Your personal net worth is the sum of all of your assets less the total amount of debt you have. While it won't provide a detailed look at someone's finances, net worth is a solid way of assessing your overall financial health.
Looking at a person’s net worth is one of the crudest ways to judge their financial health, but it does provide a broad overview of their position by comparing the total value of what they have to the total amount of money they owe.
Calculating net worth can be both simple and complex. On the one hand, it’s simply taking your assets and then subtracting your liabilities (debts). On the other, depending on your financial situation, getting a complete list of those two categories can be complicated.
Your assets include not just the cash you have in the bank, but everything you own, including property, cars and investments. Likewise, your liabilities can include anything from credit cards to personal loans to a mortgage.
While your net worth will give you a clear sense of how much you owe against how much you have, it won’t necessarily give a complete picture of your financial health. Frequently, the total number is less important than the change in that number from year to year.
You might have a net worth of -$50,000, but if the rest of the context is that you’re earning $100,000 a year in a stable job, you have a healthy 401k, your debt is solely in a low-interest mortgage on a house that’s quickly appreciating in value and your net worth was -$100,000 just five years ago, your situation might be a lot rosier than your net worth alone would indicate.
Likewise, a net worth of $5,000 may seem much better, but if you’re only earning $30,000, renting an apartment, have three kids quickly approaching college age, and you were worth $10,000 just last year, you may be more than willing to switch places with the person in our previous example who has a lot more debt.
While a higher net worth is usually more desirable, it’s important to remember that it’s just one piece of a bigger puzzle when it comes to your financial health.
Your net worth comes down to your assets and liabilities, which can come in a variety of different forms.
Any money you have in your bank account or on your person (or, God forbid, stuffed under your mattress) is a part of your net worth. Cash can be a key piece of net worth as it’s “liquid,” meaning you can access it quickly in times of need.
Your IRA or 401k are also among your assets. Putting money into stocks and bonds is one of the best ways to grow your total net worth as you collect interest and stock returns.
You also need to calculate the value of the stuff you own. In the case of a car or your house, that can be relatively easy, but you should also consider the remainder of what you own, like furniture, jewelry and even clothing.
Life Insurance and Annuities
Most annuities or life insurance policies will include a cash surrender value that you should include in your assets to get an accurate figure.
If your employer offers a pension plan, you should figure that into your net worth. Ask the human resources department for a dollar figure, or you can also try to estimate the value based on the total amount you can withdraw.
There are a lot of reasons for taking on debt, some of which may actually do a lot to boost your net worth in the long run even if they drag your number down in the short term. Failing to responsibly manage your debts, though, will likely result in a significant drag on your net worth, so it’s important to consider any debt carefully.
Credit Card Debt
Anything you owe on your credit cards is considered a liability. Few things will ruin your net worth faster than credit card debt, which usually comes with high interest rates that compound monthly.
Student loans can be considerable, but given that they usually greatly increase your earning power over the course of your career, they often improve your net worth in the long term. That said, in the short term they can be burdensome on your finances.
Auto loans are a liability that will weigh on your net worth, but they almost always come with a car that is an asset of similar value.
The right mortgage can do wonders for your net worth in the long term. When you pay rent, you’re essentially just getting a place to live for a month. Your mortgage payment, though, gets you both a place to live and ownership of the house itself, which can be a very valuable asset. That said, the wrong mortgage can end up costing you far more than your house winds up being worth, so no one should sign a mortgage without doing a lot of careful research beforehand.
Taking out a personal loan for the purposes of debt consolidation or to take advantage of an opportunity to acquire an asset with limited availability can grow your net worth in the long run. A personal loan simply to cover expenses, though, will probably result in a significant drop in your net worth.