What is net worth and how can you calculate yours? Read on to find out.
How well placed are you financially? When all your assets and debts are taken into account, do you come out in the black or deep into the red?
If your financial situation is complex, it can sometimes be difficult to accurately gauge whether or not you are financially secure. But by calculating your net worth, you can work out your overall financial health and what you need to do to become even healthier.
What is net worth?
Your net worth is basically the value of everything you own minus everything you owe. In slightly more technical terms, net worth is the value of your assets minus your debts or liabilities.
Assets include shares, real estate, cars, savings and the like - basically anything of value that you own. Liabilities include an outstanding home loan balance, credit card debt, a HECS debt and any other money you owe.
Your net worth is therefore the amount by which the value of your assets exceeds your liabilities. If this figure is negative, something fairly common for many recent graduates, your net worth reflects how much debt you would still owe even if you sold off all your assets.
In 2014, a Global Wealth Report from Credit Suisse revealed that the net worth of the average Australian was USD$431,000 (AUD$485,947), a substantial increase from the average Australian net worth in 2000 of USD$103,151 (AUD$116,305).
How do I calculate my net worth?
Calculating your net worth is actually a very simple process. You can do it yourself with a piece of paper and a calculator, or there are plenty of free online calculators designed to help make the job even easier. The formula: Assets - liabilities = net worth.
Calculate your net worth by completing the following steps:
- Make a list of all your assets. Be as thorough as you can. As well as obvious assets like your house and car, include shares, other investments, the amount in your transaction and savings accounts, superannuation, businesses, caravans and boats. Include the value of each asset in your list and be as accurate as possible with your estimates.
- Add up the value of all your assets. Use the value of each individual asset to work out the total value of all your assets.
- Make a list of all your debts. Once again, be as thorough as possible and don’t leave anything out. Include your mortgage, credit card debt, car and personal loans, HECS debt, business loans and anything else you can think of. Include the amount of each debt.
- Add up the value of your debt. Use the amount of each debt to work out the total amount you owe.
- Subtract. Subtract your total debt from the total value of your assets. The number you get is your net worth.
It’s worth pointing out that some financial experts recommend against including some assets such as your house and car in your net worth calculation. The argument is that if you wouldn’t consider selling these assets to pay off your debt, there’s no point in including them in your net worth sums. Whether or not you choose to count them is up to you.
Why is net worth important?
Calculating your net worth is a simple and very effective way to determine your financial wellbeing. When you work out your net worth, you can gauge how much money you would have left over (or how much money you would owe) if you had to sell all your assets to pay off all your liabilities.
Of course, the reality of net worth isn’t quite that simple. For example, you probably don’t want to consider selling your house to settle debts, while some of your assets (such as super) can’t be accessed until you reach a certain age. So your net worth isn’t really a true reflection of how much money you could get your hands on if you cashed in all your assets and paid off any liabilities.
However, while this may make net worth seem a little impractical and even pointless, calculating your net worth is actually an extremely useful exercise. When you know exactly what your financial status is, you can make informed decisions about your financial future and work to increase your net worth.
For example, if your net worth is calculated as a negative figure, you could look at ways to reduce debt and improve your financial health. If your net worth is positive, you might want to consider a range of investment opportunities that could help you grow your worth even further.
Your net worth is also changing all the time. If you’ve just paid for a two-week overseas holiday or taken out a car loan, your net worth will have taken a hit. But if you’ve paid off your credit cards and made regular deposits into a savings account for the past year, your net worth will be a much more pleasing figure than it was 12 months ago.
Once you understand how your financial decisions affect your net worth, you can start making smarter choices about how you manage your money. And by regularly calculating your net worth and comparing it with past results, you can track your financial performance over time.
What if I have a negative net worth?
If your calculations result in a negative net worth, that doesn’t necessarily mean it’s time to panic. In many cases, you may have a negative net worth because you’ve only recently graduated from university. While you may have run up a substantial HECS debt and also have credit card debt to your name, you probably haven’t had enough time to start earning enough money in the workforce to pay off the money you owe.
However, a negative net worth could be an indication that you have borrowed too much money. From mortgages and car loans to personal loans and credit card debt, these large numbers can quickly add up in the liabilities column. And if you don’t own any assets to offset those liabilities, a negative net worth is the result.
The good news is that even if your financial situation looks somewhat less than ideal at the moment, there’s plenty you can do to improve your net worth.
What your net worth means for your savings
Your net worth represents where you stand financially at this exact moment, so it can have substantial implications for how you manage your savings accounts. For example, if you have a negative net worth, your main focus in the immediate future may be on paying down debt rather than boosting your savings balance.
If your net worth works out to be a negligible value, now might be the time to look at what you can do to boost the value of your assets. One simple and efficient way to do that is to develop a regular savings plan and start putting money aside each week.
Finally, if your current net worth is a substantial positive figure, it may be time to reassess your financial goals. While a savings plan offers a secure and steady way to boost your finances, other investments such as property and shares may offer the potential for higher returns.
Simple tips to improve your net worth
Open a savings account and save money
Open a savings account and contribute to it regularly, for example, once a week or month when you receive your pay. You might be surprised just how quickly you can build a substantial balance with a little discipline, and this can have a hugely positive effect on your net worth.
Investing your money can help you grow your wealth - if you make the right investment decisions. From shares and property to exchange traded funds (ETFs) and forex, there are plenty of ways you can invest your money to build for a better financial future.
Cut back on spending
Work out a budget and see where you can cut back on your outgoing expenses. It also pays to reduce frivolous spending and impulse purchases - these will only have a negative effect on your net worth. Make sure you actually need to make a purchase before parting with your hard-earned dollars.
Borrowing large amounts will offset the value of any assets you own, so it’s important that you make sensible decisions when borrowing money. Taking out a large loan or multiple loans can severely impact your finances, so make sure you can comfortably afford to service any loan you apply for.
Set a goal
Once you know what your net worth is you can set yourself a goal. For example, what is your ideal net worth for retirement? Work out a realistic figure and then start to think about what you need to do to make it a reality.
Pay off debt
The lower the value of your liabilities, the better your net worth will be. So regardless of whether you owe money on a credit card or home loan, paying down the amount you owe will reduce your future interest payments and boost your net worth. Setting up a debt payment plan and/or consolidating all your debt into one loan can help.
Calculate net worth regularly
Sit down and calculate your net worth once a month. Doing this regularly will allow you to work out exactly how your decisions affect your financial standing, and can help you work out whether you are well on your way to achieving your financial goals or if you are straying off course. Keeping your net worth at the front of your mind will ensure that you are always thinking of ways to improve it, and it will act as a wake-up call if you need to rethink your money management.
Calculating your net worth allows you to determine your level of financial health and track its improvement over time. Calculate your net worth and start making better financial decisions today.