Ever wondered what you are worth in monetary value? In this article, we will determine what net worth is, how to calculate it, and why it is important to track.
So what is your net worth?
You determine your net worth by summing up all that you own (Assets), summing up all you owe (Liabilities), and then subtracting the liabilities from the assets.
What is net worth in detail?
Net worth is a snapshot in time of your financial situation. It helps you to answer the question of how wealthy you are. People that want to become wealthy will keep track of their net worth and want to see it grow on a year-on-year basis.
If you want to take a bank loan or a mortgage for example, usually the bank or other financial institutions will want to know your net worth in order to determine the amount that they will lend you. This is called loan-to-net-worth-ratio. A bank might also look at your net worth to determine how much of your wealth you can invest in stocks, bonds, or other financial assets. Additionally, it can also be used for your retirement planning. Based on your income it is possible to calculate a target net worth to see by when you can retire.
What’s important here is that if you want to build up wealth, you should keep track of your net worth, and aim to grow it year on year.
How do I calculate my net worth?
You calculate your net worth by summing up all that you owe that has a monetary value (Assets), summing up all that you owe (Liabilities), and then subtract the liabilities from the assets.
FORMULA: NET-WORTH = ASSETS – LIABILITIES
The result can be positive or negative.
If the result is negative, it means that you are in debt. This could be due to a student loan, over-borrowing, or buying depreciating assets.
What are Assets
In general, you can count everything towards your assets, that you own and has a monetary value, based on the price you could sell it today. There sometimes is a distinction made between tangible and intangible assets.
Intangible assets are patents, trademarks, copyright, or similar. Usually, these are difficult to quantify and therefore it’s questionable if you should include them, as their value is difficult to determine. They might hold future value, but as long the value hasn’t materialized, it might be better to not include them in your calculations.
There are certain assets such as Vehicles, Furniture, and Electronics, that lose their value very quickly after purchase.
One good example of a depreciating asset is a car. A car will lose 20% of its value within the first year you’ve bought it. Then for the next four years, it will lose around 10% annually. If you for example buy a car for $60’000, after the first year the value has decreased to $48’000. In year 2 the value will have fallen to $42’000. In year 3 the car will be worth $36’000. In year 4 it will be worth $30’000. And in year 5 it will be worth $24’000. So your car might lose value at a faster rate than you can pay back your loan.
Another good example of a depreciating asset is a TV. A TV will lose around 40% of its value within the first year, and another 20% in the second year. So if you take a loan to buy a TV for $4’000, it will be worth $2’400 after the first year. And $1’600 after the second year.
If you want to increase your wealth you should avoid buying depreciating assets.
If you, however, really need a car, it might be more advisable to buy it secondhand. If you don’t require Cable TV, and your primary media sources are YouTube and Netflix, you can buy a cheaper computer screen instead of a TV and hook up your laptop or mobile. This will not only save you money on the TV, but you can also avoid paying for the Cable TV channels.
There are also use cases where it makes sense to buy a depreciating asset. If you, for example, are in the Taxi business, and your clients want to travel comfortably, then it makes sense to buy a new car, as the clients will pay for the premium. If you are in the transportation business, then it might make sense to buy a new bus.
Airlines purchase new planes, which are also depreciating assets. They need to be concerned with the passenger’s safety, and demand to travel comfortably. And for that, they can charge the customers a premium too.
Assets such as a property (land, house), for example, will usually keep their value. House prices can increase or decrease over time, depending on demographics and demand. Antiques and Art usually also don’t lose their value. If you have money invested in shares of good companies that pay a dividend, the value fluctuates but can increase over time. If you own a rental property, you will get paid the rent. You might have taken up a mortgage for the property, but as long the housing market stays stable, and it’s rented out, you can use the rent of your tenant to pay back the mortgage, and might even have something left.
Illustrated below is a list of typical assets that you can count towards your assets.
- Bank Accounts
- Pension Money
- Mutual Funds
- Retirement Funds
- Life insurance
- Apartment / Condo
- Rental Properties
- Commercial Properties
- Airplanes / Helicopters
- Other valuable collectibles
What are Liabilities
Liabilities are debts that you owe to other people, companies, or the government. This can be credit card debt, mortgages, diverse types of loans, or unpaid taxes.
- Home mortgage
- Mortgage of rental properties
- Mortgage of commercial properties
Loans / Dept
- Car loan
- Student loan
- Credit Card dept
- Tax dept
- Other depts
Sample net-worth calculation
Below you can see an example of a net worth calculation with a positive net-worth. On the assets side, you have $1’200 stored at home, $12’300 and $14’200 in the bank, a mutual fund with a current value of $25’280, a house worth $450’200, and a car worth $6’500. On the liabilities side, you still need to pay back $320’000 for the house, and you have a credit card debt of $2’500. If you now subtract the liabilities from the assets, you end up with a positive $187’180, which is your net-worth.
If your outcome is negative, then it means that you are in debt. In that case, you should first focus on settling your debt before investing, as you will have to pay interest on the dept, which would most likely negate gains of investments.
|Bank Current Account||$12’300|
|Bank Savings Account||$14’200|
|Credit Card Debt||$2’500|
Assets – Liabilities = Net Worth: $509’608 – $322’500 = $187’180
How to keep track of my net worth
In general, you can measure your net worth whenever you need to. Usually, it boils down to checking whether or not you have enough money for an investment or to track your financial situation.
We suggest tracking your net worth year-on-year. You can use a net worth tracker such as the one below to keep track of your net worth growth. Each year, you will calculate your net worth and add the new amount to the tracker below. If you subtract the 2019 value from the 2020 value ($187’180 – 146’080 = $41’000), you will be able to capture the “Change”. If you have, for example, put efforts into cutting down costs on spendings, or you have increased your income, the “Change” should be higher, which indicates that your net worth is increasing faster.
Once you went through calculating your net worth, it will be easy to do it on a year-on-year basis. You might be asking now why we only do this yearly. It’s because we will use another method to calculate and track our savings every month in the “How to manage your cashflow” article.
We recommend using a spreadsheet to do your calculations, such as Microsoft Excel, Apple Numbers, or Google Sheets. But in case you want to take a quick glimpse, you could use a tool such as a net worth online calculator such as the one on financial-calculators.com.