In terms of personal finance, the metric of net worth is widely discussed yet also frequently misunderstood. Knowing your personal network is an important step when you want to have a better understanding of your financial position or if you’re looking to achieve financial freedom. Keep reading to find out what net worth is, the importance of this metric, and how you can apply this knowledge to reach financial goals and build wealth.
What Is Net Worth?
The core concept of net worth is a measurement of your current financial health. It’s the difference between your assets and what you own versus your liabilities and what you owe. The formula is simply “Net Worth = Assets – Liabilities.”
Assets are anything you own that has financial value, such as investments, cash, real estate, retirement accounts, vehicles, and personal possessions. Liabilities are financial obligations and debts, such as student loans, car loans, credit card balances, mortgages, and other kinds of outstanding debt.
Assume you own a home worth $250,000 with a remaining mortgage balance of $200,000. The equity in your home is $50,000, and it counts as a component of your net worth.
Why Does Net Worth Matter?
Net worth, at first glance, is a number. However, it’s also a reflection of the financial trajectory that you’re on. It gives you a clear financial snapshot and a big-picture view of your current financial standing. Income is a good metric for the money coming into your life, but net worth is what considers assets and liabilities for a holistic understanding of how you stand right now.
Regularly calculating your net worth lets you track your financial progress and see if you’re moving closer to financial goals, falling back, or just stalling. Increasing net worth usually signals that you are effectively reducing debt, investing, or saving. Understanding your net worth helps you set realistic goals, such as managing debt, saving for retirement, or buying a home. It’s a foundation for forming actionable financial plans.
Understanding your net worth also helps you counter the unpredictability of life. A positive net worth can be a safety net. You’ll have assets you can draw upon for unexpected expenses and emergencies.
Understanding Positive vs. Negative Net Worth
You need to understand that net worth can be positive or negative. A positive net worth is when your assets are more than your liabilities, and this indicates an ability to build wealth and maintain financial stability. Negative net worth happens when your liabilities surpass your assets, and it’s common for individuals who have high levels of debt, such as student loans. Fortunately, you can improve this over time.
How To Improve Your Net Worth
Is your net worth not where you want it? There are several actionable steps you can take towards improving it.
1. Reduce Debt
Pay off your highest-interest debts first, including credit card balances. Think about refinancing loans to take advantage of lower interest rates. Don’t take on unnecessary debt.
2. Increase Savings
Create an emergency fund so you can cover unexpected expenses. Automate savings to make sure contributions are consistent. Eliminate unnecessary expenses so you can boost savings rates.
3. Invest Wisely
Invest in assets likely to grow over time, including real estate, mutual funds, and stocks. Diversify investments to minimize risk. Maximize retirement account contributions to take advantage of compound growth.
4. Build Equity in Your Home
Build your home equity faster by making extra payments on the mortgage. Don’t over-borrow whenever you buy property.
5. Protect Your Assets
Insure your most valuable assets, including your health, car, and home. Update your estate plan regularly to protect the financial legacy you leave behind to your loved ones.
Common Misconceptions About Net Worth
There are several common misconceptions many people have about net worth. For starters, many people assume that a high income is equivalent to a high net worth. Income is essential, but it doesn’t guarantee you wealth. A high earner with poor saving habits can wind up with a low or even negative net worth.
A second misconception is that net worth only applies to wealthy individuals. Everyone, no matter their income level, can benefit from tracking their net worth. It helps identify areas where you can improve by forming better financial habits.
Third, many people assume that homeownership automatically boosts financial net worth. Owning a home can contribute to net worth, but it also depends on numerous factors, such as upkeep costs, mortgage debt, and market conditions.
Tools To Track Your Net Worth
Technology makes it easier than ever to track your net worth. Consider the following helpful tools:
- Spreadsheets: Track your liabilities and assets by creating a simple Google Sheets or Excel document.
- Net Worth Calculators: Online calculators make quick estimates possible.
- Financial Apps: Personal Capital, Mint, and You Need a Budget (YNAB) are apps that automatically update your net worth using data from linked accounts.
Why You Should Regularly Reassess Your Net Worth
Life changes can significantly impact your overall net worth. These can happen with home purchases, inheritances, marriages, and jobs. Periodically reassessing your net worth enables you to:
- Adjust your financial goals as necessary
- Track progress to stay motivated
- Made educated decisions when major life events happen
More Than a Number
Your net worth is a powerful tool that indicates your financial health. Use it for guidance when making financial decisions. Whether you’re planning for your future, reducing debt, or building wealth, regular assessments and improvements to your net worth are critical to attaining long-term financial success. Understanding what it is, why it matters, and how you can effectively manage it means you can assume control of your finances in the direction of the life that you envision. Take your first step to financial freedom today by calculating your net worth.