The net worth of entrepreneurs, investors, celebrities, and other well-known individuals has long piqued the interest of millions of people around the globe.
Often, the term “net worth” is assumed to be related to the ultra-rich, but as a matter of fact, it is a common misconception – anybody can benefit from knowing their net worth.
So, what does a net worth definition entail, how to calculate an individual’s net worth, and why is it important to know your own net worth?
We cover all the above and more in this article.
What does net worth mean?
Rest assured, figuring out your personal net worth is simple. Your personal net worth is the amount by which your assets exceed any liabilities, and it is an accurate reflection of your financial health.
Simply put, one can say that net worth is a measurement of everything you would be left with if you sold all of your current assets to pay all of your debts.
With that in mind, every financial step you take should be towards increasing your personal net worth. You can achieve that by either acquiring more assets or reducing your debts.
But what exactly are the assets and liabilities that one must consider when calculating their net worth?
Let’s take a look at them below.
Net Worth: Assets and Liabilities
In order to determine a person's net worth, it is necessary to know what assets and liabilities they have.
What Constitutes Assets?
An asset is basically anything that has a specific value and can be converted into cash. This includes:
- Real estate
- Personal property (this can include jewelry, furniture, or anything of value that can be sold)
- Retirement accounts
- Stocks and bonds
- Life insurance with cash value
- Savings bonds
- Money in checking
- Savings accounts
What are liabilities?
Liabilities are all the debts you owe to other parties and can include things such as:
- Car loans
- Student loans
- Credit card debts
- Any other debt you might owe
How to Calculate Net Worth?
To correctly calculate net worth, you need to make a list of everything you own (your assets) and everything that you owe in debt (your liabilities). Then, simply subtract your total debt from your total assets. This equation will calculate your current net worth.
Assets - Debts = Net Worth
How Is a Person’s Net Worth Calculated: An Example
To give you a better understanding of how to calculate personal net worth, we will provide you with a real-life situation.
Let’s say you have a $20,000 note on your student loans, $350,000 left to pay on the mortgage for your Manhattan apartment, and $10,000 of credit card debt. That’s a pretty hefty sum. However, you have $15,000 in cash, a $200,000 IRA (self-funded retirement plan), and you’ve already paid off half of your $700,000 mortgage.
- Cash - $15,000
- IRA (self-funded retirement plan) - $200,000
- Half of your mortgage paid - $700,000
Total assets: $915,000
- Student loans - $20,000
- Manhattan apartment mortgage - $350,000
- Credit card debt - $10,000
Total debts: $380,000
In this case, your net worth would be $535,000.
To get to that number we take the liabilities (-$350,000, -$10,000, -$20,000= -$380,000) and we add in the assets (+$700,000, +$200,000, +$15,000 = $915,000-$380,000=$535,000). Because you own the title and just owe one -half balance, the title is still considered an asset. When you’re done paying off the balance, you will own the property.
Now, take into account that you bought the apartment 10 years ago. Maybe you delayed paying off your student loan debt because you wanted to buy a property in a place like New York City where you could earn a great living.
Even though the value of the note 10 years ago was $700,000, the property has appreciated and is now worth $900,000. Add in the $50,000 of renovations you’ve done, and that will raise the property value even further.
Why Might It Be Important to Track Your Net Worth?
Figuring out your net worth and tracking it over time can be beneficial for several reasons. Here are some of them.
1. It helps to Track Your Financial Progress
First and foremost, calculating and periodically measuring your net worth helps you to quantify your financial progress and assess your overall financial health. It lets you see where you have started and whether your finances are trending in the right direction.
Regularly tracking your net worth also motivates you to take action and positively influence the growth of your wealth. Since it looks at everything – your assets and liabilities – it offers a fairly accurate representation of your financial standing. And if you measure and track your progress regularly, you can take positive steps to improve your net worth.
2. It Reveals Areas Where You Can Improve Your Wealth
Negative or far-from-ideal net worth could indicate that things are getting out of control. Maybe your debt levels are too high, or you are spending a significant amount of your income; an accurate calculation of your net worth can reveal areas that need your attention.
3. It Shifts the Emphasis Away From Income
Many individuals consider income as the main indicator of their financial wealth. However, income is not as accurate as net worth – just because you are earning a 7-figure annual salary, that does not mean you have a high net worth.
Measuring net worth allows you to focus on your income as much as your liabilities (or expenditure) so you know where you truly stand.
4. It Facilitates Applications for External Funding
If you are looking into investing in a property or obtaining funding for a new business, lenders might be asking for your net worth to assess your viability in repaying the loan.
If you have a solid track record of increasing your net worth, banks and other financial institutions may even offer lower interest rates and favourable repayment terms, providing you with the extra cushion and leverage in whatever endeavours you are looking to pursue.
5. It Serves as a Deciding Element for Applications for a Second Passport
It is not unusual for wealthy individuals to look for business or investment opportunities in foreign countries while seeking to secure a second passport or a residence permit.
Holding dual citizenship brings numerous advantages, from increased global mobility for you and your family to favourable taxation regimes.
However, most citizenship-by-investment and residency-by-investment programs ask you to prove your net worth as part of the application process. For instance, the Irish citizenship-by-investment scheme requires a minimum of €2 million in personal wealth.
Therefore, tracking and measuring your net worth can prove to be helpful when seeking to acquire a second passport, among other reasons.
Tools and Methods to Calculate Your Net Worth
The easiest way to work out your net worth is perhaps using pen and paper and the formula we presented above. On the flip side, noting down your net worth on paper might not be sustainable long term and could easily get lost.
Thanks to technology, you can automate your net worth calculation for easier tracking. There are various net worth calculators on the internet, such as this one by Kiplinger, or you can simply use an accessible Excel spreadsheet.
Regardless of the tool you choose, ensure that it lets you monitor your progress over time.
Conclusion: Knowing Your Net Worth Is Key
Whether you are looking for an accessible and straightforward way to track your financial growth, measure your ability to carefully manage your assets and liabilities, tap into the benefits of better financing options or even acquire a second passport, knowing your net worth is paramount. Learn about the five characteristics of high net worth individuals.
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