What is Net Worth and Why is it Important?
Net worth is a commonly-used measurement of wealth, but what does it really measure and why should you care? There is no one “right” net worth. Even the idea of a “good” net worth varies widely from person to person. But, tracking your net worth over time can be a powerful method for evaluating your financial health.
How do I calculate my net worth?
You calculate your net worth by adding the dollar amount of all of your assets and subtracting the dollar amount of any liabilities. Assets are anything owned that has monetary value. This includes checking and savings account balances, the value of investment accounts, property values for real estate (including your home), and the market value of any automobiles or other valuable possessions. Liabilities are also known as debts. These include any amount you owe on mortgages, car loans, student loans, and any outstanding credit card balances.
What does my net worth mean?
Tracking your net worth over time can be a good indication of your financial health, without the need for detailed budgeting. If your net worth is increasing, you are saving more than you are spending. The rate at which your net worth is increasing can be a good indication of the pace at which you are working toward your financial goals, and can help give you a clue as to whether or not your goals are realistically achievable.
If your net worth is decreasing, you may need to make changes in order to make your financial plan work. A decreasing net worth may indicate that you need to reevaluate your savings rate, spending habits, investment choices, or all three.
What is liquid net worth?
One common type of net worth is liquid net worth. Liquid net worth is a measurement of the amount of wealth you can access quickly, if needed. You calculate your liquid net worth by adding the dollar amount of all of your cash and cash equivalents and subtracting the dollar amount of any liabilities. Cash equivalents are assets that can be easily converted into cash, such as treasury bills or notes, certificates of deposit (CDs), or money market funds. Examples of assets that are included in your net worth but excluded from your liquid net worth are real estate holdings and retirement accounts.
What does my liquid net worth mean?
Liquid net worth is an important measurement of your financial stability, because it shows how much money you have available for unexpected events, such as the loss of a job, an unanticipated home or auto repair, or a true emergency.
Even financially savvy individuals can be surprised by how much lower their liquid net worth is than their net worth. Diligent savers often use their assets to save for retirement, pay off their debts, or purchase valuable property. These actions may improve their net worth, but not their liquid net worth. In fact, using extra cash flow in these ways can decrease your liquid net worth. That is why it’s important to understand the differences between the two, and interpret the two numbers accordingly.
Know your net worth
We can’t tell you what your net worth should be – because a good net worth will look different to everyone reading this article. But, we can tell you to know your net worth, as well as your liquid net worth. Tracking your net worth year-over-year, can help you draw a picture of your financial health over time. It can help assure you that you are on the right track, or persuade you to make necessary changes. Knowing your liquid net worth can help you be confident that you are ready to face life’s many unknowns. If you’d like help calculating and evaluating your net worth, reach out to your Affiance Financial Planner today.
