What is Net Worth?
And Why does it Matter?
“I demand the sum of… one million dollars.”
A million dollars may not mean as much as it did when Dr. Evil* came of age in the 1960s. Even so, it is a significant threshold that continues to be a target for many households even today. The point, though, is not so much whether you or I are worth a million dollars. Rather, this figure is used to signify a degree of wealth, or net worth.
The Basic Idea
At its most fundamental, net worth is the difference between total assets and total liabilities. As financial calculations go, this one is pretty simple: Add up the value of everything you own and subtract everything you owe. The difference is your net worth.
A Simple Net Worth Calculation
See the following table. In this case, we have a married couple who have assets that are owned individually and jointly: TOTAL ASSETS – TOTAL LIABILITIES = NET WORTH
|ASSETS||Spouse 1||Spouse 2||Joint||Total|
|LIABILITIES||Spouse 1||Spouse 2||Joint||Total|
Why is Calculating Your Net Worth Important?
Net worth is a snapshot in time. It will change year by year and for most people an annual calculation is probably enough. Early on, we may have little to no net worth. For example, a person with a new job who has just graduated from university may find themselves with a net worth of less than zero if they borrowed money to help pay for their expenses during their student years. As time passes and income increases, however, the student loans get paid back and more can be set aside to purchase a home or to fund retirement.
The important thing, then, is not so much where you stand in terms of your net worth right now, but the direction in which your net worth is going. For most people who have a regular income from employment, it should go up over the longer term. If you are retired, living off your assets and government benefits, your net worth will probably decrease as you draw down those savings in order to maintain a desired lifestyle.
What should I do if my net worth is not where I want it to be?
The financial management measure we have discussed today is net worth. The other common measure is referred to as cash flow. It is when you have more money coming in than going out, positive cash flow, that you can set aside that surplus cash to increase your net worth. More on cash flow in a future article.
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*See the first Austin Powers movie.
Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, accounting or legal decisions.