You've probably heard this important-sounding term many times, but what exactly is meant by a person's "net worth"? And is your own net worth something you should worry about?
Net worth is the number you get when you add all of the assets you own and subtract all of the debts you owe, and it can serve as a useful indicator of your overall financial health.
The importance of net worth
Calculating net worth is a quick way to shine a light on your personal finances. Because many people have a negative net worth, even possessing a modest positive net worth can be a good thing. Having a positive net worth makes it more likely that you'll qualify for loans and better credit terms.
By comparing your net worth on an annual basis, you can get a good feeling for your financial well-being. If your net worth is rising each year, you're probably in good financial health. If your net worth is diminishing, you'll want to take a closer look at your finances to see what's causing the decline.
How to calculate your net worth
Determine assets by adding up the total value of each category below:
- CDs, checking, money market and savings accounts
- Investment accounts
- Stocks and bonds A variety of resources can help you estimate the value of stocks that are publicly and privately traded, and you can get the value of your bonds by going to the Federal Reserve's website and entering the bond information.
- Personal items This includes things such as cars, boats, recreational vehicles, antiques, jewelry, electronics and artwork. While estimating the value of personal items can be tricky, there are many resources available to help determine the worth of all sorts of possessions.
- Life insurance Look at your life insurance document for the face value of the policy, and if it isn't a term policy, take out a recent statement and add in the current net cash value.
- Retirement accounts IRAs, 401ks, SEPs.
- Non-tangible assets This category includes inventions, websites or other valuable assets that could be sold.
- Money owed to you
- Oil, gas and mineral rights values
- Equity in your home Calculate this by subtracting what you owe on the home from its current value.
Determine liabilities by adding up what you owe on the following:
- Auto loans
- Credit card balances
- Any other debts or loans This includes money you owe to individuals.
Once you have those figures, calculate your net worth by subtracting your liabilities from your assets. If the figure is positive, congratulations--this means you own more than you owe. If the total is negative, you owe more than you own, but don't panic--this is common, especially for people who've recently made a major purchase such as a house. But you should start looking at how you can start moving your number toward the positive side.
The impact of outside factors
When calculating your net worth, remember that the economic downturn, including the fall in the stock market and home values, negatively affected the net worth of many. According to the Federal Reserve Bank of Minneapolis, many of the gains in the net worth of American households have been erased in recent years by the financial downturn.
But remember that your net worth is not a static number. If you're bothered by your current net worth, instead of focusing on the fact that it isn't as high as you'd like, concentrate on how you can save and improve the number in the future.
A way to motivate
Perhaps the best thing about knowing your net worth is that it allows you to analyze your long-term financial goals and make plans to meet them. For instance, if you dream of buying a vacation home and determine that you need a higher net worth in order to qualify for that sort of purchase, this knowledge can motivate you to save more money and raise your net worth.
And when your net worth does rise, enjoy it--it means you've done something significant to improve your financial standing.