The How and Why of Your Net Worth

Over the years, I have developed a network of other fiduciary financial planners. From time to time, I invite one of these individuals to contribute an article of interest. Today, Phillip Christenson of Phillip James Financial shares his thoughts about The How and Why of Your Net Worth. Phillip is a CFA, Chartered Financial Analyst and financial advisor in Maple Grove, MN. He is co-founder at Phillip James Financial where he performs comprehensive financial planning and portfolio management.

The How and Why of Your Net Worth

You hear it all the time in regards to politicians and celebrities: what is their net worth? Net worth is a term discussed frequently to show how well off someone is, yet many people are not entirely certain of just exactly what it is or how to calculate it. Net worth is much more broad and all-encompassing than income from your job and investments. Your net worth consists of everything you own minus your liabilities and debts. Your income doesn’t factor in to your net worth at all, just what you have saved up. Think of it as your own personal Balance Sheet, similar to what a company uses to track its financial health. It’s all based on a single point in time although it can be very helpful to track it over time by recalculating it every so often.

There are two basic sections to a net worth Statement; your assets and your liabilities. Your assets is everything you own that has value. For a lot of people their house will be their biggest asset on their net worth statement. Other common assets are investment and retirement accounts, automobiles, collectibles, and other miscellaneous personal property. The second part, liabilities, is your debts. The biggest usually being a mortgage but could also include student loans, credit card debt, auto loans, or even a personal loan. Basically, any amount of money you owe to someone else. Your net worth is then calculated simply by adding up all your assets and subtracting all your liabilities. What’s left over is your net worth. Essentially, it measures how much you are financially worth as a person. This can be somewhat of an enlightening exercise as it provides an overall picture of your financial standing. In fact, it not only provides you a full picture of what you own and what you owe all in one statement, but is a good reflection of how a third party (like a bank) would view your financial stability. And it’s separate from your income. While income and net worth are usually correlated, you can have someone with a high income but very little net worth. Likewise, you can have someone with a small income but a very good saver and investor with a high net worth. For example, a person making $30,000 a year who is debt-free and has several investments to their name will have a greater net worth than the debt-laden spendthrift making $150,000 a year.

Here is an example Net Worth Statement that lists the most common assets and liabilities used to calculate your net worth. It even breaks them down into sub-categories so they can be tracked and monitored more easily. Keep in mind the value will change quite considerably over time, and occasionally recalculating your net worth will give you a solid and unbiased understanding as to what your financial health looks like.

As I mentioned earlier, your debt subtracts from your overall net worth. So, what happens if you have more debts than assets? Well, that just means you have a negative net worth. In most instances this is a not the best place to be financially, especially if the debt stems from poorly managed finances and a lack of savings. One common exception to this would be if you are still young and you are taking on certain forms of useful debt like student loans. It may be a good strategy to take on student loan debt if it will lead to a higher paying job and the potential to increase your net worth in the future.

Not only that, the type of debt you have can be just as important as how much of it you have. If your debt consists of a lot of credit card debt and other high-interest loans, that is a worse situation to be in than if you have debt accrued from a mortgage. The reason is because a mortgage is generally at a lower interest rate and is used to purchase a house which over time is an appreciating asset. So even though you are adding a liability (the mortgage) you are also adding an asset (house). Credit card debt, alternatively, is usually at a much higher rate and used to purchase highly depreciating consumer goods and services. This type of debt only adds to the liability side of your net worth statement without a corresponding asset.

Remember that your calculated net worth is only a snapshot in time – what you do with that information is up to you. If you realize that your net worth is not quite where you’d like it to be, map out a plan for paying some of your debts and investing in more assets. Your income will play a factor in how fast you can improve your situation but keep in mind it’s not how much you earn but how much you are ultimately able to save that is going to have an impact.

If you have more questions or want help creating your statement of net worth, then maybe it’s time to talk to an financial advisor in Plymouth today. They’ll not only be able to create your net worth but also help determine the best way to improve and grow it over time.