What is Net Worth?
The term “net worth” gets thrown around a lot as an essential financial value that you should pay attention to.
Indeed, it is a metric that you should have a vague knowledge of. But probably not for the reasons you are thinking.
It can be a bit misguiding.
Before I get into why that is, let’s first go over how to calculate your net worth, in the traditional sense.
How to Calculate your Net Worth
Calculating your net worth is a bit like calculating your personal budget.
On one side of the equation, you have the good stuff. With budgets, it’s income. With your net worth, it’s your assets.
On the other side of the equation, you have the bad stuff. With budgets, it’s expenses. With your net worth, it’s your liabilities.
What goes into each column?
- Your assets typically consist of:
- Home Value: How much your home is worth on the market
- Cash: Checking account, savings account, cash
- Retirement Accounts: Total value of your 401K’s, IRA’s
- Non-Retirement Investment Accounts: personal investment accounts
- Depreciating Assets: Market value of your vehicles and other personal property (excluding home)
Your liabilities consist of:
- Mortgage/Home equity loan debt
- Student loan debt
- Auto loan debt
- Credit card debt
- Any other outstanding debt
What is Net Worth?
The definition of net worth is the total value of what you are worth on paper with the categories listed above as guidance. After you’ve done that:
Net worth = total assets – total liabilities
Mint.com will email you your net worth on a weekly basis, if you’d like to make it really easy.
But is it something you should even worry about?
Why it can be Misguiding
Many people think that net worth is synonymous with their ability to retire. To do that opens up potential for disaster.
You need somewhere to live. Unless you plan on drastically downgrading your home when you retire or move to a much cheaper part of the country or world, your home equity is completely irrelevant to your ability to retire.
Also irrelevant is the value of your vehicles, jewelry, and other personal property – unless you plan to sell them all.
And yet a third irrelevant category, if you plan to retire early, is your actual retirement accounts! If you plan on withdrawing before the age of 59 and 1/2, you’ll be heavily penalized and taxed in many cases. When you turn 59 and 1/2, absolutely, these should be considered assets. But until then? I wouldn’t do it.
Do not equate net worth with retirement unless you plan on making drastic changes when you retire.
In fact, there is a way to make net worth more usable.
What is Net Worth Good for then?
Not much, to be honest. It’s an over-rated financial word.
However, there is a TON of value in mapping out your assets and your liabilities in order to gain actionable financial insights.
For example, if after mapping out your assets and liabilities, you realize that you are up to $20,000 in a savings account and you have $10,000 in credit card debt that you are paying 12% interest on, that can be an incredibly valuable insight to take action on.
Does that insight have anything to do with “net worth”. No.
Calculating your net worth just for the sake of calculating it might have some value if your goal is to make your peers at the local yacht club feel insignificant. Otherwise, the value is in mapping out your assets and liabilities.