(DailyAnswer.org) – When you read about people like Elon Musk, King Charles, and Taylor Swift, one of the things that the reporter usually mentions is their net worth—the overall value of their assets. While you’re wondering what it would be like to be so rich that you’re worth billions, there’s one really important thing you should think about—do you know your own net worth?
What is Net Worth?
In the simplest terms, which is usually the best way to explain anything, net worth is the value of everything you own, after you’ve subtracted liabilities—basically, your debts.
Why Do I need to Know My Net Worth?
Here’s where it gets a little more complicated, but it’s still a simple concept.
Knowing your net worth helps you manage your money and plan for the future. When you really understand how much money you have, and how much debt you’re carrying, it’s a lot easier to make sound financial decisions than when you are flying blind, with no real clue about your real asset and debt situation.
How to Calculate Your Net Worth
If you’ve ever applied for a home loan, the mortgage lender needs to know the basics of your net worth when they’re determining the size of the loan you can qualify for. They match up the debts you list on your application against the debts on your credit report, and then match up your listed assets (savings, checking, and investment accounts) against your tax returns and statements.
This is usually a fairly accurate picture, but it doesn’t always tell the whole story.
Suppose you have a payment plan with your dentist, or took out a 401(k) loan during the pandemic. These debts won’t show up on a credit report, but they are surely there and you have to pay them every month. Also, you may have some assets that you haven’t considered—company pension plans, personal property, or life insurance policies.
To calculate your net worth, gather all your financial information—tax returns are a good starting point, and make two piles of paper or a two-column spreadsheet. One is for assets, the other for debts. List each asset and liability, the value of each, and add them up. Then subtract the amount of the liabilities from the debt, and there’s your net worth.
What’s Missing from the Math?
This is where a lot of people with good-paying jobs are stunned that their net worth isn’t nearly as high as they had thought—probably because a mortgage lender had said they could qualify for a gigantic mortgage loan.
Income is not really considered a factor in figuring out net worth, except in the sense that you stash your cash in savings and checking accounts, and if you’re smart, in a 401(k) or an IRA. So whatever the average amount is in your bank accounts, that’s the amount that goes into net worth calculation. If you’re prudent with your money, that big salary is reflected in your bottom line.
Could Be in Your Home
If you took advantage of that big loan and bought an expensive home, then the value of your home—minus the mortgage—is considered an asset.
Net worth is fluid, and shifts with your financial situation. As your home increases in value and the mortgage balance drops, your net worth increases. The same principle applies to other debts, although your home is typically the only personal asset that increases in value. But as you pay off debt, your bottom line does increase.
If you use a spreadsheet to keep up with your assets and liabilities, updating as debts are paid off and your incur new debts ( a sad fact of life), you’ll always have a good idea of your net worth and can use that information for smart financial management.
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