Your net worth calculation provides a financial report card for how you are doing at this point in time.
Net worth is calculated by subtracting all of your liabilities (what you owe) from your total assets (what you own). If your assets exceed your liabilities you have a positive net worth. If your liabilities are greater than your assets, then you have a negative net worth. Keep in mind, your net worth fluctuates over your entire adult life, responding to changes in income and spending habits.
While it is helpful to calculate your net worth in order to figure out how you are doing financially today, your net worth is most beneficial when it is calculated and evaluated periodically over time. By noting changes in your net worth, you can see trends in your financial situation, be proactive about making better financial decisions and figure out what you need to do to reach your short-term and long-term financial goals. You can improve your net worth by increasing your assets, reducing your liabilities or a combination of the two.
A Quick Review
Net worth is the difference between your assets and liabilities, calculated as:
Net Worth = Total Assets - Total Liabilities
While your liabilities are easy to quantify (you probably receive a reminder each month that states the exact amount of money you owe to each creditor) it can be challenging to determine accurate values for some of your assets. It is best to make conservative estimates to avoid over-inflating your net worth (which may give you a false sense of financial security).
Your house is likely your most valuable asset and the value that you assign to it can have a great impact on your net worth calculation. A qualified real estate professional can give you an estimate of your home's value, or you can do your own research using online real estate aggregators such as www.trulia.com or www.zillow.com. Here, you can look up real estate trends in your area and determine the sales prices for recently sold, similar properties in your area. To be realistic, subtract the going commission (such as 4% or 6%) to cover the future cost of selling the home.
When in doubt, be honest and conservative in estimating the market value of any of your assets - including your home, vehicles, collectibles, furnishings and jewelry. Be realistic about the condition of your assets, and try to base these figures on what you could sell each asset for now, rather than:
- How much you paid for it
- How much you wish it were worth
While any asset can boost your net worth, several "large" assets are likely to have a greater positive effect on your bottom line. These include your:
As mentioned previously, your house is probably your most valuable asset (it may simultaneously be your biggest liability). The more equity you have in your home, the more it will increase your net worth. Keep in mind that when you determine your net worth, you must subtract your liabilities - including your mortgage. If your home is valued at $300,000 and you owe $200,000 on your mortgage, your home will effectively add $100,000 to your net worth ($300,000 - $200,000 = $100,000 equity). If you owe only $50,000 on that same home, however, the house will add $250,000 to your net worth ($300,000 - $50,000).
There is a bit of controversy surrounding the usefulness and appropriateness of including your home in your net worth calculation. Proponents believe that your home is your most valuable asset and should definitely be included in your net worth calculation. Opponents argue that you should not count it because if you sold it (for example, during retirement) where would you live?
To appease both schools of thought, many individuals choose to create two net worth statements: one that includes the house (as both an asset and a liability if there is a mortgage), and one that leaves it out as an asset (while still including it on the liability side of the equation if there is a mortgage).
Vacation Homes and Rental Properties
Vacation homes and rental properties may have a positive effect on your net worth. In many cases, these other-than-primary-residences are paid for outright with cash. For example, many people purchase condominium units as vacation homes. Condos are often paid for in cash because, firstly, they tend to be cheaper than single-family homes in the area, and secondly, the mortgage requirements are a lot more complicated and strict than for a single-family home.
If you paid cash for your vacation home or rental property, your net worth will increase by the same amount by which the home is valued, less any expected capital gains taxes (if you were to sell the home), if applicable, and any related expenses such as property taxes and insurance. And because you will still have a place to live if you sell your vacation home or rental property, you can safely count it as an asset without worrying about the don't-count-your-home-as-an-asset school of thought.
Investments can be another major contributor to overall net worth. Although there are several different types of investments, some of the most common include stocks, bonds, mutual funds, ETFs and any other securities. The value of your investments in any tax-deferred retirement plans, such as 401(k)s, 403(b)s and IRAs (individual retirement accounts) can significantly increase your net worth. Most investments will fluctuate over time, so it is important to reflect these changes in your periodic net worth calculations. Note: taxes on these assets are contingent liabilities that should be included in the liability side of your net worth statement in order to provide a more realistic view of your financial situation.
Art and Other Collectibles
Art and other collectibles can add considerably to your net worth. The value of these assets, however, is often fickle and changes depending on current trends and the demand for such items. Because market values do change over time, and because we are often not aware of the value of certain collectibles – consider the many people who strike it rich on PBS's "Antiques Roadshow," bringing in garage sale finds to discover they are worth tens or hundreds of thousands of dollars – it may pay to seek out professional appraisals. In addition to having a good estimate for your net worth statement, you can also make sure the item is adequately insured against losses (your homeowner's insurance policy may not cover art and other collectibles without a specific rider).
The Bottom Line
Your net worth statement is a highly personalized financial report card. It provides a picture of where you stand – financially speaking – at this point in time, and can help you make progress towards reaching your short-term and long-term financial goals.
Certain assets, such as homes, investments and art, may have the greatest impact on your overall net worth. When valuing any asset, it is important to determine fair market values – how much money you could make if you sold the item today – whether it's a stock, your house or a piece of jewelry. Accurate values can provide you with a realistic net worth, which can help you make better financial decisions.