Every financial decision that you make brings you closer or further away from your goals. To evaluate your financial progress over time, one useful measure to consider is your net worth.
Your net worth is a measure of your overall financial health at one point in time, calculated as the difference between your assets and liabilities:
Assets – Liabilities = Net Worth
An asset is anything that you own of value. This includes:
- Personal property and household items
- Any business or real estate that you own
- Investments (checking/savings, stocks, bonds, ETFs, mutual funds, etc.)
- Retirement savings (pensions, social security, 401k, IRA, 403b, 457, etc.)
Most people stop at financial assets when calculating net worth. For a comprehensive view, you should also include non-financial assets like your human capital (the present value of anticipated lifetime earnings). The reason for this is simple – human capital is converted into financial capital through the process of saving.
For example, a recent college graduate often has negative financial assets (debt), but significant human capital (earnings potential). After starting a new job, the graduate can begin saving part of each paycheck, converting human capital into financial capital. At retirement, human capital is depleted but financial capital should be peaking.
Financial liabilities include any form of debt, such as:
- Auto loans
- Student loans
- Mortgage loans
- Credit card debt
- Money owed to anyone
When calculating your assets and liabilities, the value of each item should be estimated using the current market value. For example, the best estimate for the value of your jewelry is the price that someone else is willing to pay in your local market (today), not the price you paid at the time of purchase.
Net Worth Example
Let’s assume that you have the following assets:
- Furniture worth $5,000
- A home worth $150,000
- Two cars worth $25,000
- Electronics worth $5,000
- $125,000 saved in your 401k
- $20,000 in your savings account
Total assets (ignoring human capital) = $330,000
Let’s also assume the following liabilities:
- Student loans totaling $50,000
- A mortgage balance of $105,000
Total liabilities = $155,000
Net Worth = ($330,000 – $155,000) = $175,000
What Does Your Net Worth Mean?
Most financial decisions will increase or decrease your net worth. By tracking your net worth over time, you can determine if your financial decisions are helping or harming your financial progress. If your net worth is continually moving upward, that means you are increasing your assets faster than your liabilities. If your net worth is decreasing, the opposite is true.
Consider a few examples:
- Eliminating debt (a liability) will increase your net worth.
- Investing (usually) results in financial gains, increasing your net worth
- Increasing your income and/or decreasing your expenses will result in more available cash (an asset), increasing your net worth.
- Buying a brand new car, new electronics, household products, or other depreciating assets will decrease your net worth, because after being used these products are worth far less than the price you paid new.
Insurance is a tool used to protect your net worth. Most insurance products will actually decrease your net worth over time because you must pay ongoing premiums to the insurance company in exchange for coverage. But without insurance, an unforeseen event could destroy your net worth in a flash. The small premium payments eliminate the possibility of a major loss.
Your Net Worth Can Be Misleading
Your net worth is a financial snapshot at one point in time. Checking your net worth once is not very valuable because it provides no context.
There are several situations which highlight this problem:
1) Your stage of life
- Individuals graduating from college often have a negative financial net worth (student loan debt), but significant earnings potential (human capital). Many have borrowed to finance an education or trade, with the expectation of earning higher wages after graduation.
- Individuals in peak earning years are able to increase their net worth quickly, converting their human capital into financial capital by spending less than they earn.
- Individuals in retirement will often see their net worth decline with age. Instead of saving, retirees often spend their accumulated financial assets.
For most people, net worth will fluctuate in each stage of life.
2) Investment fluctuations
Hypothetically, let’s assume that you have $500,000 invested in the stock market. If the stock market has a major correction like the one observed in 2008, the value of your investments (and your net worth) could be cut in half.
If you sell all of your stock holdings after the market tanks, you will guarantee the loss and realize a massive reduction in your net worth. If instead, you remain invested long enough for the market to rebound, your net worth will recover. This scenario highlights the importance of tracking your net worth to evaluate your financial progress over time.
3) Comparing to others
Another dangerous game is comparing your net worth to someone else. You probably have unique financial goals, a different career, a different family situation, and many other differences. But your net worth doesn’t capture these differences.
For example, consider a net worth of $1 million. There are multiple interpretations of that number:
- Some consider $1 million to be an unattainable fortune.
- Others consider $1 million to be the ideal retirement nest egg.
In the end, your net worth is just a number. What matters is achieving your number. If your net worth allows you to achieve your financial goals, you shouldn’t worry anything else.
How to Track Your Net Worth
There isn’t any perfect method for tracking your net worth, but I personally recommend the following:
- An Excel spreadsheet
- Personal Capital
An Excel spreadsheet is useful for two reasons. First, it forces due diligence. To list all of your assets and liabilities, you must think about and acknowledge your financial situation. And second, it can help keep your family on the same page. Should something ever happen to me, my family can use the Excel sheet to identify assets and liabilities.
Personal Capital is a much easier solution. After signing up for a free account and securely linking your financial accounts, the software automatically updates your net worth in real time. This allows you to track your assets and liabilities without any manual effort.
We use a combination of Excel and Personal Capital to track our net worth.
Final Thoughts on Net Worth
Your net worth is a measure of your overall financial health at a single point in time. Tracking your net worth will allow you to better understand how your financial decisions affect your financial progress over time.