WHAT IS IT?
Net worth is simply your total assets minus your total liabilities. The calculation is simple, but the challenge is figuring out the location, type, and amount of all the components in your portfolio.
In the post on liabilities, we discussed how the various categories of assets and liabilities overlap. We came up with the ven diagram as shown below.
Liquid assets are assets you can access the total value of quickly. Income producing assets are assets whose value increases with time. They can be both liquid and non-liquid. Non-liquid assets are assets you need to sell or otherwise trade to access the value. Liabilities are the loans and debt you owe to others. Some assets can also be considered liabilities. Specifically if you still owe money on them, or they require money to function.
TOTAL NET WORTH VERSUS LIQUID NET WORTH
The simplest way to define net worth is to determine the value of everything in the diagram, and add it together into one simple number. This is called total net worth.
The problem with net worth is it is very cumbersome to calculate the value of everything you own. As discussed in the assets post, the value of non-liquid assets is not necessarily equal to what you will receive when you sell the asset.
There is also the debate of what is considered a non-liquid asset and what is a liability. For example, some people consider cars and houses to be in the overlap between non-liquid assets and liabilities due to their high cost of operation and maintenance. Others consider houses to be income producing assets, since house value increases over time due to market demand.
Because of these factors, when people ask you for your net worth, they are usually referring to your liquid net worth. Your liquid net worth is still your assets minus your liabilities, but it does not include non-liquid assets. When I refer to “net worth” on this site, I am referring to liquid net worth.
WHAT SHOULD I INCLUDE IN MY LIQUID NET WORTH?
The value of everything in your home should not be included in the calculation of your liquid net worth. You should not include the value of your clothes, books, electronics, kitchenware, furniture, or decor. Any non-liquid assets of value would also have to be categorized as income producing or a liability to be included in the calculation. Some examples:
- A CD is an income producing asset that is also non-liquid during it’s term. The current value of the CD would be included in the liquid net worth calculation.
- A financed appliance that is partially paid off is a liability because you still owe money on it. You would include the money you owe in the liquid net worth calculation. However, you would not include the appliance as an asset once it is paid off because it has become a non-liquid asset.
- A paid off car would not be included in the liquid net worth calculation. It is paid off, so you cannot consider it a liability. However, it is not producing income. The car is depreciating and requires money to function; it is a non-liquid asset.
My general rule of thumb: If you use it regularly, and cannot sell it without creating strain on your daily life, do not include it in your liquid net worth calculation.
WHERE TO CATEGORIZE A HOUSE
A house should not be included in your liquid net worth calculation.
Think about it. Would you really be willing to sell your house in a buyer’s market in the event you need to access the value for another investment? No. Selling your house would put a large amount of stress in your life. And you would still need to find another place to live.
If you owe money on a mortgaged home, however, you should include the amount you owe on the mortgage in your calculation. The remaining mortgage is a known sum of your assets that belongs to another entity. It is the definition of a liability.
Note that net worth can be negative (liabilities are greater than your assets), zero (your liabilities equal your assets), and above zero (your assets are greater than your liabilities).
It can also fluctuate as frequently as hourly depending on your asset allocation (where you chose to spend/invest your money). One moment you could be well above zero. The next moment you could lose 10% of your net worth due to a stock market swing.
The goal of net worth is to get your assets to outweigh your liabilities, and ideally eliminate all liabilities. I highly suggest you calculate your net worth and monitor it regularly. I recommend recording it on at least a monthly basis.
HOW TO MONITOR YOUR WORTH
You can use a well-crafted spreadsheet to summarize and calculate everything. Excel is a great program and there are many open source spreadsheet software options available. An advantage of this method is that you can customize the calculations and outputs to fit your needs.
There are also various computer programs and apps available. In addition to a spreadsheet, I use and highly recommend Personal Capital. It a free app you can get on Andriod and iOS. You can also use their online version. You enter your information once and Personal Capital gives you a powerful summary of your finances, which you can use for simple calculation summaries as well as budgeting.
Calculate your net worth. Are you happy with it? Leave a comment telling me how you plan to improve it!
Next time, we will discuss interest.