula
If you want to calculate your net worth mathematically, it’s pretty simple. The formula is:
Value of assets – value of liabilities = net worth
How to Calculate Your Net Worth
The formula for calculating your net worth may be simple, but things get a bit more complicated in practice.
The first thing you need to do to calculate your net worth is to find the total value of your assets.
Start with your biggest assets. For most people, this will be things like their home and their car. Get the current estimate of their value and set it aside.
Next, add the value of all your bank accounts, cash, and investment accounts. This one should be fairly easy.
Finally, add the value of your remaining assets. For simplicities sake, you may want to set a cut-off price below which you just ignore the items. No sense tracking down every last push pin in your desk to estimate its value.
Add these three figures together to get the value of your assets.
Now comes the liabilities.
Start with your biggest debts, such as car or mortgage payments. Then add your personal debts. These include things like credit card bills or student loans.
Add them together, and you have the figure for your liabilities.
Now subtract the total liabilities from the total assets. The result is your net worth.
Example of Calculating Your Net Worth
Let’s use an example to help you understand how this calculation might play out,
Bob wants to calculate his net worth. Following the steps above, he knows to start with assets.
He has $214,000 in equity in his home and owns his car worth $19,000. Added together, this makes $233,000.
Next, he looks at his accounts. He has $10,000 in his checking account, $23,000 in savings, and $11,000 in an investment account. This gives him $44,000 for the next figure.
Finally, he has considered his nicest furniture and jewelry. Together they have an estimated value of $12,000.
Altogether, his total assets are worth $289,000
He moves on to his debt.
He still owes $103,000 on his house. He also has $1,500 on a credit card and a student loan balance of $5,000.
Adding this together, his total liabilities are $109,500.
He subtracts $109,500 from $289,000 and gets $179,000. This is his net worth.
Why Is It Important to Track Your Net Worth?
Tracking your net worth is less about reaching any specific number and more about keeping a general pulse on your finances.
If your net worth is increasing, you know you’re doing something right. You’re spending less than you make or paying down loans. This is a good sign that you have your financial life together.
On the other hand, if your net worth is decreasing, you know you’re spending more than you make. You should use this information to audit yourself and try to save more efficiently in the future.
Tips for Increasing Your Net Worth
If you aren’t happy with your current net worth, here are a few ways to work on increasing it.
#1. Follow a Budget
One of the simplest but most effective ways to raise your net worth is to budget. Spending less than you make will increase your liquid assets, directly increasing your net worth.
>> More: Best Budgeting Apps
#2. Pay Off Outstanding Debt
You can also work to pay down debts if you’d like to up your net worth. Getting rid of your outstanding liabilities will increase your net worth in the long run, as you won’t be stuck paying interest on your debt.
#3. Own Equity in a Business
Investments are a fantastic way to raise your net worth. Owning equity in a small business means the value of the business is added to your asset calculations.
Additionally, your net worth will increase as you receive your returns.
#4. Invest Responsibly
Not all investments are good ideas, though. If you invest recklessly, you may wind up losing money on your investments.
Take your time and research to ensure your investments wind up paying you more than you initially put in.
How to Track Your Net Worth Over Time
Tracking your net worth over time is simple.
All you have to do is run the calculations on a somewhat regular basis, using the same estimation tools for consistency’s sake.
So long as your estimates are roughly equivalent, you can compare the figures you get to understand the general trends in your net worth. If the number is increasing, keep doing what you’re doing. If not, find ways to budget or pay off debts.
Bottom Line: What Is Net Worth?
Ultimately, net worth is a concept most valuable because of its practical applications.
No net worth calculation is going to be perfect, but so long as they are consistent, you can use the number to track your financial wellbeing.
If possible, you should strive to increase your net worth by budgeting, paying off debt, and making smart investments. Doing these things now will set you up for a brighter financial future.