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What Is Net Worth & What Does It Mean To Have It?

By on October 26, 2021
Categories: FINANCIAL PLANNING, INVESTING

Calculating your net worth gives you a real-time snapshot of where your finances stand. Doing so allows you to evaluate both your assets and your liabilities to find out how they compare. Tracking your net worth comes with benefits throughout your lifetime; so no matter where you are in life, learn what net worth means and why it’s important to you.

What is net worth?

Net worth is a comparison of your assets and liabilities. It gives you a glimpse of your overall financial picture. If you’re unsure, click here to assess what your net worth should be? A positive net worth is when the value of your assets is greater than the value of your liabilities.

Over time, tracking your net worth gives you an idea of whether you’re on the right path to meet your financial goals or if you need to recalibrate in order to reach them on time. Additionally, it’s good to know how your debt stacks up to your cash and other assets. Your hefty brokerage account balance may not seem as solid if it’s heavily outweighed by lots of outstanding loans.

Your net worth can also serve as a motivator to make good financial decisions on a daily basis. It’s also good information to have when it comes time to make a major financial decision, like how to fund a large purchase.

Personal net worth

Anyone can (and should) track their personal net worth, regardless of their current stage of life. When you’re in the middle of your career, you may be at the top of your earning game, but you also may have lots of expenses, like a house big enough to fit the whole family, cars for your teens, and impending costs like tuition. Regularly looking at your net worth helps you create a balance between maximizing your earning power and managing your wealth so that it serves you both today and in the future.

Personal net worth is also a helpful metric during your retirement years. It helps you make sure you’re not on pace to outspend your savings. And tracking the value of your assets can help you decide when you may potentially want to downsize; for instance, if property values are up, you may decide it’s time to sell your house and move into a maintenance-free condo.

Business net worth

What does net worth mean from a business perspective? It’s basically the same as a personal net worth — the difference between your assets and liabilities. But if you own a business, you may have a lot more data to track in order to determine your company’s net worth. You may have a variety of different types of financing, from credit cards to business loans. And you also may have a range of assets, including commercial real estate, equipment, inventory, and cash reserves.

Tracking business net worth reveals the health of the business, both for you as the owner and for potential investors and lenders. Keep a record of the company’s estimated net worth over time, which can be helpful in securing the funds you need to expand.

How to calculate net worth

The formula for calculating net worth is a simple one. You just subtract your assets from your liabilities to see your financial health:

Net Worth = Assets – Liabilities

A negative value means your debt heavily outweighs your assets. This could signal it’s time to pay down some of those balances. A positive answer means you have more assets than debt, which is a good thing.

Let’s take a look at a sample situation of an individual’s total net worth. A married couple owns a primary residence valued at $750,000, plus cash and investment accounts totaling $1.5 million. Their mortgage balance is $425,000, their two auto loan balances total $100,000, and they have a credit card balance of $50,000.

So their assets total $2.25 million and their outstanding liabilities total $575,000.

$2,250,000 (assets) – $575,000 (liabilities) = $1,675,000 (net worth)

Together, the couple has a net worth of $1.675 million.

Assets

What assets should you include when calculating your net worth? Here’s a starting point of all the things you can add up to represent your assets.

  • Real estate (include the full property value — any mortgage will be addressed in liabilities)
  • Investment accounts
  • Cash reserves
  • Art
  • Jewelry
  • Collectibles
  • Vehicles

Liabilities

There are a variety of outstanding liabilities that impact your net worth statement, including:

  • Mortgage
  • Home equity loan or lines of credit
  • Credit card debt
  • Student loan
  • Personal loan
  • Auto loan
  • Business loans that have a personal guarantee

Benefits of tracking your total net worth

Your net worth doesn’t define you, but it does reveal what’s possible for you to achieve with the money you’ve worked hard to earn. Here are three important reasons why you should regularly track your net worth.

Know where you stand

You may have lofty goals for your future, but it’s hard to achieve them without a plan. And you can’t make a plan without knowing exactly where your finances stand today. Plus, if you have multiple investment accounts, employee-sponsored plans, and tax-advantaged retirement accounts like an IRA, tracking your net worth is a good opportunity to look at those balances all at the same time. Calculating your net worth gives you the opportunity to take a snapshot of all those different values at the same time so you actually know where you stand when it comes to your retirement needs, kids’ college tuition, and other future financial goals.

The same holds true for your debts. You make your mortgage and car payments every month. Maybe you occasionally draw on a home equity line of credit (HELOC) or charge a family vacation on your credit card. But could you accurately name those balances off the top of your head? Your mortgage might be a lot lower than you thought — maybe it’s time to refinance into a shorter-term mortgage. Or, after making interest-only payments on your HELOC, you could be reaching your credit limit without even realizing it.

Prioritize financial goals

When you regularly check in on your net worth, you’re able to constantly evaluate your goals and home in on the ones that are most important to you. For instance, your adult child may be getting married. Checking all of your assets and other obligations gives you a responsible idea of what to contribute to the wedding and what type of gift you may wish to give.

Your net worth can also influence your work plans. Should you work a few more years to continue earning, or are you in a stable financial place that allows you to retire in the near future? It’s hard to answer these questions unless you have a strong grasp of your true financial situation.

Maximize financing options

Your net worth also plays a role in any upcoming financing applications. Lenders want to know your net worth as part of any loan application, especially when financing things like second properties. Second homes come with tighter lending requirements, including a larger down payment and a higher interest rate. A lender likely also wants to see that you can make your payments along with your primary residence mortgage for several months out of your cash reserves.

Any business loan application with a personal guarantee also evaluates your net worth. You may even need some of those personal assets to serve as collateral. The higher your net worth, the less risk you pose to the lender and to your own financial security.

Bottom line

Your net worth plays a huge role in the financial planning process. It’s not meant to be a way to measure yourself, but instead should be viewed as a way to measure the resources you have to achieve your goals in life, especially when it comes to estate planning. Net worth fluctuates throughout your lifetime. After all, some years come with big bonuses or a large inheritance, while others may come with a tumultuous stock market or multiple large expenses. That’s why it’s important to look at your net worth and financial assets regularly. You’ll be able to identify trends, pivot when life throws you a curveball, and celebrate in a way that is generous and secure.

Ready to not only track your net worth, but create a plan to manage it as well? Contact Dowling & Yahnke Wealth Advisors today.

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