In society, we often equate net worth with the financial status of the rich and famous. Maybe you associate net worth with the economic standing of famous Hollywood actors, high-profile politicians and successful business leaders. Or perhaps you view net worth as a benchmark of your own wealth compared to others. While your financial value can be determined by tallying your assets and subtracting anything you owe (think: debts and mortgages), the reality is, it's still widely misunderstood.
So if you're wondering about the importance of net worth -- and how to calculate this crucial financial metric -- here's a primer.
What is net worth?
The term "net worth," put simply, is the total value of your assets after you remove any liabilities. Rather than measuring your salary or what is in your bank account, net worth is the sum total of your savings, the equity in your home and essentially every substantial asset you have after you subtract all of your debt, from credit card balances to student loans to mortgages.
Does net worth matter?
"Understanding your net worth is the key to getting a snapshot of where money goes in your life. Net worth matches up your liabilities (what you owe) and your assets (what you own) to give a high-level picture of your financial status," says Kathy Longo, founder and president of Flourish Wealth Management in Minneapolis.
Think of it this way: It's hard to map out your financial future, and forge plans that may involve spending a lot of money, such as buying an Italian villa when you're retired or sending your kids to college, if you don't know how much money you really have.
Even if you're thinking that you don't need to calculate your net worth to know whether you're likely to live large in retirement one day, figuring out your number can also help with your budgeting in the short term, Longo says. "Creating a net worth should also help identify your income and expenses," she says. "This is an important part of the broader budgeting process. If your expenses are lower than your income, then you should take advantage of the opportunity to save more for the future."
How do you calculate your net worth?
While calculating net worth is a fairly simple process, if you have many assets and debts, it can be more complex. Frank Shields, founder and director of financial planning at Future Map Financial in Houston, suggests creating a personal balance sheet, a document or spreadsheet that shows your current financial standing.
"Calculating your net worth is fairly easy and straightforward," Shields says. "You can simply begin by labeling a sheet of paper with the left side titled 'assets' and the right side titled 'liabilities.'"
Next, Shields says you should list and add up all of your assets under the asset column, which would include cash, saving accounts, money market funds, brokerage accounts, retirement accounts, automobiles and real estate. "Do the same for liabilities, which are what's owed to creditors," he says, reeling off a list of examples, such as credit card bills, auto repair or medical bills, auto loans, student loans and mortgages.
"The final step in calculating your net worth is to subtract your liabilities from your assets. If your number is a positive number, that's a good sign," Shields says.
How does your net worth compare to others?
According to the Federal Reserve's 2016 Survey of Consumer Finances, the average U.S. household net worth was $692,100. If that seems high to you, that's because the numbers have shot up due to extremely wealthy households. The median U.S. household's net worth is approximately $97,300.
However, you're asking the wrong question. Experts say you shouldn't compare yourself to other people, or worry about how you stack up financially to make progress on your long-term money goals.
"Far too many people pay attention to what they own but ignore what they owe, and thus fool themselves into thinking they are wealthy," says Beverly Miller, a personal finance coach based in Pittsburgh. "The doctor who makes $400,000 a year and owns a $750,000 home but has so much debt that his net worth is $50,000, is far from wealthy."
If you're making $50,000 a year, but are debt-free and have money put toward savings, you could argue that you're better off than the high-paid doctor, Miller adds.
How can you change your net worth?
"The fastest way to increase your net worth is to increase your assets, while simultaneously decreasing your liabilities," Shields says.
For instance, by investing more money and paying off debt, you can boost your wealth. However, if you have a lot of debt, you should mostly focus on paying that off, says Rick Vazza, president of Driven Wealth Management in San Diego.
"The fastest way to increase net worth is to increase your savings rate and use the excess savings to either pay down high interest debt, or investing -- if you do not have high interest rate debt to pay down. You typically can't out-invest bad habits, so it is important to get control over your cash flow and that in turn will help build net worth."
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