Calculating your net worth: why it’s important

Have you heard someone say that a celebrity or business person is "worth" a certain amount of money? That dollar amount refers to their net worth. The most basic explanation of net worth is the total of your assets minus any liabilities. Assets are the things you own, and liabilities are what you owe. Why is this important? You don't need to know your net worth to brag to other people; you need to know it to plan your financial goals accordingly. Think of it as your financial report card.

Calculating net worth

Calculating your net worth can be pretty straightforward in many cases. You simply deduct any liabilities from assets. Start by adding everything you own, including the fair market value of your possessions and home, business ownership, digital currency, and any money in investments, retirement funds, and savings accounts. When calculating annuities or pensions, use today's value, not the future expected income.

Next, deduct all the money you owe, including car loans, mortgages, credit card debt, student loans, etc. Don't forget any money you owe other people, such as friends or family. Some people forget about other loans, such as furniture or appliance accounts.

If you have a home, it's likely your most valuable asset, but it can also be a large liability. That is why it's essential to calculate the current market value accurately. If you incorrectly think the home is worth significantly more than it is, you could have a much lower net worth than you realize.

Once you've calculated your net worth, you may feel that the number defines you. However, it doesn't. You should not look at your net worth to compare against friends and family. You should use it as a tool to figure out where you want to be financially later in life and what your financial goals are.

What personal items should you include in your calculations?

Some personal possessions can add to your overall net worth, which is why you want to make sure to include them in your calculations. Assets aren't limited to real estate, cash, or business ownerships. Some personal possessions have significant value and can boost your asset portfolio. Some items include:

• Jewelry
• Antiques
• Artwork
• Tools and machinery
• Professional equipment

Does someone owe you money? You should include any current loan balances that people are paying you.

Why don't you include some possessions or a future inheritance?

You might be tempted to add all your personal possessions as assets, but what are they really worth? If they are items that hold their value or even increase in value, then they could help increase your total assets. However, many items depreciate (lose value) over time, which could falsely inflate your actual net worth.

Expensive automobiles are one example of an asset that could falsely inflate your net worth. Unless you own a rare car with significant value, it will continue to depreciate. Also, driving the vehicle means you are at risk of an accident or theft. Typically, vehicles that have been in a collision have a lower overall value.

A future inheritance isn't necessarily an asset as you don't have it until the current owner of that money passes. And, unless you are very sure about what you are receiving, it's not an accurate reflection of your assets either.

Difference between net worth and net income

Some people mistakenly assume net worth and net income are the same. Your net income is your income after you deduct taxes, Social Security, 401(k) and retirement contributions, etc. Your net income is separate from your net worth.

What is a good net worth number?

A negative number means you owe more than you own. If the final number is positive, then you own more than you owe. For example, if you calculate your assets at $500,000 and your liabilities are $200,000, then you have a positive net worth of $300,000. If your assets are $200,000 and you owe $500,000, you have a negative net worth of $300,000.

A good net worth number isn't necessarily one that is huge. Having a high net worth doesn't necessarily mean you've been making all the right financial decisions. What's important is tracking your current net worth and making better decisions from now on to reach your intended goals.

Once you calculate your net worth, look at your overall financial picture. For example, you only have a net worth of $10,000, but you earned $100,000 annually for the last 10 years. Where did it all go? Unexpected emergencies such as accidents and medical treatments are understandable. If you spent it all on luxury possessions and expensive cars, it might not be so wise.

Your net worth will also change over time. It's similar to the stock market. Your investments may go up or down in value depending on the market trends. Your home value may increase if there is a surge in home prices.

Concentrate on your net worth

People have different financial goals, which is why you shouldn't concern yourself with what other family members, friends, or co-workers are doing. Do you have children who will be going to college one day? You may need to work on your income-to-debt ratio to put more money aside for your children's education.

Other people may not have the same significant expenditures coming up, which is why they are buying new cars or going out often. Remember, someone isn't necessarily richer because they own fancy things or go out to eat all the time. They may be racking up significant debt on credit cards or taking out a home equity loan. That is why it's not easy to establish a general "ideal" number for your net worth. You need to determine your ideal net worth, both where you want to be in the near future and in the long-term.

Consider a personal financial management (PFM) tool

If you are concerned about doing the math or keeping track of your net worth as time goes on, consider using a personal financial management (PFM) tool. Numerous options are available. Look for one that allows you to safely track your bank accounts and credit cards. You can manually update any assets you have outside linked accounts as values change. The personal financial management tool will do the rest and calculate your net worth.

To learn more about calculating your net worth and increasing your savings, here are several other articles to check out:

• How to calculate your net worth
• Savings account tips
• Playing retirement catch-up