You know how much you earn. You probably know your credit score, too. But there’s another equally important number that you might be neglecting: your net worth.
Although having your entire life boiled down to a single number can seem intimidating, that’s exactly what your net worth does. And it’s crucial you know it.
According to Kaya Ladejobi, a certified financial planner (CFP) and founder of Earn Into Wealth Strategies, your net worth is “a measure of your true overall health.” So are you financially healthy? Here’s how to find out.
How To Calculate Net Worth
The formula for calculating net worth is simple: Add up everything you own that has value (assets) and then subtract everything you owe (liabilities). However, figuring out what belongs in those two categories can be a bit tricky.
Let’s break it down.
When it comes to your assets, there are a few items you should always include. “Typical assets include financial assets, such as cash, stocks, bonds, retirement accounts and other financial instruments,” said Ladejobi.
What about property? This tends to be a point of contention among financial professionals. On one hand, assuming your home’s value increased over time, the equity you gained is an asset. But if the Great Recession taught us anything, it’s that you shouldn’t bank too heavily on the future value of your home. Plus, your home also costs you money every month; there’s the mortgage, insurance, property taxes, maintenance and household items that need replacing.
Your best bet is to consider your home and any other property to be both an asset and a liability. “The key thing is to be honest with yourself and try to factor in what the true value of your assets are, so you don’t inflate your net worth,” said Ladejobi.
When it comes to equity in a business or other passive income streams, David Clarken, a chartered financial analyst, CFP and the owner of fee-only financial planning firm FWI Wealth Management, says you should answer three questions: “What’s the cash flow stream, what’s the likelihood you’re going to receive it and how long do you expect to receive it for?” You’ll also want to consider the risk associated with that business when estimating the value of your ownership.
It’s also important to note there are certain possessions that should not be counted as assets. Included in that group, according to Clarken, are things like restricted stock, options or any other ownership that vests over time.
“Nobody’s going to buy a used engagement ring. Especially for what you paid for it.”- financial analyst David Clarken
“Anything that’s on your asset side of the equation should be two things: liquid and marketable… meaning you could sell it quickly and for the price that it’s worth,” he explained.
So that means personal property, such as a baseball card collection or jewelry, should be left out of the equation no matter how valuable you personally feel it is.
“Nobody’s going to buy a used engagement ring,” said Clarken, “Especially for what you paid for it.”
On the other side of the equation are your liabilities. According to Ladejobi, typical liabilities include student loans, credit card debt, car loans, mortgage debt, home equity debt and medical bills.
“Factor in all debts that you are on the hook for,” said Ladejobi. “This includes any debts that are in your name, as well as any debts you may have co-signed for other people,” she said, since you are 100 percent responsible for that debt if the primary borrower can’t pay.
It’s usually a good idea to include a vehicle, such as a car, motorcycle or boat, in the liability category unless it’s a classic or a brand-new vehicle you paid cash for. Vehicles depreciate in value rapidly, as well as cost you in fuel, insurance and maintenance on top of any loan you might have.
What Should Your Net Worth Be?
Once you take the time to calculate your net worth, your next question will likely be how you stack up. It’s only human nature to compare ourselves to our peers. But when it comes to net worth, there’s simply no one-size-fits-all answer. In fact, according to Clarken, your net worth as a standalone number doesn’t actually mean anything.
“A 25-year-old who is just graduating from law school and hasn’t had a real full-time job yet will have a different net worth than a 25-year-old who has been in the workforce for four years,” explained Ladejobi. Neither of these two situations is right or wrong ― they’re just different.
Rather, Clarken suggested evaluating your net worth according to what you think it should be, given your goals down the road.
“We can all give rules of thumb,” Clarken said. “The problem is it might sound great and generally apply to some groups of people, but it almost never applies specifically to any one person.”
The bottom line, he said, is that if you are worried that your net worth is not what it should be, sit down with an expert and find out. And despite the fact that net worth is an important number to know, don’t get too hung up on yours.
“A more important measure than net worth is whether you’re making changes on a regular basis that are tracking toward a positive outcome,” Clarken said.