Calculating your net worth, or personal wealth number as it is sometimes called, sounds much more difficult than it is. It is a very simple calculation that often requires just a few entries in a spreadsheet. It can even be done for you automatically by using an online service like mint.com. But for some reason, very few people know their net worth and even less track their number over time.
There are three steps to calculate your wealth number:
- Make a list of all your assets
- Make a list of all your debts
- Subtract your debts from you assets
Here are the steps in greater detail:
Contents and Quick Links
Make a list of all your assets
Assets will include everything you own that has value. Things to include:
- Home value
- All banking, investment and retirement accounts
- Stocks, bonds
- College savings accounts
- Current value of vehicles
- Valuables (fine jewelry and artwork)
- Overall estimate of everything else (anything that would sell at a garage sale or on ebay and you wouldn’t just donate)
Personally, I don’t include the small things, like my clothes or TV. Instead I imagine that if I held a garage sale and wanted to sell everything in my house, what is a rough estimate of what I’d make?
Try not to get caught up in the details with this step. It’s really up to you how detailed you want to be when you list your assets. This could just come down to your personality type. Are you super detail oriented and want to know down to the dollar how much you own? Or do you want a basic estimate? If you feel compelled to list off everything you own down to those hand weights in the garage that are collecting spider webs, go for it. It doesn’t hurt to have a clear idea of just how much “stuff” you have accumulated over time and what the value is now.
Also, be aware of any emotional bonds you feel between you and your stuff.
I really try to be objective here. For example, I have an antique chair that I love. It’s perfectly sized for my 5’1” frame. It has horse hair stuffing. I don’t own a horse anymore, and I dearly miss having horses in my life. It’s the silliest thing but I LOVE that my chair has horsehair stuffing! I found this chair at a little antique shop in a cute little beach town, while strolling along with my close friend. It didn’t even matter to me that the chair was a hideous pink color. I had it reupholstered. It took combing through at least 15 websites selling an infinite variety of upholstery fabric. If you ask me how much this chair is worth, I’ll tell you it’s worth at least $5,000.
To me. But, really. Would someone buy this off craigslist and how much would they haggle the price down before handing over the cash? My chair is probably worth about $150. I don’t bother to include it in my overall net worth calculation.
My rough estimate comes from imagining that I put everything out on my front lawn, hold my yard sale, and at the end of the day I’d probably have about $2,000 for all my stuff. So this is the number I use.
Make a list of all your debts
Here is where you will include the remaining loan amount on your house and vehicles, credit cards, student loans, personal loans, etc.
Add them all up and subtract debts from assets.
Net worth = Assets – Debts
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Why is it important to calculate your net worth?
Indicator of financial health:
Your net worth is a metric for assessing your overall financial health. Some important indicators include:
A negative net worth
This is often the case for younger individuals just finishing up college or entering the workforce. Student loans and not enough time earning income to build up net worth are common causes for this. If you take on too much debt, this can also lead to a negative number.
A positive net worth
This is a great indication that you are on the right track and your debts do not exceed your assets. The next goal is to work on increasing your total net worth.
Changes in net worth over time
Once you calculate your net worth and know exactly what your personal wealth number is, any small changes you make in your personal finances will have clear implications. If you buy a new car and take out a loan for it, you will see a clear decrease in your net worth. Conversely, if you increase your savings and contribute to your retirement account, which earns a 15% return during a good year, you will see a very clear increase in your net worth.
Another benefit to tracking all of your assets and debts is just knowing what opportunities may be available to you. If you know what your equity is in your home, you may consider opening a line of credit in order to have funds easily accessible. When an opportunity presents itself, like furthering your education, launching a side business or investing in real estate, you know exactly how much cash you could have to invest with. Simply being able to act on opportunity can open doors and grow investments that you never would have known existed before.
Highlight and monitor problem areas
As you go through the process of listing all your assets and debts, you may come across problem areas. This is a great opportunity to track these weaknesses and brainstorm how to make improvements. As an example, let’s say you have some high interest credit card debt that you’re working on paying off. Every month you make $100 over the minimum payment and know that it will take you 15 months to pay off completely. When you calculate that debt into your overall wealth number, you realize that you could use your home equity line of credit to pay off the credit card debt in full and then work on paying back the line of credit at a much lower interest rate. Without writing out the details and amounts of every debt and asset, you may not realize what various options and strategies are available to you.
Small changes make a big impact
Once you start tracking your net worth, it is really fun to think of ways to increase your wealth number and watch that number grow over time. Small changes and decisions that you make in your personal finances begin to make a big impact. As you see this number increase you start to think about additional ways to budget and save as opposed to spending without much thought.
I tracked my net worth for a couple of years before investing in my first rental property. I saved enough money to purchase a duplex with a partner at auction and then hired a contractor to make the repairs necessary to rent the units. While it felt like I was handing over all of my savings, when I input all the numbers into my net worth spreadsheet, my wealth number almost doubled! This is because I purchased an asset that was undervalue, added value to it by fixing it up, and then it had a strong market value well above my purchase price. This was instant wealth generation.
I wouldn’t have been nearly as excited about the steps necessary to invest in my first rental property if I didn’t have some idea of the impact it would have on my wealth number. Once you track those numbers, small changes in personal finances or investment strategies begin to show huge potential.
The beauty of calculating your net worth is that it covers every area of your finances in just one calculation. It is an overall snapshot of your financial health. As powerful as it is to run through the calculation for the first time and discover where you stand, it’s even more powerful to track your progress over time. This is how you know where you are on your path to financial independence and how long or short your path is. The faster you see your wealth number increasing, the shorter your path will be. This can act as a really powerful incentive to keep making positive changes to build wealth. Which leads me to my final reason for why it’s so important to calculate your wealth number.
As you track your number, a few things become very clear to you. When you invest, your net worth goes up. Or, when you spend, your net worth goes down. As you track your progress, you find ways to make that number continue to rise. This can be the motivation you need to make important decisions and plan your path to FI.
Now that I’ve stepped through the process of calculating your personal net worth as well as some reasons why you would want to do this, it’s time for some practical examples.
Remember Joe and Rebecca?
You can read about them in Personal Finance: Winning the Team Trophy but Losing at Life, and again in How to Calculate Your Savings Rate – And Why You Need To.
Joe is an attorney and Rebecca is a nurse. They paid $1.35 million for their home 3 years ago. The remaining mortgage is $1.03 million and it’s current value is $1.5 million. They have two newer BMW’s, total owed is $56,000 and value is now $48,000. Collectively they have $100,000 in their retirement accounts and $5,000 in their bank accounts. They have $5,000 in credit card debt. Total value of their various possessions is approximately $9,000.
Step one is to calculate total assets:
Step two is to calculate total debts:
|Credit card debt||$5,000.00|
Step 3: Subtract debt from assets
Net Worth = Debt – Assets
Net Worth = ($1,662,200 – $1,091,000)
Net Worth = $571,200
While Joe and Rebecca have a terrible savings rate and a lot of debt, their overall net worth is positive. With a low savings rate they will find that their net worth increases slowly over time as their home is paid down and appreciates over time, they continue contributing to their retirement accounts and pay down their auto and credit card debts.
As we saw later with the post How To Calculate Your Savings Rate – And Why You Need To, Joe and Rebecca were able to make some adjustments to their personal finances and increase their savings rate from 4% up to 38.4%. They converted their basement into a rental unit to help cover their mortgage, replaced their overpriced luxury cars with less expensive cars requiring less maintenance and moved their kids to the nearby public school. By making these changes they will now see a nice improvement to their net worth as they track it over time.
Calculating your net worth is well worth the effort. It can be done in just three steps.
Step 1: List all your assets
Step 2: List all your debts
Step 3: Net worth = Assets – Debts
There are many benefits to calculating your net worth.
- It’s a great Indicator of your financial health
- It allows you to highlight and monitor any problem areas
- It becomes clear that small changes to your personal finances can make a big impact
- It’s a great way to track your financial progress
- It’s a great way to stay motivated
You know what you need to do.
- List all your assets
- List all your debts
- Calculate your net worth
- Continue monitoring every 1-6 months
If this post was helpful, leave a comment below and let me know if you have any questions on calculating your personal wealth number. You can also follow me on Pinterest!