The term “net worth” gets thrown around a lot as an essential financial metric 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, as 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?
Assets
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)
Liabilities
Your liabilities consist of:
- Mortgage/Home equity loan debt
- Student loan debt
- Auto loan debt
- Credit card debt
- 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.
Why?
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. And, for many Americans, most of their net worth is in the form of home equity.
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, the value you receive minus taxes should be considered assets. But until then? It’s a flawed, over-inflated number.
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 overrated financial metric.
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.
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I disagree that until you hit 59.5 you should not count your retirement vehicles. You can remove your contributions to your Roth without penalty before 59.5 and you can remove money from your 401k if they are equal payments (72t), though I would not recommend it.
How far do you take that though? Do you count estimated social security payments or pension payments as part of net worth when you’re 30 years old? The point of retirement accounts is that you don’t access them until you retire barring some major emergency. When you retire, absolutely include them.
Last time I checked, I believe social security are taxes we pay to the federal government that sets up a so called retirement for the nation as a whole in which the taxpayer really has no control over. As for pensions the funding is not from the individual which means again we have no control over it and its really not your money. So yeah of course you dont take it that far.
You wouldnt not include the value of a rental property if you have no intention to sell it for the next 15 years would you?
I agree with your point that net worth can be taken wildly out of proportion – I tend to look at it the way you explain, to have a rough sketch of my assets and liabilities in order to gain insight for personal finances … and nothing more. When I looked at my assets and liabilities last year, I realized that I could begin to start paying extra principal on my student loans in order to try and accelerate the elimination of that debt.
Nice post, G.E. However, I have to disagree on a few of your points.
Retirement accounts are assets and should be included in the net worth calculation. Retirement funds are technically available at any age in the event of a financial hardship (or other reasons depending on the type of account – despite the nominal penalty)
Although people shouldn’t be fixated on their net worth, they also shouldn’t entirely dismiss it, which is what you seem to suggest in this post. Net worth, as you define it, is an important number which lenders calculate when they determine your financial health and ability to repay a loan. I think people should periodically calculate their net worth, including its growth rate, to make sure their financial situation is healthy and improving.
Joe
Interesting perspective. I think it is healthier than most. I read a great ‘net worth’ definition though that changed how I view it though. It described NW as the assets you could live on without your labor. So, I would not count home equity or retirement accounts unless you are retired or have a reverse mortgage.
Personally, I don’t think home equity counts; as we can see from recent years, real estate is not a great back up plan. You may not get what you paid for a house nor what you’ve put into it, and there is no promise that you can sell when you need the money. I tend to count only my assets that generate dividends (which, at 26, I reinvest) that I could use to fund my lifestyle if I wanted. Even though I max my Roth and 401k, I wouldn’t count that $21,500 because I can’t tap it for that value.
Because people tally NW so many different ways, I would agree it isn’t something to be fixated on. But, like you pointed out, it can provide insight to manage money better. When you realize you are in the hole, you reach for a shovel and find the angles of exit!
Good article G.E. I agree that people who are concerned about ‘net worth’ mainly care about it so they can feel good about themselves if it’s a big number. You’d have to be a snapperhead to go around telling people what your net worth is :)
That being said, I agree with the earlier post that it can be a good indicator of financial health. But I don’t think most people need to set up a balance sheet to figure out if they’re financially healthy. I think it’s mostly common sense…Are you carrying around revolving credit card debt? Are you not able to put away money into savings & retirement accounts? If the answers are yes then you need to rethink how you manage your money and make some changes.
It provides you with peace of mind, like a safe home. Knowing your net-worth can help you realise if you need to increase your income level to support retirement in the long run or if you are on the right path.
I view net worth as a way to track your progress towards goals.. Obviously the overall goal being to INCREASE your net worth on a monthly/yearly basis. Like everything, take it with a grain of salt and realize nothing is perfect.
:)
So net worth has nothing to do with the value of fishing equipment?
If the equipment produces enough fish for you to save on your groceries….. perhaps. Haha.
Is the lump sum payment of your pension plan be ncluded in your net worth?