What is net worth? Simply put, net worth is the difference between the value of your assets and your debts. It can be negative or positive. Over time, net worth can go up or down.
Let’s do a simple example. Andrew, who is 22 years old, has a car worth $15,000 that he owes $10,000 on. He has $5,000 in his emergency fund and $4,000 in his checking. Andrew’s 401(k) has $10,000 in it. He rents an apartment, and he doesn’t own a home. He has $20,000 in student loans outstanding. Is his net worth positive or negative?
Assets - Liabilities = Equity (net worth)
Car: $15,000 - $10,000 = $5,000
“Cash”: $9,000 - $0 = $9,000
401(k): $10,000 - $0 = $10,000
Student Loans: $0 - $20,000 = -$20,000
Total: $34,000 - $30,000 = $4,000
As you can see, Andrew’s net worth is positive, and that’s a great thing. Many Americans have negative net worth.
Why should I care what my net worth is? At some point, assuming social security and pensions (if you receive them) are not enough to support your lifestyle, you will need to live off your portfolio. It’s important you know what your net worth currently is and what it needs to be in the future.
How much net worth is good? The amount of capital needed to live off is different for every person. Some professionals suggest you should be able withdraw 4% from your portfolio each year. So, if your living expenses are $50,000 you will need $1,250,000 when you retire. Note that this amount should not include your personal use assets (like your car or your home), because you won’t actually be selling those and using the proceeds to support your lifestyle. Others say you should have 12 times your salary when you retire, or 25 times whatever your living expenses are. You could also hire a professional to run some simulations to arrive at your “number.” Whatever method you use, you need to know where you are before you can get where you need to go.
How often should I calculate my net worth? My husband and I have always taken the long view to investing and checked our net worth once per year. We figured this smooths stock and housing market fluctuations, and still allows us to see trends. I was curious what other people do, so I took to Twitter and asked. Here are the results:
· Never: 2
· Yearly: 1
· Twice a year: 1
· Quarterly: 4
· Monthly: 19
· Daily: 1
· It varies: 2
As you can see, checking net worth monthly seems to be the overwhelming choice for my Twitter followers, although most of them are also passionate about personal finance. My husband and I are going to step our calculation up to quarterly. You should do what works for you.
What’s the best way to calculate my net worth? You can use a platform, like Mint, which will do it for you. Or you could do it yourself using a spreadsheet. My husband and I use a spreadsheet. We find that manually entering the data forces us to focus on it. I’m not sure if we’ll have to automate the calculation now that we’re going to be calculating our net worth more often.
I’ve said this before and I’ll say it again, don’t judge yourself too harshly. No net worth number is in itself good or bad. Your net worth merely is what it is. You need to know where you are in order to set financial goals and – eventually – reach them.