Though you often hear the term net worth used when describing the very wealthy, knowing this calculation for your own personal finances is just as important. Referring to how much you are worth when all of your debts are subtracted from your assets, this figure gives a good indication of your overall financial health.
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Why is net worth so important?
Creditors look at your net worth when determining if they should loan you money. When you possess a positive net worth, like a good debt-to-income ratio, this often indicates that you have limited debt. Having less debt compared to assets also makes your credit score considerably higher, which positively affects your life in many ways. Good credit means you can qualify for loans with the best rates and that you’ll find it easier to complete financial transactions like renting an apartment or house.
Getting to know your own net worth is the first step toward becoming financially responsible. When you face the facts and determine how much you’re actually worth, this tells you if you’re doing well financially or need to make improvements. If your net worth is in the negative by a substantial amount, for instance, knowing this gives you sufficient reason and motivation to make serious changes, like pay off loans sooner, change your lifestyle, and increase your income.
Net worth also gives you a solid way to measure your financial progress over time. Ideally, you want your net worth to rise, which indicates that you’re paying off debt and keeping spending under control. If your net worth falls, this may mean that your spending has outpaced your debt reduction. If left unchecked, such behavior can lead you down the path to financial trouble.
Steps to calculate your net worth
1. Add up all of your debt
This figure is the total of every penny you owe. Include your mortgage, credit card balances and all loans, including auto, student and personal loans.
2. Total all of your assets
Include the equity in your home, savings, money market and checking account balances. Also include investments such as certificates of deposit, stocks and bonds, 401K, SEP and IRA accounts, the value of life insurance policies, money owed to you and the value of any businesses that you own. To this total add an estimated value of your possessions, like electronics, art, vehicles, jewelry and antiques.
3. Subtract your debt from your assets
This calculation gives you your net worth. If the amount is positive, you have more assets than debts, which is cause for celebration. If you calculate a negative number, don’t panic. Instead, consider recent purchases or looming student loans. Have you recently purchased a new car or a home? Such expenditures initially cause a dip in net worth but over time will usually result in it rising.
When you pay off your car in a few years, your debt will lower but your assets will contain the value of the car. In the same respect, making home improvements, such as updating your kitchen, will initially cause a dip in your net worth, but the renovations will increase your home’s equity over time.
You don’t have to keep track of all these numbers and figures on a sheet of paper; Bookmark an online net worth calculator and take a screenshot of the results. As your assets or debts change over time, update the information and recalculate.
The key is to keep track of your net worth on a regular basis, either annually or semiannually. This way you’ll know if your net worth is climbing or declining. If it is climbing, you can keep on doing what you’re doing, but if it’s falling, this gives you the opportunity to take a close look at your spending and debt reduction goals and make necessary changes.