The Complete Guide To Calculating Your Net Worth: What Your Net Worth Means
If your net worth is a negative number, your liabilities exceed your assets. If your net worth is positive, your assets are greater than your liabilities. Keep in mind, your net worth figure is a snapshot of your financial situation at this point in time. A positive net worth now does not guarantee it will be so in the future; nor does a negative net worth today mean you are destined for a lifetime of debt.
It is difficult to meaningfully compare your net worth to someone else's. Someone else may have a higher net worth than you, but at what cost? Are they working 80 hours each week and leading an unhealthy and unsatisfying lifestyle (i.e. no exercise, no time with family, etc)? Rather than using your net worth to evaluate where you stand against your peers, use it to track your own progress over time. Just like a marathon runner gunning for her personal best, focus your attention on your own numbers.
Changes Over Time
Your net worth inherently changes over time in response to your income, spending and saving habits. As mentioned previously, ideally your net worth increases as you age as you pay down large debt, build equity in your home and enjoy a salary increase as your career advances. It is not uncommon, however, for your net worth to fluctuate in much the same way as your stock portfolio. The value of your assets changes from day to day – look at the what a volatile housing market can do to home prices – and as a result you can hold the same assets but suffer a drop in value from one net worth statement to the next. You have to set your own goals for where you want to be in one, five, ten or twenty years from now. By evaluating your net worth statements over time, you can tell if you are moving in the right direction, or if some changes are in order.
Most people will spend more money if they have more money to spend. For instance, when someone is fresh out of college and not earning much money yet, he or she might be getting by on $1,000 a month for an apartment, used car loan, groceries, etc. But when that person moves into a more profitable position, his or her monthly expenses will correspondingly rise. This phenomenon is known as lifestyle inflation, and it can be a problem because even though you might still be paying your bills, you are limiting your ability to build wealth.
A driving force at work here is the keeping-up-with-the-joneses mentality. For example, many people who work at offices where everyone drives BMWs might feel the need to drive a BMW as well. And it's not just cars – expensive homes, vacations, boats, private school tuition – there are endless ways to spend more than we need to or should.
Being aware of lifestyle inflation can help you curb your spending appetite so that, despite the fact that you are earning more money, you can save and build wealth instead of purchasing unnecessary (or extravagant) material objects that don't help your bottom line. Remember, the Joneses are typically servicing a lot of debt over a period of decades. Just because they look "rich" doesn't mean they are.
Personal Wealth Versus Material Wealth
It should be noted that your net worth is the result of your income and spending up until this point in time, and cannot account for your personal happiness or life experiences. A high net worth does not guarantee happiness or personal fulfillment, and a low net worth does not promise discontent. Your net worth statement does not allow you to place a value on your life experiences, which to many people represents a more accurate picture of "wealth" than numbers on a page. While we can acknowledge this limitation, it does not provide an excuse for not managing your finances and not completing a net worth statement. The fact is, even if you are content leading a minimalist lifestyle and prefer to measure wealth in terms of happiness and experiences, you are still going to have to plan for your financial future.
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