When starting any journey, it is crucial to know where you are beginning so you understand the direction you need to head to reach your destination. That is why one of the first steps in any financial journey should be learning how to calculate your net worth.
What is Net Worth?
Your net worth is a measure of your financial health. It represents the value of everything that you own (assets) minus everything that you owe (liabilities). Here is the simple formula:
Assets
In the simplest of terms, assets are what you have. I like to think of assets as having two categories:
Category 1: Something that has monetary value
- Examples: Boats, Cars, houses
- These are tangible items with a market value.
- These items typically serve a tangible purpose such as shelter or transportation.
Category 2: Something that produces monetary value
- Examples: Stocks, bonds, businesses
- These assets generate income or can appreciate (grow in value) over time.
When talking about money and investing, the term “asset” gets thrown around a lot. For example, many people would describe their house as their largest “asset”. However, depending on who you ask—including me—your house might actually be your biggest liability.
Items commonly labeled as assets, such as cars, houses, and boats, are not actually assets in the way most people think they are assets. Cars, houses, and boats have value, but they consume money through payments, interest, and depreciation (loss of value), especially in the case of cars and boats.
This being said, some assets may fall into both categories. For example, a car has a market value, making it a Category 1 asset–you could go to a dealership and sell your car in exchange for money. However, cars can be used to produce value–if you use that car for a rental business or ridesharing, it also becomes a Category 2 asset because it is now producing income. Similarly, stocks have value and can produce value through dividends and appreciation, qualifying them as both Category 1 and Category 2 assets.
It’s important to note that nearly all assets that produce monetary value also have monetary value. This is because assets that generate value (Category 2) almost always possess inherent value (Category 1). Think of it as an “every square is a rectangle, but not all rectangles are squares” situation.
Liabilities
Liabilities are debts—what you owe. They represent obligations that consume your money. Just like assets, liabilities can be broken down into two categories:
Category 1: Bad Debt
- Examples: credit card balances, personal loans
- This refers to debts that do not contribute to generating future value.
Category 2: Good Debt
- Examples: mortgages for rental properties, business loans
- This includes debt used to acquire Category 2 assets, which can generate future income.
How to Calculate Your Net Worth
Now that we have defined assets and liabilities, we can move into how to calculate your net worth.
When calculating your net worth, you look at everything through a Category 1 asset lens. We calculate the value of every asset that you own and subtract everything that you owe.
There are two schools of thought when it comes to calculating net worth. You can calculate your total net worth and your liquid net worth. Liquid net worth is only different from total net worth because it does not include any debt associated with your primary residence.
Now that we have a background understanding of net worth calculations, let’s dive into a few examples.
I’ll use my current financial picture as an example:
1. Let’s tally up my assets:
- Cash (Emergency Fund, 3 Months’ Rent, Down Payment): $21,181.95
- Investments (401k, Roth IRA, TSP): $27,034.49
Total Assets: $48,216.44
All of my assets are liquid assets, meaning that I can spend them with relative ease. For example, I could sell all of my stocks, cash out my brokerage accounts, and spend all of my money. I am not going to do that, but I could.
Note: I do not include the value of my car, which I own, in my calculations, because I view it as a depreciating asset. While it may have some value if sold, its worth decreases over time, and I don’t rely on it as a source of financial security. I want my net worth calculations to reflect the long-term.
2. Let’s look at my liabilities:
- Student Loans: $2,000
Total Liabilities: $2,000
3. Let’s calculate my net worth:
To arrive at my net worth, we subtract my liabilities from my assets:
$48,216.44 (Assets) – $2,000 (Liabilities) = $46,216.44 (Total/Liquid Net Worth)
So, as of September 1st, 2024, my total and liquid net worth is $46,216.44
Since all of my assets are liquid, my total net worth and my liquid net worth are equal to one another. To illustrate the impact of having non-liquid assets, let’s consider our imaginary friend Bill (as in dollar) for a more complex example involving both liquid and non-liquid assets.
A more complex example with a mortgage:
For this example, we are going to calculate Bill’s net worth. Bill is 30 years old, lives in Minnesota, and possesses an average amount of assets and liabilities in this example.
1. Bill’s Financial Picture:
- Bill has a home in Minnesota, and as of the time of writing this article in 2024, the average home price in Minnesota is $340,000. He purchased the home in 2021 for $290,000 and since then has paid about $20,000 towards the principal of his mortgage.
- Bill went to college and possesses the average student loan debt of $28,950.
- Bill has the average credit card debt for a 30-year-old of $4,110 (side note – make sure to pay off your credit cards on time and in full every month if you are able).
- Bill has $11,250 in his savings accounts.
- Bill has a retirement account balance between his 401(k) and his Roth IRA of $41,250.
- Bill owes $8,000 on his car.
2. Let’s Tally Up Bill’s Assets:
- Home Equity: $340,000 (Home Value) – $290,000 (Mortgage) + $20,000 (prior payments to the principal of his mortgage) = $70,000
- Bill’s home equity represents the portion of his house that he owns outright. It is calculated by subtracting the remaining mortgage balance from the total value of the house. Since Bill still owes money on his mortgage, he only owns a fraction of his home.
- Cash: $11,250
- Investment Ballance: $46,250
Total Assets: $127,500
3. Let’s Look at Bills Liabilities:
- Mortgage: $290,000 (Mortgage) – $20,000 (Principal Payments) = $270,000
- Bill’s primary liability is his mortgage, which reflects the amount he still owes to the bank for his home. The equation above illustrates this outstanding balance.
- Student Loan Debt: $28,950
- Credit Card Debt: $4,110
- Car Loan: $8,000
Total Liabilities: $311,060
4. Total Net Worth
To calculate Bill’s total net worth, we simply need to subtract Bill’s liabilities from his assets.
$127,500 (Assets) – $311,060 (Liabilities) = -$183,560 (Total Net Worth)
Therefore, Bill’s total net worth is -$183,560.
5. Liquid Net Worth
To calculate Bill’s liquid net worth, we need to subtract Bill’s liabilities that are not tied to his house.
Bill’s liquid assets are as follows:
- Cash: $11,250
- Investment Ballance: $41,250
Liquid Assets: $52,500
Bill’s liabilities without his house are as follows:
- Student Loan Debt: $28,950
- Credit Card Debt: $4,110
- Car Loan: $8,000
Total Liabilities: $41,060
Now, to calculate his net worth, we subtract his liabilities from his assets:
$52,500 (Liquid Assets) – $41,060 (Liabilities) = $11,440 (Liquid Net Worth)
Only looking at Bill’s liquid net worth paints quite a different picture, right?
Being able to calculate these numbers is great, but these calculations are ultimately useless if we don’t know what to do with them. So, without further ado, let’s discuss why calculating your net worth is important and how to use this number as a benchmark to guide your course to financial independence.
Why Your Net Worth is Important
Knowing your net worth is a phenomenal way to keep a pulse on your financial health.
Is your net worth going up month after month? Awesome! Keep doing what you are doing and search for opportunities to increase your net worth.
Is your net worth going down each month? That is okay! It’s a good thing to know. You can’t make any meaningful change if you don’t realize there is a problem. Now that you know, you can look at your finances, pinpoint what things are causing your net worth to decrease, and take action to mitigate them.
Ideally, the general trend of your net worth is up and to the right. Notice how I underlined “your”? Your path to financial freedom is your own. Your net worth is not a way to compare yourself to others, but a tool to compare your financial health now to a point in the past.
Everyone has their own take on how to calculate their net worth. My liquid and total net worth model is not the end-all-be-all way to calculate your net worth. The most important thing when calculating your net worth is to calculate it the same way month over month so that it can be used as the tool it is meant to be.
How Often Should You Calculate Your Net Worth?
When considering how often to calculate your net worth, think about the purpose of doing it. Your net worth is a tool to benchmark your financial health. A tool must be used in order for it to be effective.
So, calculate your net worth however often you need to in order to effectively keep track of your financial health. Are you detecting a pattern here?
Personal finance is personal. I calculate my net worth monthly because I am a personal finance nerd who loves to get freaky in the Excel sheets. I enjoy it.
But you could calculate your net worth monthly, quarterly, biannually, or yearly. I think the sweet spot is somewhere between monthly and biannually. I would not calculate your net worth more frequently than monthly.
So, how often should you calculate your net worth? The answer is however often it takes for you to know where you stand in your finances.
Conclusion
Calculating your net worth is a crucial step in gaining a clear understanding of your financial health. Remember, net worth is not just a number—it’s a tool for financial empowerment. More importantly, it is a tool for YOU, not for comparisons to others.
Whether your net worth is positive or negative, knowing where you stand is the first step toward improving your financial future. Use this knowledge to set realistic goals, make informed decisions, and chart a course toward greater financial stability and success.
I wish you prosperity on your journey towards financial independence. Remember, financial freedom isn’t achieved overnight, but rather through consistent, informed decisions made day by day. Until next time, chase your “Freedom by the Day!”