Net Worth

It's funny to think of people in terms of how much they are worth, but in finance, our monetary worth is calculated all the time.  A person's financial worth, or net worth, is a tool used in finance to determine the dangers or benefits a bank, credit card, or lending company may experience in lending a person money.  In personal finance, calculating and keeping track of your own net worth can help you get on track, stay on track or attain financial goals, so net worth becomes as important a tool for individuals as it is for financial institutions.

How is Net Worth Calculated?

 
Net worth is actually a simple calculation.  By listing your assets and liabilities, you can subtract the total of each to find your negative or positive net worth (typically calculates out to be negative in the beginning of your personal finance life and positive in the years to come).  Assets, as we remember from our Assets post, are the things you own that you can sell for a substantial amount of money, like your home, car, boat or jewelry.  Reviewing our liabilities post, we are reminded that liabilities are the amount of money we owe, or the amount of money we are in debt.

Show Me the Money

 
To go more in depth with a net worth calculation, let's look at an example.  John Smith is 25 years old, and he is just beginning his financial journey.  John has a 2007 Hyundai Accent worth $6,500, and he recently bought a cute bungalow for $100,000.  Recently, John married his college sweetheart, Joan, and he put a $5,000 wedding/engagement ring combo on her finger.  Joan brings a 2002 Dodge Durango worth $4,000 and a 1973 Harley Davidson motorcycle worth $3,500 to their combined assets.  Also, they have combined their savings accounts for a total of $10,000.  Adding all of their assets together, John and Joan's assets total $129,000. 

Moving on to liabilities, we see that John owns the Accent outright, owes $89,000 on the bungalow, and owes $4,500 for the rings, and Joan owns both her Durango and Harley outright.  John also had trouble with credit cards in recent years and owes $10,000, and Joan does not have credit cards but does owe $30,000 in school loans.  That means that John and Joan's liabilities total $133,500. 

Now for the fun (or painful) part: we can calculate the net worth.  If we subtract the liabilities from the assets, John and Joan's total net worth is...drumroll please... -$4,500.  I know, I know, that is very disappointing to a lot of young people first starting out.  They are worth a negative amount of money.  However, this is just the beginning, and as John and Joan continue their financial journey, they begin to gain job experience and financial knowledge needed to increase their wages, begin 401Ks, and sock away money toward their assets and their savings.  As their financial world becomes more stable, John and Joan will be positive about (and in) their net worth. 

When you calculate your own net worth, don't get too bogged down in a negative number, no matter how old you are.  If your net worth took a plunge in the recent market crash, for example, you always have time to re-assess your financial plan and begin diversifying your assets for a more stable financial status.           

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Anonymous's picture

Jeff @ Sustainable Life Blog wrote:

Mon, 12/06/2010 - 20:37 Comment #: 1

Christa -
One thing important to know about net worth is that it's only good for that the time that it is calculated. While the example had -4500 in debt right now, with prudent use of resources, it could be 0 the next month, and 4500 two months from now!

Christa Palm's picture

Christa Palm wrote:

Mon, 12/06/2010 - 22:04 Comment #: 2

Excellent point, Jeff! Way to stay positive...pun intended :)

Anonymous's picture

Aloysa wrote:

Tue, 12/07/2010 - 02:38 Comment #: 3

First time I calculate our NW, I was really bummed. Becase we are in debt, and our condo value dropped a lot. But as Jeff mentioned as long as we use our funds responsibly (and I don't run out shopping :-)), our NW improves. Slowly...

Anonymous's picture

Invest It Wisely wrote:

Tue, 12/07/2010 - 04:49 Comment #: 4

Also depends on where the assets are. If you are in a position to increase assets and reduce liabilities, that's good. Unfortunately, assets like cars and diamond rings depreciate (well, the diamond ring has a big premium to it, anyways). If you can buy in cheap, and only take liabilities when they help you get assets either now (a mortgage on an affordable home) or in the future (a student loan for a degree that will give you a good future) then that net worth should be on a good upwards trajectory.

Anonymous's picture

FB @ FabulouslyBroke.com wrote:

Tue, 12/07/2010 - 12:58 Comment #: 5

Assets also mean your laptop, clothes and so on... but I generally only count my cash and financial assets in the mix, not my physical ones

I don't even put my car in there.

If I were to count my physical assets, I'd adjust it to the price of what I could get for it today. Like my car, would be $500, even though I paid $2000 for it.

Christa Palm's picture

Christa Palm wrote:

Thu, 12/09/2010 - 02:01 Comment #: 6

Aloysa, I was bummed about my net worth at first, too. With school loans in the mix, my husband and I were really negative, but we just turned positve!

Isn't depreciation disappointing, Invest It Wisely? Your tips on the mortgage and school loans are great -- thanks!

FB, excellent tip on counting the assests at the depreciated value (cars) or appreciated value (houses {in some cases}). Like you, I don't account for all my assets either -- just the car, house, cash, and financial assets.

Anonymous's picture

Weekend Reading: Snow Edition | Invest It Wisely wrote:

Sun, 12/12/2010 - 22:01 Comment #: 7

[...] Net Worth (MomVesting) [...]

Anonymous's picture

Welcome to this week’s Carnival of Personal Financ wrote:

Mon, 12/13/2010 - 07:08 Comment #: 8

[...] explains the concept of net worth and offers words of advice if that number is below [...]

Anonymous's picture

Financial Definitions - Glossary for Understanding Finances wrote:

Thu, 01/19/2012 - 21:46 Comment #: 9

[...] N Net Worth [...]

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