It sounds like something we say only when referring to the filthy rich people of the world, doesn't it? We'd say things like, "Jeff Bezos has a net worth of $148B", but what does that really mean?
Put simply, net worth is the total value of your assets less the total value of your financial liabilities. If your assets are worth more than your liabilities you'll have a positive number. If your liabilities are worth more than your assets you'll have a negative number.
An asset can be defined as:
"An item owned by a person or company, regarded as having value"
Examples are things like your:
House
Car
Boat
Cash
Investment property, etc.
Stick to the big ticket items. I wouldn't include small items like lawn mowers, kitchen appliances, and things of that nature as "assets" in this context.
A financial liability can be defined as:
"An obligation to deliver cash or something similar to cash"
Liabilities are basicslly debts that you owe.
Car loan
Mortgage
Credit card debt
Student loans
Your mate you owe $100 from the beers you couldn't afford on the weekend
Why is important to know for the everyday person?
Understanding what assets you own and what liabilities you owe helps with financial decisions on your wealth building journey. Growing your assets and shrinking your liabilities is always the goal.
I've met people in my life where I've thought wow, they're rich. They'd have the newest $100k SUV, a 5 bedroom house with a pool, top of line appliances. You name it, they had it. That's what I thought "rich" was. To keep things simple for the explanation, let's put all of the items I mentioned in the "asset" bucket.
Now here come the "liabilities". Factor in that their SUV is leased at 4% for 4 years, the mortgage is higher than the house value, and the appliances are rent-to-own or lease arrangements from a local department store.
The people in this example have more debt than they do assets. So what you see as wealthy on the surface can be at times poor in reality. This would be an example of negative net worth.
Once you know your net worth number, you can assess if a financial decision will improve your number, or dip into the negative further.
Is it bad if I have a negative number?
Absolutely not. Sometimes it's necessary to drive your net worth lower in order to grow it higher in the future. Student loans are a perfect example of this. You have to invest in education fees to get a qualification that will - hopefully - land you a job with a higher income in the future. For this, it makes perfect sense to take a step back in order to take 3 steps forward.
Help me calculate my net worth
Ok, so we're going to list all your assets (car, house, boat, investments, cash, etc.) on one side, and list all your liabilities (mortgage, car loan, personal loan, credit cards debt, etc.) on the other side. List the values of each and total them at the bottom of the column. Here's an example of what it could look like:
Example net worth illustration
It's important to note that you list the "current value" for your assets and liabilities, as your net worth is a snapshot of your financial situation and will change over time.
Figuring out your asset values
For some assets like cash, it's easy to know their current value. You check your bank balance and it's there. For others, it can be a little bit more difficult.
House (a few options to choose from):
Use your purchase price - Depending on how long ago you purchased your home, this could be a good number to use. Generally (not always) house prices tend to go up, or "appreciate" over time, so if your house is over 10 years old or you live in a rapidly growing area this option might not be the most accurate for you.
An online valuation tool - These are known as AVM's or "automated valuation models". They use data like recent sales in your area along with some specifics about your property to try and predict what your property is worth and spit out a value range. This value will vary depending on which website you use so I'd recommend using a few and taking an average if you're going to use this method.
Professional appraisal - This is the most expensive but by far the most accurate way of determining the current value of your property. This is a requirement before you sell your house too, but you could choose to do this every few years to ensure you're capturing the most accurate price for this asset.
There are more options you could use like evaluating comparable properties, but 've just listed the ones I think could be most useful to you. My house in Canada isn't in a "high-growth" area and isn't too old, so I choose to use the purchase price in my calculator.
Car
I like to use an online tool for this. Just plug in your cars details or VIN number and it will spit out a range for current estimated value. Cars depreciate like crazy over the first 3-5 years so recalculating each month makes sense in this situation and is especially important to know if you run a business and use the car for that purpose as it has tax implications. Anyway, use a few tools and take an average to get a good estimate for your cars worth.
Investments
Most investment accounts have online platforms or apps that you can log into to see what your portfolio is worth at any point in time. For real estate investments, refer to the house section above. For retirement and other investment fund accounts, log into your account at the end of each month and plug that value in.
Here's what my net worth is comprised of
This is a snapshot of what makes up my net worth, represented with percentages.
As you can tell, the mortgages make up the bulk of what we owe. The goal is always for us to increase our assets while lowering our liabilities (paying down debts).
A good practice to adopt is to calculate your net worth at the end of each month and track it over time. Your number may rise and fall and not be a straight upward trend from month to month, but if you're making good financial decisions you should see your net worth climb in the long run.
We'd love to hear your thoughts on this topic or if you have any questions. Give us a shout in the comments below or follow us on Instagram.
Blake - FIRE with a family