Your net worth is the amount by which your assets exceed your liabilities. Simply put, the difference between what you own and what you owe is your net worth. If your assets exceed your liabilities, you have a positive net worth. On the contrary, if your liabilities are greater than your assets, it would be a negative net worth.

Your net worth provides a snapshot of your financial situation at this point in time. If you calculate your net worth today, you will see the end result of everything you’ve earned and everything you’ve spent up until right now. This could either be a wake-up call if you are completely off track or a “job-well-done” confirmation, if you are doing well. Monitoring your net worth over time offers a more meaningful view of your finances.

Regular computation your net worth can be viewed as a financial report card that allows you to evaluate your current financial health and can help you figure out what you need to do in order to reach your financial goals.

Net Worth = Assets – Liabilities

Anything of value that you own that can be turn into cash is called an asset such as investments, bank and brokerage accounts, retirement funds, real estate and personal property (vehicles, jewelry, and collectibles) and of course—cash itself. At times, intangibles such as your personal network are sometimes considered assets as well. Your liabilities, on the other hand, represent your debts, such as loans, mortgages, credit card debt, medical bills, and student loans. The difference between the total value of your assets and liabilities is your net worth.

In calculating your net worth, it is really important to assign accurate values to all of your assets. Creating conservative estimates when placing value on certain assets is also important in order to avoid inflating your net worth (i.e., having an unrealistic view of your wealth). Example is your most valuable asset and can have a significant impact on your financial situation—your home. Determining an accurate value of your home by comparing it to similar homes in your area that have recently been sold or by consulting with a qualified real estate professional can help you calculate realistic net worth.

However, there is some argument about whether personal residences should be considered assets for the purpose of calculating net worth. Some financial experts believe that the equity in your home and the market value of your home should be considered assets because these values can be converted to cash in the event of a sale.

That said, other experts feel that even if the homeowner did receive cash from the sale of the home, that cash would have to go toward the purchase or rental of another home. This essentially means that the cash received becomes a new liability—the cost of replacement housing. Of course, if the home being sold has more value than the replacement residence, part of the former home’s value can be considered an asset.

What Does It Mean?

Your net worth can tell you many things. If the figure is negative, it means you owe more than you own. If the number is positive, you own more than you owe. For example, if your assets equal $200,000 and your liabilities are $100,000, you will have a positive net worth of $100,000 ($200,000 – $100,000 = $100,000). Conversely, if your assets equal $100,000 and your liabilities are $200,000, you will have a negative net worth of minus $100,000 ($100,000 – $200,000 = -$100,000). Negative net worth does not necessarily indicate that you are financially irresponsible; it just means that—right now—you have more liabilities than assets.

Like the stock market, your net worth will fluctuate. However, also like the stock market, it is the overall trend that is important. Ideally, your net worth continues to grow as you age—as you pay down debt, build equity in your home, acquire more assets, and so forth. At some point, it is normal for your net worth to fall, as you begin to tap into your savings and investments for retirement income.

Since each person’s financial situation and goals are unique, it is difficult to establish a generic “ideal” net worth that applies to everyone. Instead, you will have to determine your ideal net worth—where you want to be in the near-term and long-term future. If you have no idea where to start, some people find the following formula helpful in determining a “target” net worth:

\text{Target Net Worth} = \left[\text{Your Age} – 25\right]* \left[\frac{1}{5}*\text{Gross Annual Income}\right]Target Net Worth=[Your Age−25]∗[51​∗Gross Annual Income]

For example, a 50-year-old with a gross annual income of $75,000 might aim for a net worth of $375,000 ([50 – 25 = 25] x [$75,000 ÷ 5 = $15,000]). This does not mean that all 50-year-olds should have this same net worth. The formula can be used simply as a starting point. Your ideal net worth may be much more or much less than the amount indicated by the guideline, depending on your lifestyle and goals.

If you want to save some time in tracking your net worth, use our free Net Worth Tracker, which allows you to calculate, analyze and record your net worth.

Why Your Net Worth Is Important

When you see financial trends in black and white on your net worth statements, you are forced to confront the realities of where you stand financially. Reviewing your net worth statements over time can help you determine 1) where you are, and 2) how to get where you want to be. This can give you encouragement when you are heading in the right direction (i.e., reducing debt while increasing assets) and provide a wake-up call if you are not on track. Getting on track requires you some fo the following below:

Spend Wisely

It is really necessary to know your net worth to be able to identify areas where you spend too much money. Just because you can afford something doesn’t mean you have to buy it. To avoid having unnecessary debt, always take into consideration if something is a need or a want before you make a purchase. To reduce unnecessary spending and debt, your needs should represent the majority of spending. (Keep in mind that you can falsely rationalize a want as a need. That $500 pair of shoes does fulfill a need for footwear, but a less expensive pair may do just fine and keep you headed in the right financial direction).

Pay Down Debt

Reviewing your assets and liabilities can help you develop a plan for paying down debt. For instance, you might be earning 1% interest in a money market account while paying off credit card debt at 12% interest. You may find that using the cash to pay off the credit card debt makes sense in the long run. When in doubt, crunch the numbers to see if it makes financial sense to pay down a certain debt, taking into consideration the impact of no longer having access to that cash (which you might need for emergencies).

Save and Invest

Your net worth figures can motivate you to save and invest money. If your net worth statement shows that you are on track to meet your financial goals, it can encourage you to continue what you’re doing. Conversely, if your net worth indicates room for improvement (for example, over time you have dwindling assets and burgeoning liabilities), it can provide a needed spark of motivation to take a more aggressive approach to saving and investing your money.

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