Taking the time to schedule an annual check-up with your physician is important to maintaining your overall health and wellness. The same goes for your finances. Just like a routine health exam, a thorough review of your finances can help you screen for potential problems and identify opportunities to improve your financial health for the long term.
It can also be motivation to make a change.
The first step to keeping your finances in check? Determining your net worth. Think of your net worth as a barometer of your financial health — it helps you assess where you’re at and can provide a reference point for measuring your progress toward your goals.
How do I calculate my net worth?
At the most basic level, your net worth is the total of all your assets (what you own) minus the total of all your liabilities (what you owe). Put simply, it’s the amount you’d have left over if your assets were converted into cash and used to pay off your debts.
To calculate your net worth, make two lists — one for your assets (your investments, retirement account or house) and one for your liabilities (your student loans, credit card debt or mortgage). Be sure to list the current value, or level of debt, for each item on the list. Tally up the items, and then subtract your total liabilities from your total assets.
This figure represents your net worth.
How can net worth be used?
Periodically calculating and tracking your net worth numbers will allow you to identify the realities of where you’re headed from a financial standpoint. The figure may gradually shift, depending on your age or current stage in life. For instance, the net worth of a young person who is just starting out in his or her career may be inherently low.
After all, they have yet to earn much income and may be saddled with student debt.
This is where negative net worth can come into play. For example, let’s say that Mary, a young, college graduate, tallies up her assets and liabilities to arrive at her net worth.
She may have a simple balance sheet, like the following:
Net worth can be negative when your liabilities, or debts, exceed your assets. In the example above, Mary has a negative net worth, because she owes more than she owns. As you can see, her student loan is her biggest liability.
Although a negative net worth can be disheartening at first, it’s important to focus on developing steps to make progress and move forward. Ideally, as you progress in your career, your asset growth will outpace your liability growth, causing your net worth to increase.
It’s also helpful to sit down with a financial advisor to evaluate your entire financial picture and find ways to build up your assets. In this example, a financial advisor could help Mary kick-start the process by identifying certain areas where she can cut back and free up funds to devote to extra student loan or car loan payments.
Why is net worth important?
Your net worth can provide a simple, yet meaningful picture of your financial state at a specific point in time. And as time passes, the fluctuations in the number can mean even more. They can indicate positive (or negative) growth within your financial life, and can show the impact of any life changes you’ve made — particularly how those changes relate to your long-term goals. Where is your income going? Is your net worth better — or worse — than last year? A decline in your net worth number could be a wake-up call, prompting you to identify the causes of the decline and take action. Or, if your net worth increases, it can signify that you’re on the right track, as you come closer to achieving your goals.
Whether you’re investing for retirement or saving for your child’s college education, keeping track of changes in the number can help you decide when to adjust your savings plan or diversify your assets to build your net worth and keep moving forward.
How often should I check my net worth?
Everyone’s preference for how often they calculate their net worth is different, but a good rule of thumb is to calculate it every quarter. As you gather more data points, you can check your progress over time and take note of patterns in your spending or saving.
Be sure to revisit the value of your assets every once in awhile as well. The value of your car or home, for instance, may change based on use or market fluctuations, so it’s important to modify those numbers as needed. To ensure your calculations are accurate, it’s always a good idea to regroup with your financial advisor and make any necessary adjustments together.
How is net worth used to create a financial plan that is right for me?
Whether it’s on a monthly, quarterly or yearly basis, regularly checking your net worth numbers can give you an instant starting point to building your financial plan. Additionally, knowing how well you are paying down debt and increasing your assets can help shape other aspects of your plan, whether it’s knowing how much to save for retirement or how much you can feasibly pass down to your family.
While net worth is a valuable indicator, keep in mind that it doesn’t give you all of the information needed to completely assess your financial situation. That’s why it’s important to supplement your plan with other information, such as cash flow planning, investment advisory and tax strategies. A financial planner can help initiate these practices and devise strategies for the short and long term.
Determining your net worth is more than coming up with one number. It can go a long way in encouraging you to pay down your debts, save more and understand your financial future.