Here is Why it is Important to Know Your Net Worth

Understanding your net worth is vital as it provides a clear picture of your financial situation. When your assets are higher than your liabilities, then your financial status is considered positive. On the contrary, if your liabilities exceed your assets, you’ve got a negative financial status.

That said, calculating your net worth can help you identify areas in your life that need improvement in order to attain your financial objectives.

Understanding Net Worth

As mentioned, two elements are involved when calculating your net worth: assets and liabilities. Assets include any items of value that can be exchanged for money, such as vehicles, real estate, retirement funds, brokerage accounts, investments and many more. Liabilities, on the other hand, are your debts, which include credit card debt, mortgage, car loan, student loans, and medical bills, among others.

The biggest challenge that you are likely to face as you calculate your net worth is giving each asset an accurate value. To avoid overestimating your net worth, making conservative value estimates on each asset is advisable. For example, if you want to get a close-to-accurate value of your home, it is recommended to compare it to similar properties in your neighbourhood that have been sold recently. Moreover, you can hire a professional real estate agent to help you find a realistic value for your house.

Meanwhile, some experts believe that the cash received from selling a house can be an asset or liability, depending on various factors. For instance, if the home you sold has a higher value than the one you purchased to replace it, then the remaining cash becomes an asset. Conservely, if the replacement house’s value is higher than the sold home and you added more money to buy it, then that’s a liability.

What Does It Mean?

Net worth tells a lot of things. For example, if you subtract liabilities from assets and you get a negative figure, then it means that you are owing more than you’re owning. A positive figure means that you’re owning more than you’re owing. A negative net worth doesn’t necessarily mean you are not financially responsible. It simply means that your liabilities are currently higher than your assets.

Net worth fluctuates just like the financial markets. The most important aspect is the overall trend. Ideally, everyone’s net worth should continue to grow as they get older. This could involve acquiring more assets while paying off your debts. Note that your net worth is likely to fall at some point, especially when you have retired, since there is a chance you will start tapping into your investments and savings for retirement income.

What’s the Ideal Net Worth?

Each individual has a unique financial situation and objectives. This makes it challenging to establish a “standard” net worth that can apply to all. That said, we all need to determine our ideal net worth by ourselves. To get started, ask yourself where you wish to be financially in the long and short term.

You can use this formula to determine your target net worth: “My Target Net Worth” = [My Age – 25] * 1/5 *Gross Yearly Income]. For instance, a 40-year-old man receiving a gross yearly income of $50,000 might be looking to achieve a net worth of $400,000. Here is how he can use the formula to determine how much he needs to grow his net worth every year. $400,000 = [40-25=15] * [$50,000/5 = $10,000]. This means the 40-year-old man will have to set aside $10,000 every year for 15 years to build his desired net worth.

What’s the Difference Between Net Worth and Net Income?

Net income is the money you receive after payroll deductions and taxes, while net worth represents the total value of your assets minus your debts.

How Often Should You Calculate Your Net Worth?

​While there is no specific rule on when a person should calculate their net worth, many prefer determining their net worth every three months.