This is one of those things that should be taught in school. There are so many misconceptions about it that most people don’t even know where to start.
To keep things simple, all we need to look at is a simple equation:
Your net worth = Your assets – your liabilities
That’s it. Deducting your assets from your liabilities will give you your worth. Some people may be wondering, “If I have $35 in the bank, but I owe my credit cards $2400, what is my worth?”
You then have a NEGATIVE net worth equaling to -$2,365. This is NOT a good place to be, yet millions of people have it in the negative.
Check out the 7 Most Common Financial Mistakes.
What Are Assets?
The money you have in your bank is an asset. Add up all the money in your different accounts and the sum total is an asset. Any bonds, stocks, mutual funds, future pensions/benefits that can be converted into cash are assets.
A rule of thumb is that if it can be converted into cash, it’s an asset too. This rule will also include your home, car and your belongings.
When calculating your assets, you need to focus on belongings that are of significant value. Do not try to list everything you own.
For homes, you can go with the current market price. For cars, you can consider the blue book value. Remember, your car is a depreciating asset – meaning, its value will get progressively lower as time passes. However, it is still an asset.
Once you have the value of all your significant possessions, add them all up and you have the total value of your assets.
What Are Liabilities?
Anything you owe is term as a liability. Your credit card bills, home loans and other type of debt where you need to make payments are liabilities.
Do note that your utility bills, food bills, etc., are usually considered a double entry in accounting because they’re both an expense and a liability.
To keep things simple, we’ll exclude your living expenses such as utility bills and food bills from our calculations. What we really want is a general figure of where you stand financially.
Get a list of all your liabilities including mortgages, car loans, personal loans, student loans, credit card balance, etc. Sum them all up and you have the total value of your liabilities.
If you wish to go into the nitty-gritty details, you can always hire a financial planner to write up a report for you and do a proper analysis. The goal here is to give you a general idea of where you stand.
Importance of Net Worth
Just knowing your worth will tell you what you need to do. If you are at a negative, you’ll need to reduce your liabilities and find ways to increase your income/assets too.
This two-pronged approach is one of the fastest ways to remedy all your financial problems. Many people try to tighten their belts and curb expenses. While that is helpful, being able to increase your income will help you settle your debts and increase your worth at a much faster pace.
Net worth is also great when it comes to assessing the right lifestyle for you. Some people are “cash poor”, meaning they have all their money tied up in non-cash assets like real estate properties or fixed deposits. They might be worth well over $500,000 but still struggle for everyday expenses.
In such cases, you need to analyze the different ways you can free up cash. For instance, breaking up your fixed deposit or refinancing your properties can give you a way to free up cash for living expenses. To do that successfully, you need to know what you are worth and understand your financial situation.
“Focus on all 4 of your net worth factors: increasing your income, increasing your savings, increasing your investment returns, and decreasing your cost of living by simplifying your lifestyle.” – T. Harv Eker (Author of Secrets of the Millionaire Mind)
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