There are many reasons why you need to track your net worth, but the biggest is that you can’t adjust fire if you don’t know where you’re impacting. Look, how can you ever expect to be wealthy if you don’t understand how net worth works, and how to figure out where your money is going?
What is net worth? If you aren’t sure, then you need to read this entire article and learn!
What is Net Worth?
According to Bankrate, “Net worth is the value of all assets, minus the total of all liabilities. Put another way, net worth is what is owned minus what is owed.” (Source)
For example, if you own a $100,000 house, but owe the bank $50,000 from the mortgage, your net worth (from that home) is $50,000.
$100,000 asset – $50,000 liability = $50,000 net worth.
Net worth is a method individuals and businesses alike can use to determine their absolute value. Think of it as, “If I sold everything that has debt attached, what would be left?”
Net worth is how you track your wealth.
What Net Worth is Not…
Net worth is NOT just the value of something you own. For example, if you see somebody purchase a $2,000,000 building and then talk about how they are worth millions…it is probably just a sales tactic. Unless they purchased that vehicle in cash, there is a debt against it. The debt counts against your net worth, and that is important to know.
I see this gloating periodically in real estate, and it is good to be able to spot the crap and recognize the ego versus net worth conundrum.
Why Should You Care?
Net worth is one of the most important metrics to track for your personal finances, and here are a few reasons why.
1. Knowing your net worth can help you identify areas where you spend too much money.
- If your net worth drops, you will want to know why. By paying attention to your assets and liabilities, you ensure that you will know if something is negatively affecting it.
2. It refocuses your financial outlook beyond just income.
- There are many more factors that affect your overall wealth other than just income.
- That is why people who earn $500,000 a year can still find themselves living paycheck to paycheck.
- Your expenses, assets, liabilities, etc., are all just as important (if not more) than your income is.
3. Net worth is the most accurate way to measure your overall wealth.
- This is the big picture. By calculating your net worth, you ensure absolute vigilance on your overall wealth building.
4. It puts your debt in perspective.
- Not all debt is created equal. Debt can be good debt if it is utilized to purchase assets that produce cash flow, build equity, and increase your net worth every month.
5. If the bank cares, you should too.
- The bank cares about your overall net worth. Why do you think they require a personal financial statement every time you submit a loan application?
- If the bank cares about your net worth, don’t you think you should monitor it in order to improve your financial situation?
6. Tracking your net worth is (hopefully) fun!
- Tracking your net worth is fun. You get to watch the dollars slowly tick up and then begin to increase speed as you build wealth more efficiently. I enjoy this calculation every month and certainly enjoy the results!
- It may not be fun all the time, but it is useful. If it goes down, you may not enjoy that…but it is better to find out at the beginning of the month than to have it continue decreasing without your knowledge.
The bottom line is this: having a solid understanding of what your net worth is will only help you improve.
Your Reticular Activating System
Have you ever bought a car and then, almost magically, started seeing that car all over the place? This is due to your Reticular Activating System (RAS). The RAS takes what you focus on and creates a filter for it. For that reason, as you focus on your new car, your brain starts to subconsciously pick those vehicles out of traffic and recognize them.
The way your RAS functions is also known as the Baader-Meinhof phenomenon, or frequency bias. This phenomenon is the reason journaling and writing your goals is so important. The more you focus on your vision, the more your brain starts to recognize opportunities and help it become a reality.
How Often Do You Need To Calculate Your Net Worth?
As the saying goes, “What gets measured gets managed.”
The more attention you pay to your net worth, the better you will understand what affects it. For this reason, I recommend that you track your net worth AT LEAST quarterly.
I have recently started calculating my net worth at the beginning of every month. This allows me to notice if there is a sharp increase or decrease and investigate what affected it.
The better you understand the factors that help increase your net worth, the better!
What Factors Affect Your Net Worth?
Essentially, an increase in asset value or a decrease in liabilities are the two factors that affect your net worth.
For example, if you get a $20,000 bonus and spend it on a vacation, your net worth will not change.
However, if you use that money as the down payment to purchase a $100,000 home, your net worth will increase by $20,000. Every month after that, your net worth will increase a little bit as you pay off the mortgage and (hopefully) receive some cash flow!
Every time you make a payment on a loan, the principal that gets paid down is added to your net worth.
This is one of the reasons that buying a new car is so detrimental. You buy a new car for $50,000 and in five years, it is only worth $25,000 (if you’re lucky). Meanwhile, you will probably spend $55,000-$60,000 on the car due to the amount of interest you paid.
That means you took over a $30,000 hit to your net worth, all while paying higher insurance, and potentially wasting money on extended warranties and other upgrades.
How to Calculate Your Net Worth
In our example above, owning a $100,000 house, that you owe the bank $50,000 on, means that your net worth (from that home) is $50,000.
$100,000 asset – $50,000 liability = $50,000 net worth.
Calculating your net worth is pretty simple. Line up all of your assets on the left side of a piece of paper, and then line up all of your debt/liabilities on the right side.
Simply subtract your total liabilities from your total assets, and the difference is your net worth.
Here is an excel spreadsheet you can use to manually track your net worth every month.
You should also look into Personal Capital, which is a great website (and app). You can link all of your bank accounts, mortgages, checking/savings accounts, and more to Personal Capital.
This website updates automatically and automatically tracks the growth of your net worth. It will also help you discover any spending trends you have, which allows you to plug these holes and increase your net worth even more!
Here are some common assets that people have. The valuation of these will count towards your net worth.
- Checking and savings accounts
- Real estate and other property
Please note that it is important to give an accurate valuation. If you inflate the value of your business unrealistically, you might as well not track your net worth haha.
Here are the most common liabilities that people have.
Some of these, like mortgages, can be good debt and be tied to an income-producing asset. The mortgage negatively affects your net worth, but if it is tied to a rental property, it decreases with every payment…and your tenants are making the payments!
- Student loans
- Auto loans
- Consumer debt, such as credit card balances and lines of credit
- Personal loans
- Miscellaneous, medical bills, taxes, judgments, etc.
Some of these liabilities, like medical bills and taxes, are unavoidable. But the vast majority are under our control. You can absolutely control auto loans, consumer debt, child support (to an extent), etc.
Don’t be a victim of your liabilities. Spend your money intelligently and avoid unnecessary liabilities.
Average Net Worth by Age in America
I read an article on wallethacks.com that was very interesting. They talked about the average net worth of Americans, and it was staggering…staggeringly low!
According to this chart, people my age should have a net worth of $10,200 if they own real estate and only $5,044 if they do not own real estate.
Damn, I’m doing much better than I thought!
This data is terrible, people. You have the ability to blow these numbers out of the water. Just be smarter with your money.
Build Wealth, Increase Your Net Worth
Make it a point to look at your net worth every month. Step back and look at the big picture in order to ensure you are moving in the right direction!
Comment down below to share your wins in this arena! What is the biggest gain you have ever experienced with your net worth?