How to Calculate Your Net Worth — And Why It Matters
Calculating your net worth is pretty easy in theory. You just make a list of everything you owe and everything you own, and see what the difference is between them. If you own more than you owe, you have a positive net worth. If you owe more than you own, you have a negative net worth. If things somehow turn out to be exactly equal, you have a zero net worth.
In reality though calculating your net worth is a little bit subjective, because you have to decide how much the things you own are actually worth — and they’re usually not worth as much as you think they are. It doesn’t do you any good to decide that the couch you paid $1000 for is still worth $1000, for example. It’s best to use net worth as a tool, not to use it as a way to make yourself feel better.
How to calculate your net worth so that the result is useful
In order to get useful information out of figuring your net worth, you have to do three things:
- Include all of your debts
- Include all of your assets
- Value your assets as if you were willingly selling them to an equally willing buyer
Debts and assets
All of your debts literally includes everything you owe money on right this very minute: things like personal loans, credit cards, student loans, your cars, mortgage, HELOCs, the $5 you borrowed from a coworker yesterday, etc.
Your assets include stuff like the contents of your house, the house itself, jewelry, your car, money you’ve got sitting in the bank, investment accounts, the current balance of your 401k, cash, money that’s owed to you, etc.
Too many people decide that they “won’t count” things like their car or house, or over-inflate the value of what they own. You have to count everything as accurately as you can in order to make the results useful. I’ve never really understood the logic between not taking everything you owe and own into account; to me all that does is muddy up the picture.
Why getting a clear picture matters
Your net worth is a tool that can help you see how you’re doing financially and what areas you need improvement on. If you decide to selectively ignore certain areas for whatever reason, you’re not going to know what’s really going on there. That would be like wearing blinders and basing your financial decisions on just the things that are directly in front of you.
Calculating your net worth once can be either a good wake up call or a reassuring exercise, depending on the results that you get. But calculating it on a regular basis (whether that’s monthly, every six months, yearly, etc) can help you to see trends over time.
For example, I do my net worth each month, and base it on the value of things on the last day of the month. I’ve been doing this for years — starting with a negative net worth — and mine’s been heading generally upward ever since. Of course, there have been dips — sometimes at fairly regularly intervals.
When you have dips, it’s good to figure out why. In my case there’s been a dip every April when I pay my the balance of my taxes. The same goes for increases. Ever since I started investing, there have been dips & increases along the way that pretty much mirrored the way the stock market was acting.
Helping you pay attention
Doing your net worth helps you to pay attention. When you get used to looking at your money regularly, it can also help you to determine if you might have too much of your money in one place. Suppose I had most of my money in a mutual fund. My net worth would then be heavily dependent on whatever that particular fund did — which might seem great if it were skyrocketing, but would not be so good if it tanked. Knowing where your money is and how it’s spread out can help you take steps to minimize risk.
It can also help you to see areas where you might want to consider diversifying, or where you could make great strides by doing things like getting out of debt. And of course, it can make you feel good if it’s going up, or cause you to take appropriate action if it’s going down.
And as we all know, paying attention to your money and holding yourself accountable is key. Calculating your net worth can help you do exactly that.