What is Your Net Worth and What Does it Mean?

Last updated on July 25th, 2017

Every financial decision that you make brings you closer or further away from your goals. To evaluate your financial progress over time, one useful measure to consider is your net worth.

Your net worth is a measure of your overall financial health at one point in time, calculated as the difference between your assets and liabilities:

Assets – Liabilities = Net Worth

An asset is anything that you own of value. This includes:

  • Cash
  • Automobiles
  • Personal property and household items
  • Any business or real estate that you own
  • Investments (checking/savings, stocks, bonds, ETFs, mutual funds, etc.)
  • Retirement savings (pensions, social security, 401k, IRA, 403b, 457, etc.)

Most people stop at financial assets when calculating net worth. For a comprehensive view, you should also include non-financial assets like your human capital (the present value of anticipated lifetime earnings). The reason for this is simple – human capital is converted into financial capital through the process of saving.

For example, a recent college graduate often has negative financial assets (debt), but significant human capital (earnings potential). After starting a new job, the graduate can begin saving part of each paycheck, converting human capital into financial capital. At retirement, human capital is depleted but financial capital should be peaking.

Financial liabilities include any form of debt, such as:

  • Auto loans
  • Student loans
  • Mortgage loans
  • Credit card debt
  • Money owed to anyone

When calculating your assets and liabilities, the value of each item should be estimated using the current market value. For example, the best estimate for the value of your jewelry is the price that someone else is willing to pay in your local market (today), not the price you paid at the time of purchase.

Net Worth Example

Let’s assume that you have the following assets:

  • Furniture worth $5,000
  • A home worth $150,000
  • Two cars worth $25,000
  • Electronics worth $5,000
  • $125,000 saved in your 401k
  • $20,000 in your savings account

Total assets (ignoring human capital) = $330,000

Let’s also assume the following liabilities:

  • Student loans totaling $50,000
  • A mortgage balance of $105,000

Total liabilities = $155,000

Net Worth = ($330,000 – $155,000) = $175,000

What Does Your Net Worth Mean?

Most financial decisions will increase or decrease your net worth. By tracking your net worth over time, you can determine if your financial decisions are helping or harming your financial progress. If your net worth is continually moving upward, that means you are increasing your assets faster than your liabilities. If your net worth is decreasing, the opposite is true.

Consider a few examples:

  • Eliminating debt (a liability) will increase your net worth.
  • Investing (usually) results in financial gains, increasing your net worth
  • Increasing your income and/or decreasing your expenses will result in more available cash (an asset), increasing your net worth.
  • Buying a brand new car, new electronics, household products, or other depreciating assets will decrease your net worth, because after being used these products are worth far less than the price you paid new.

Insurance is a tool used to protect your net worth. Most insurance products will actually decrease your net worth over time because you must pay ongoing premiums to the insurance company in exchange for coverage. But without insurance, an unforeseen event could destroy your net worth in a flash. The small premium payments eliminate the possibility of a major loss.

Your Net Worth Can Be Misleading

Your net worth is a financial snapshot at one point in time. Checking your net worth once is not very valuable because it provides no context.

There are several situations which highlight this problem:

1) Your stage of life

  • Individuals graduating from college often have a negative financial net worth (student loan debt), but significant earnings potential (human capital). Many have borrowed to finance an education or trade, with the expectation of earning higher wages after graduation.
  • Individuals in peak earning years are able to increase their net worth quickly, converting their human capital into financial capital by spending less than they earn.
  • Individuals in retirement will often see their net worth decline with age. Instead of saving, retirees often spend their accumulated financial assets.

For most people, net worth will fluctuate in each stage of life.

2) Investment fluctuations

Hypothetically, let’s assume that you have $500,000 invested in the stock market. If the stock market has a major correction like the one observed in 2008, the value of your investments (and your net worth) could be cut in half.

If you sell all of your stock holdings after the market tanks, you will guarantee the loss and realize a massive reduction in your net worth. If instead, you remain invested long enough for the market to rebound, your net worth will recover. This scenario highlights the importance of tracking your net worth to evaluate your financial progress over time.

3) Comparing to others

Another dangerous game is comparing your net worth to someone else. You probably have unique financial goals, a different career, a different family situation, and many other differences. But your net worth doesn’t capture these differences.

For example, consider a net worth of $1 million. There are multiple interpretations of that number:

  • Some consider $1 million to be an unattainable fortune.
  • Others consider $1 million to be the ideal retirement nest egg.

In the end, your net worth is just a number. What matters is achieving your number. If your net worth allows you to achieve your financial goals, you shouldn’t worry anything else.

How to Track Your Net Worth

There isn’t any perfect method for tracking your net worth, but I personally recommend the following:

  • An Excel spreadsheet
  • Personal Capital

An Excel spreadsheet is useful for two reasons. First, it forces due diligence. To list all of your assets and liabilities, you must think about and acknowledge your financial situation. And second, it can help keep your family on the same page. Should something ever happen to me, my family can use the Excel sheet to identify assets and liabilities.

Personal Capital is a much easier solution. After signing up for a free account and securely linking your financial accounts, the software automatically updates your net worth in real time. This allows you to track your assets and liabilities without any manual effort.

We use a combination of Excel and Personal Capital to track our net worth.

Final Thoughts on Net Worth

Your net worth is a measure of your overall financial health at a single point in time. Tracking your net worth will allow you better understand how your financial decisions affect your financial progress over time.

Do you think net worth is an important measure of financial health? Share with a comment below.

Comments
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  2. Reply

    Great post! I agree it’s important to keep the time of life in mind when thinking about net worth. Someone in their late ’20s who just graduated from medical or law school will likely have a negative net worth, but substantial earning power over the next few crucial years. I think it’s important to capitalize on your own situation for your benefit. For example, the recent med school graduate may choose to have a much riskier investment portfolio, knowing that the high salary can smooth out the volatility ride. Someone who earns less, but has a higher net worth because of years of saving may want a more conservative portfolio to make a career change, or retire.

    • listy
    • March 2, 2017
    Reply

    This is a great way to think about it! I do calculate my net worth on a regular basis, but, I agree with you that understanding each of the elements behind the total number is almost more important.

    • Lynsey
    • August 8, 2016
    Reply

    Our net worth isn’t high at the moment, but we think we’re doing great that our net worth is in the positive 5 figures with me being two years out of college and my husband still being a student. We plan to continue saving and stay debt-free throughout the rest of his school. Once he graduates, we hope to kick our savings and investing into high gear. Thanks for the motivation help.

      • Jacob
      • August 8, 2016
      Reply

      Sounds like you guys are definitely doing well. Congrats!

    • Mike
    • August 1, 2016
    Reply

    Good article. I agree on the spreadsheet use . not only does it keep you informed , it would be very useful for family to locate assets.

      • Jacob
      • August 2, 2016
      Reply

      Thanks Mike

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    • Meg
    • May 23, 2013
    Reply

    I love tinkering around with numbers! Our number is $500,000 even. We have less than $40,000 left on the mortgage and then the mortgage payment will be going toward investments. We currently have just over $60,000 in cash and retirement accounts, so we have a ways to go.

      • Jacob
      • August 1, 2016
      Reply

      It’s great that you have a number in mind, and that you continue working towards that goal.

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    • Mr. Bonner
    • May 22, 2013
    Reply

    Sadly for us, we’re quite far away from our goals, so we’ll continue to chip away at our debt while investing in our retirement accounts.

    • Martin
    • May 21, 2013
    Reply

    I have never looked at my net worth (or worth net-work, hehe) I cannot include my home equity, since I am under water, so it is currently actually negative… at least I will pay lower taxes.

    • Million
    • May 21, 2013
    Reply

    Interesting post. I’m not close to financial freedom yet, but I’m happy with the progress I’ve been making towards that goal over the past couple years.

    • John
    • May 21, 2013
    Reply

    Great overview Jacob and has been said I think it’s relative in nature as what’s important to some will likely not be important to others. We’re slowly, but surely, growing our net worth and us starting our own business was a key part in that equation.

      • Jacob
      • May 21, 2013
      Reply

      Yeah, to each his own. Keep up the great work and you’ll have no worries.

    • Grayson
    • May 21, 2013
    Reply

    I have just started growing positive net worth after I got out of my credit card debt. That was my first goal. It will take me some time to get to financially secure, but I won’t stop trying to reach that goal.

    • Tina
    • May 21, 2013
    Reply

    I’m using the 4% rule to figure out how much I need to be financially independent. My magic number is $625,000 ($25,000 x 25). I’m currently sitting at $128,000, so I have a ways to go. I do include my retirement accounts in my networth even knowing that I don’t plan on touching them until age 59.5. I have a separate calculation to figure how much I need to live on until I can withdraw from the Roth 401k and Roth IRA.

    Once B and I get married, we’ll go through this exercise together to figure out our joint expenses (hopefully lower than living as a single) and our retirement goal.

      • Jacob
      • May 21, 2013
      Reply

      Great progress Tina!

        • Tina
        • May 21, 2013
        Reply

        Mmmm, I think I may be more than a smidge older than you two, so I wouldn’t look at it as being ahead. 😉

    • Andrew
    • May 21, 2013
    Reply

    Interesting article, and great thoughts. Thanks for sharing.

    • Jake Erickson
    • May 21, 2013
    Reply

    Nice overview. I know net worth is just a number and doesn’t really mean much, but I like to track ours just to make sure it’s headed in the right direction. Plus, it’s fun (especially when paying off debt) to watch that number go from negative to positive and then continue growing. Financial freedom is an awesome goal to have, but it’s a long ways away for my wife and I.

      • Jacob
      • May 21, 2013
      Reply

      Long ways off for us as well. You are right, it’s enjoyable to work towards and it makes for a great long term goal!

 

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