M51 What Is My Net Worth What Does Net Worth Mean

What Is My Net Worth? What Does Net Worth Mean?

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Different people have very different opinions on what it means to be “rich”. Is the guy wearing a Rolex while driving a BMW wealthy? How about the guy who owns his own house or business? Are you rich when you earn more than you spend? How about just being content with whatever your financial situation is?

All of these are valid viewpoints (except maybe the one about showing as much bling as you can). The trouble with all of them, though, is that they give only a yes/no answer as to whether someone is well off. This is useful information, certainly, but isn’t there a more helpful way to assess a person’s wealth? This is where the concept of net worth comes in. If you’re planning to get ahead in life and perhaps retire by 40, the question “What’s my net worth?” should be your starting point.

What Does Net Worth Mean?

Every year, Forbes magazine publishes a list of the 400 richest people in America. You need at least $2 billion to get into this club – once you have that kind of cash, why would you even keep counting it? Presumably, the individuals on that list don’t care all that much about money except possibly as a way to keep score of how well they’re doing. Some are happy to share their financial information with Forbes, others much less so – one thing you’ll often find with truly wealthy people is that they prefer to keep a low profile.

Even though it’s something their readers love and have come to expect, compiling this list is a huge pain for Forbes even when their subjects cooperate. It takes work untangling and valuing all of the companies they own a piece of, their real estate holdings, their debts (yes, even rich people have debt, but this is taken on strategically in order to make even more money), and several other factors.

Luckily, it’s much easier to calculate the net worth of an ordinary individual. Like most important financial concepts, the formula for figuring out “what is my net worth” is actually quite simple:

Net Worth = Total Assets – Total Liabilities

The words “liabilities” and “debts” are normally interchangeable. That’s really all there is to it: when you subtract everything you owe from everything you have, you’re left with a number representing your net worth.

Here are some examples:

1

A couple “owns” a house worth $300,000 with $200,000 left to pay on their mortgage. They have a combined income of $150,000 per year, $10,000 in credit card debt, cars they can sell for $100,000, and auto loans of $50,000.

Total Assets: $300,000 + $100,000 = $400,000

Total Debt: $200,000 + $10,000 + $50,000 = $260,000

Net Worth: $400,000 – $260,000 = $140,000

(Note that their income doesn’t matter at all when you calculate net worth). They seem to be doing well and should continue to do so as long as their paychecks keep coming and they’re not hit by any kind of financial disaster. However, though they have a reasonably nice house and cars, their actual wealth isn’t represented by these things – debt matters.

2

A property developer has sold several units of his latest housing project for $1,000,000 and is hoping that the remainder will fetch $2,000,000 more. He still owes the bank $2,000,000 on the development loan.

Total Assets: $1,000,000 + $2,000,000 = $3,000,000

Total Debt: $2,000,000

Net Worth: $3,000,000 – $2,000,000 = $1,000,000

Even though he owes a ton of money, he’s actually rich. Of course, this is only on paper: when we calculate net worth, we use the nominal, expected value of assets. If he can’t turn the real estate he owns into cash at some point, he will be in trouble.

3

A recent college graduate owns a car worth $20,000, rents an apartment, and has $50,000 in outstanding student loans. She gives $5 to a homeless person with no credit card, no bank account, and no financial history whatsoever. After the donation, he has $7.15 in his begging cup.

what is my net worth really
Photo by Marco Verch, CC 2.0A

There’s no need to run through the calculations again. The main point here is that, in terms of net worth, a person living on the street can be “richer” than somebody with a nice job and good prospects. There’s no strong connection between net worth and lifestyle. Somebody who seems to have all the money in the world may well be “living beyond their means”: owing more than they own, spending more than they earn, and gradually sliding towards financial ruin.

What Is My Net Worth Really? How to Calculate Net Worth in a Few Easy Steps

All that remains is to find out where you currently stand financially, at least as far as the issue “What is my net worth?” is concerned, is to gather up and crunch a few numbers.

1. List and Value Your Assets

An asset is anything you own. Even if you have money outstanding on your mortgage, you can count the full value of your house as an asset (the mortgage, of course, will be listed under “liabilities”). This is not the case if you rent. Similarly, though buying a car with an auto loan and leasing one are much the same in some respects, a leased vehicle doesn’t belong to you.

The following list should cover most of your assets:

  • Your savings and checking accounts balances.
  • Retirement savings like the contents of your IRA or 401(k).
  • Securities like stocks and bonds.
  • The market value of your car and other vehicles. What you paid for them is irrelevant; the only thing that matters is how much you could get if you sold them today, otherwise known as the Blue Book value.
  • Real estate. Once again, you have to work with a number that reflects your house’s current market price – it may have gone either up or down in value since you signed on it. If you get into money trouble, you don’t necessarily have to sell it; you can take out a HELOC (“second mortgage”), but only on its current value.
how to calculate net worth
  • Money owed to you (assuming that you’re sure to get it back, like in the case of a certificate of deposit.
  • Personal effects, like your furniture and clothing, are usually not included when you calculate net worth. Not only are you unlikely to sell these (though you certainly can), the amount they’ll bring in on the open market typically isn’t enough to make a difference.
  • Intellectual property. Perhaps you’ve written a book or recorded a song (and retained the rights), or patented an invention. Unless it’s reasonably certain that someone would be willing to pay you for the copyright or patent, no fair market value can be established and it shouldn’t be used to calculate net worth. What does net worth mean if it can’t be translated into reality, anyway?

2. Count Up Your Liabilities

Remember that “liability” and “debt” are synonyms, and you need to add up all of your debts to calculate net worth accurately. In theory, this includes amounts like a parking ticket you haven’t paid yet. In practice, you need only focus on those headline items used, along with things like your monthly income, to calculate your credit score and thereby influence your ability to get a new loan. Note that, unlike with assets, it’s rarely difficult to know the exact value of a liability; you probably get an email or letter every month giving you a firm number.

Common liabilities include:

  • Mortgages
  • Car loans
  • Student loans
  • Personal loans
  • Credit card balances
  • Penalties and judgments imposed on you by a court of law. This category can cover things like child support and alimony, neither of which, by the way, can be voided by declaring bankruptcy.
  • Other types of credit like store cards and money owed to friends and family.

3. Do the Math

This step is the simplest one; just follow the formula Net Worth = Assets – Liabilities. The number you come up with may be disappointing, but you cannot deviate from the strict definition of what net worth actually means. There is often the temptation to finesse the outcome by “forgetting” short-term debt or including assets that aren’t in your possession yet, such as an expected dividend payment. Also, remember that you can’t sneak in your monthly income or expenses in any way.

What Does Net Worth Mean For My Financial Future?

There should be a game show called “What’s My Net Worth?” where people find out this important piece of information for the first time. I’ll bet plenty of people would be surprised, and it’s not unlikely that you were when you completed the exercise above. Don’t panic, though:

It is perfectly okay to have a negative net worth, as many people do at some point in their lives. Recall the third example above: a positive net worth by itself doesn’t mean that you’re doing okay. People in their twenties are often saddled with massive student loan debt; hopefully, your degree will allow you to earn enough to steadily reduce this liability. Other people may have taken the plunge and started a business with borrowed money, but have a reasonable expectation of making a profit. A negative net worth doesn’t mean you are bankrupt – this only applies when you’re unable to pay off your debts barring a miracle. The more important aspect is that your net worth is increasing over time: loans are being paid off, high-interest debts like credit cards are kept under control, and your income is rising or at least stable. If you keep this up long enough, you should have no financial worries by the time you’re ready to retire.

whats my net worth

If you have a positive net worth, congratulations! Most people don’t reach this level of stability until they’re at least 30 years old. For reference, the average (median, not mean) net worth of households in the United States is about $120,000. Your goal now should be two-fold: to grow this figure and to safeguard it against events like recessions. If this sounds like a good idea to you, you’ll probably want to split your investments between relatively safe ventures like rental properties and more volatile vehicles like stocks. Once your assets (excluding the house where you live) exceed your liabilities by $1,000,000, you’re considered an “accredited investor” by the Securities and Exchange Commission and can legally invest in even more risky investments such as pre-IPO startup companies.

If your net worth is negative and going down (or in fact only barely in the black and declining), there’s a good chance that you need to make some changes in your life or face serious trouble later on. Your first step will generally be to revise your current budget or draw one up if you haven’t already. There isn’t any kind of one-size-fits-all advice that applies here, though. In general, you either need to increase your assets or pay off some of your debt. Both are easier said than done, especially if there’s no easy way for you to improve your earning potential.

Unless you already know the cause of the problem and have some idea of how to fix it, getting help from a professional financial advisor – not Bob you know from work – will be money well spent. Their fees do sound like a lot: $100 to $400 an hour is typical, but this will almost certainly save you money in the long run.

What Does Net Worth Mean for Me?

A net worth calculation doesn’t tell you the whole story about your finances. It does, however, give you a useful and important snapshot of where you are in life.

Checking your credit score will give you much the same information, but is a different number used for different purposes. One great thing about working out your net worth is that your income isn’t taken into account. Many people think they are doing well because they earn a good salary, while not taking care to build up their assets and keep their debts under control. The thing is: assets generally endure, debts will follow you to the grave – but many kinds of income can disappear in an eyeblink. If this should happen to you, you’ll be very glad that you have a solid net worth.


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    Emily

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