Defining Assets and Liabilities
What is your net worth? To put it simply it is the total of your assets less your liabilities. In order to determine what your assets and liabilities are, we first need to define assets and liabilities.
Assets are items that are of real monetary value. Assets do not include items that might be of strong personal or sentimental value but have no value in the marketplace. Your house is an asset, your extended Cheech and Chong video collection most likely is not. Assets also include any financial savings or investments you have made.
Other properties owned (if any)
On the flip side liabilities include any debts that you owe. If you borrow money in order to purchase assets (which we typically do in buying homes and cars, as well as through the use of credit cards), the money that you owe to various lending companies are your liabilities.
Lines of Credit
Calculating Your Net Worth
Now that we have a basic understanding of what assets and liabilities are, we can go about calculating our net worth. To demonstrate the process we will look at the family of John and Jane Smith, aged 35 and 32 respectively. Both have successful careers. They have one child, a daughter aged 6.
First, we must calculate their assets. The Smiths own a house that was recently appraised at $250,000. They paid $200,000 for the house 6 years ago, with a mortgage for $160,000. They currently still owe $130,000 on the mortgage.
The Smiths own two cars, a new Suburban worth $35,000 that they owe $20,000 on as well as a 10 year old Jetta that is worth $5,000 but they owe nothing for.
Totaling up the computer, home entertainment system, jewelry, refrigerator, dishwasher, and hockey equipment they have purchased you get a value of $10,000 in personal item assets.
John has currently has $3,000 in his bank account. Jane has $2,500 in hers. In their joint account there is another $1,600. They have a total of $8,000 invested in mutual funds. They also have a college fund for their daughter currently totaling $2,000. Neither has a 401(k).
Between John and Jane they currently owe $17,950 on their various credit cards. John also owes $15,000 on a $20,000 personal loan that he borrowed 3 years ago.
Now that we have determined the assets and liabilities, we can calculate the net worth of the Smith family. First we add up the assets:
$10,000 personal items (Electronics, Appliances, Jewelry, etc)
$7,100 in bank accounts
$8,000 in mutual funds
$2,000 college fund
Now that we know the total assets for the Smiths, let’s total up their liabilities:
$20,000 car loan
$17,950 credit cards
To find the Smiths net worth, we subtract the total liabilities from the total assets:
= $129,650 Net Worth
So, now that we’ve run the numbers we can see that the Smiths are doing well. They have a total net worth of $129,650.
The net worth of any individual or family is going to be different, depending on their own personal circumstances. If you are a young person just starting out, it is very possible that you will have a negative net worth. If you are an older person at the height of his career just getting ready to retire having paid off many of your debts, most likely you will have a much higher net worth.
Using Your Net Worth to Gauge Your Financial Health
Your net worth is a strong economic indicator for showing where you stand today. You might find that you are not so well off as you thought you were. If you come out in the red or just barely in the black, you will want to take a look at your liabilities. Try to find where you can cut out some of these expenses, and try to get rid of your debts.
But increasing net worth also involves building assets. If you don’t have a good savings plan, 401(k), investments in mutual funds or the like now is the time to start. Beginning a savings plan of even little amounts of money a month, invested in mutual funds or other strong, safe investments can be a great way to start building up your assets. Combine this with lessening liabilities and you will be on your way to a higher net worth and stronger financial health.