The Complete Guide To Calculating Your Net Worth: Why Net Worth Is Important
Calculating your net worth helps you figure out where you are financially at this point in time. Expressed as a dollar amount, your net worth represents your financial health and is essentially the result of everything you have earned and spent up until now. While taking the time to calculate your net worth one time is helpful, what is really beneficial is to make this calculation/net-worth/demo on a regular basis so you can see trends in your overall financial health. For most people, a yearly net worth statement may be sufficient. Others, however, may benefit or find motivation from making monthly calculations, carefully watching and responding to changes in their financial situations.
Typically, the net worth of young people (recent college grads, for example) is inherently low: they have yet to earn much income and they are likely saddled with both mortgage and student loan debt (among other debts). At any time net worth can be a negative number – where your liabilities are greater than your assets. During your working years, your net worth ideally will grow over time as you pay down large debts (like your mortgage), build equity in your home, earn more as your career advances, and acquire more assets (not to be confused with simply spending more money). Your net worth may decrease once you stop earning employment income and tap into your savings for retirement; however, it can continue to grow during retirement depending on the income you earn from various investments (for example, dividends). Figure 1 shows an example of how an individual's net worth might change over time.
Figure 1 An example of how net worth might change by age.
On Track, or Room for Improvement?
When you see financial trends in black and white – on your net worth statements – you get to see the realities of where you stand financially and where you are headed. Reviewing your net worth statements over time can provide encouragement if you are on track – reducing debt while increasing assets – or provide a wake-up call if you are not on track. As your grade school teacher would have written, you have "room for improvement." Reviewing your net worth statements and identifying these financial "areas of improvement" can help you.
By looking at your net worth, and especially these figures over time, you can identify areas where you spend too much money. Just because you can afford something doesn't mean you have to buy it. To keep debt from accumulating, consider if something you want to buy is a need or a want. It's okay to buy some things that you want, but to reduce unnecessary expenses (and prevent unnecessary debt), your needs should represent the majority of spending.
Pay Down Debt
Reviewing your assets and liabilities can help you develop a plan for paying down debt. For instance, you might be earning 3% interest in a money market account while at the same time your car loan is costing you 7% interest. You may find that using the cash to pay off the car loan might make sense in the long run. When in doubt, crunch the numbers to see if it makes financial sense to pay down a certain debt.
Save and Invest
Taking a look at your net worth can motivate you to save and invest your money. If your net worth shows you are on track that's fantastic. It can encourage you to continue what you're doing. If your net worth figures indicate room for improvement, it can provide a needed spark of motivation to start (or be more proactive) your saving and investment activities.
Being aware of your net worth can help you create a financial blueprint, which areplans for your financial future. For the purpose of analogy, let's consider a construction project. As we can all envision, having a well thought-out blueprint for a construction project is vital to its success. Imagine, for example, building your dream house without a blueprint. While you would certainly save money by not having to hire a qualified architect, how would the builders know what to do? What happens when the ceiling collapses because an internal wall wasn't built to be load-bearing? What do you do if all the drywall is in and painted, but nobody put in the wiring? We understand and accept the fact that all construction projects start with a blueprint. No builder would work without one.
When it comes to our financial futures, however, often times people are willing to "wing it" due to lack of interest or time, or because they are under the false assumption that there is nothing they can do to create a better financial future. What many people don't consider is that, like construction projects, our financial futures also require a blueprint – something that tells us where we are, where we want to go and how to get there. Calculating your net worth is important because it allows you to evaluate where you are now, and helps you make decisions that will affect how you reach your financial goals, whether it's savings for the kids' college, your dream home or for your retirement years. Even if your current financial situation truly is a "fixer-upper" (like an old house that needs a complete renovation) you can take charge and make changes that will positively affect your financial future. Keep in mind that you have to set goals to reach goals. It's impossible to reach your goals if you never identify them.
Planning to Never Retire Is Not a Plan
The financial crisis that began in 2007 negatively affected many people's home values, retirement savings accounts, investment portfolios and jobs. As a result, although people know they are supposed to be saving for retirement, many have given up on the idea of retiring and instead plan to never retire at all. Even if this is your retirement plan, unexpected events – such as health problems and job loss – can force you into a retirement you never intended to take, so planning to never retire is not a practical retirement strategy. Even if your financial outlook looks bleak at this point, you can make plans to improve your situation in the future.
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