Understanding Net Worth: What Is It, Really?

    

Understanding Net Worth - What Is It Really - First State Community Bank Blog

Do you know your net worth? Your net worth is a good indicator of your financial health; it shows whether your overall assets are worth more or less than what you owe. Net worth can be an important indicator for financial planning, such as purchasing a home or business, or mapping out a retirement strategy.

Quite simply, net worth is defined as the value of what you own minus your debt. In other words, net worth is calculated as what you have left over when you clear all your debts and liabilities. As an indicator of financial health, you naturally want your net worth to fall on the positive side of the balance sheet so you are worth more than you owe. For example, if you own a house, car, furnishings, jewelry, and anything else of intrinsic value, those are your assets. Then you have to subtract everything you owe, such as mortgage payments, car loans, student loans, credit card debt, etc. The difference is your net worth.

The best way to calculate your net worth is to create a balance sheet. In one column, list all your assets, including their value or estimated worth. In the second column, list all your liabilities, i.e., everything you owe. Subtract liabilities from assets, and that is your net worth.

When calculating net worth, you need to be realistic. You want to estimate where you are today, not where you expect to be. Once you have a calculation of your net worth, you will be in a better position to plan for the future.

List Your Assets

Calculating your net worth may not be as simple as it looks. Over time we accumulate a number of possessions, investments, bank accounts, and other things with fiscal value. In order to list all your assets, you have to take a hard look at what you own and potential cash you have stashed in different locations.

Of course, there is property. List the things you own that have cash value, such as real estate, cars, boats, and anything that you can turn into cash. In some cases, you will have a good idea of estimated value. Real estate, for example, has an appraised value that is used to calculate property taxes, and you can look up the value of your cars in Kelley Blue Book. Where you don’t have a market value, you will have to approximate, but it pays to be conservative when estimating value to calculate net worth.

You also have bank accounts, including checking, savings, money market accounts, etc. Also include retirement accounts, such as IRAs and 401(k) earnings, and any investments, stocks, bonds, CDs, or other holdings you might have.

What about insurance policies? Do you have a life insurance policy or other insurance that can be converted to cash? Also be sure to include any business interests or anything else you can think of that has worth.

Identify Your Liabilities

When determining your debt, you also want to be sure to list everything you owe.

Some debt, such as personal loans and student loans, will be money that you owe outright, so the entire balance of the debt should be listed as a liability. You can check your last loan statement to see how much is left on the debt, and use that balance in your net worth calculation.

Other debt will be tied to assets, such as a car loan or mortgage. Determine the balance you have yet to pay on a home loan or car loan for your net worth calculation. For example, in calculating the value of your home as an asset, you would take the assessed value of the property and subtract the outstanding balance on the mortgage. The value of the difference is a part of your net worth.

You also want to be sure to include credit card debt, money owed to store cards, medical debt, back taxes, or any other outstanding debt. Include any business debt that is tied to personal assets. For example, if you used personal credit cards or took out a personal loan to fund your business, those count as personal debt, not business debt.

Once you are confident you have included all your assets and liabilities, you can do the math to determine your net worth. If you want to use a simpler approach, there are online calculators available. However you approach it, be sure to include everything to get an accurate net worth value.

Setting Net Worth Targets

Once you create a balance sheet, you have a baseline to use for financial planning. Obviously, you want to increase your net worth over time so that as you approach retirement, you will be worth more.

You should consider having different net worth targets at different times in your life. According to Personal Capital, the average net worth of Americans is $6,676 by the time they reach age 35, $35,000 by age 40, $84,542 by age 50, $143,964 by age 60, and $194,226 by retirement age. The increase in net worth is the result of many factors, such as more savings and higher wages, but most of it is the result of passive income.

The concept of passive income is to get your money to work for you. Real estate investments, for example, have proven to deliver a good return, averaging 6.4 percent per year for 36 years in a row; so if you own property, it will appreciate in value as passive income. Similarly, investments will yield a return from 2 to 7 percent or higher, depending on the investment. Thanks to compound interest, even a modest return rate can translate into big money.

You also get passive income from savings accounts, CDs, and IRAs. Unlike investments, these types of bank accounts are insured by the Federal Deposit Insurance Corporation (FDIC) and are far less risky. For example, most savings accounts and CDs and many IRAs have a guaranteed rate of return that will continue to grow due to compound interest.

Your bank can help you increase your net worth. It offers savings accounts, CDs, IRAs, and other types of accounts in which you can safely save your money and earn interest. Your bank can also offer investment strategies to help you maximize your savings, and it can restructure your mortgage to lower your debt or generate cash for investment. Why not talk to your financial advisor about strategies to build your net worth?

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