Not sure exactly what “net worth” means or how to calculate it?
Net worth offers a common way to measure your personal wealth. For most people, it’s a simple calculation you can do on the back of a cocktail napkin.
Everyone should know how to calculate their net worth — and should do so monthly. Fortunately, there are several tools that help you calculate and track your net worth automatically, and for free.
What Is Net Worth?
Your net worth is quite simply the sum total of your assets minus to the total of your liabilities (more on both shortly). If you have more assets than liabilities, you have a positive net worth. If your liabilities exceed your assets, your net worth is negative.
To use an oversimplified example, imagine a high school student who recently opened her first checking account and credit card. She has $100 in her checking account, but also a $40 balance on her credit card. Her net worth is $60: her $100 in total assets minus her $40 in total liabilities.
Your net worth represents your financial wealth. Over the course of your career, you want to build a high enough net worth to be able to comfortably retire. Because in retirement, you’ll live on a combination of passive income from your investments, gradually selling off assets, and possibly Social Security benefits. Ideally you can do this without the risk of running out of money before you kick the bucket.
So, net worth offers a yardstick to measure your progress toward financial independence and retirement. But it also determines your ability to buy a home, help your kids with college tuition, and every other aspect of your financial life.
Note that your income doesn’t appear anywhere in your net worth. I’ve known high-income earners who spend every penny they earn, and have a negative net worth. I’ve also known people who earn a modest income but who maintain a high savings rate, and have built a high net worth.
Your net worth is a financial snapshot of your total wealth at one moment of time. It does not measure your cash flow.
How to Calculate Your Net Worth
The math involved in calculating net worth is as simple as it gets: addition and subtraction.
You literally add up all your assets, then add up all your liabilities, then subtract your total liabilities from your total assets.
Still, not everyone has a clear sense for what counts as an asset versus a liability. Here’s a quick overview of personal assets versus liabilities.
Your assets include everything you own that has monetary value. They may be liquid like a checking account or non-liquid like your home. A liquid asset simply means you don’t have to sell it first to realize its monetary value.
A few common examples of assets are:
- The market value of your home
- The market value of your vehicles
- The balance in your investment accounts (including your brokerage account and retirement accounts such as an 401(k) or IRA)
- The amount you have in your checking and savings accounts, including certificates of deposit (CDs) and money market accounts
- The cash value of a whole life insurance policy
- Notable items of value you own, such as artwork, furniture, fine jewelry, or collectibles
Because the value of personal property like artwork and jewelry can be highly subjective, only include them as assets if you have had them professionally appraised.
Liabilities, unlike assets, represent debts or balances you owe to others. Your total liabilities aren’t determined by monthly payments owed, but rather by the entire debt balance owed.
Common examples of liabilities include:
- Mortgage loans
- Car loans
- Credit card balances
- Student loans
- Personal loans
- Outstanding medical bills
- Back taxes
- Liens and judgments against you
Sample Net Worth Calculation
Imagine you own the following assets:
- Home market value: $180,000
- Vehicle market value: $5,000
- IRA: $7,000
- 401(k): $13,000
- Other investment accounts: $5,000
- Emergency fund: $5,000
- Checking account: $2,000
Your total assets come to $217,000. But you also have the following liabilities:
- Home mortgage: $160,000
- Vehicle loan: $3,000
- Total credit card balances: $1,000
- Student loans: $2,000
That brings your total liabilities to $166,000.
So your net worth is simply: $217,000 – $166,000 = $51,000. That represents your total monetary wealth at this moment.
In two months from now, it will look different — perhaps you pay off your credit card balance, dropping your liabilities by $1,000. If nothing else changes, your net worth will have grown to $52,000.
Should I Include Home Equity?
Traditionally people do include their home equity in their net worth calculation. I personally don’t like to do so.
To begin with, it exists only on paper. You can’t invest it to compound for you. You can tap into home equity without selling, but only by taking on new debt. So until you’re ready to sell your home, its equity doesn’t impact your other finances in any meaningful way.
You also can’t expect to walk away from the settlement table with all of your equity in cash. When you go to sell, you’ll have to pay real estate agent commissions, plus transfer taxes and other closing costs. Typical net worth calculations that include home equity ignore these costs, which makes them inaccurate and unrealistic.
Finally, home equity can also lull you into a false sense of accomplishment and wealth. Homeowners sometimes look at their equity and think “Wow, we’re richer than we thought!” And then they go out and buy that luxury car they’ve been eyeing, rather than saving and funneling money into true investments that compound in value over time.
I recommend you ignore home equity in your net worth calculations, and focus on building wealth by investing your savings.
Uses and Limitations of Net Worth
Net worth is a simple and useful way to measure your financial wealth. In fact, it’s one of three financial metrics you should check once each month. The other two include your savings rate and FIRE ratio, or the percentage of your living expenses you can cover with passive income. (Read up on other personal finance metrics here.)
As outlined above, you will one day need to live on your nest egg in retirement. Your net worth represents your progress toward your target nest egg. Know how much you need to retire, and use your net worth as a progress gauge. Once you reach that net worth, you can retire early, regardless of your age.
Your net worth can also determine which investment opportunities are open to you. In the U.S., some investments are only available to accredited investors: people with a net worth over $1 million (or with high salaries). Otherwise Uncle Sam doesn’t think you know enough about money to invest responsibly.
But net worth tells you nothing about your income, cash flow, or monthly budget. While a higher income certainly makes it easier to build a high net worth, and you can use a high net worth to invest for passive income streams, net worth is merely a snapshot of your wealth at that moment.
How to Track Your Net Worth Automatically
I use Mint.com to track my net worth automatically. I connected all my bank accounts and investment accounts to it, and every time I log in, it pulls the latest data from them.
Once per month on the same day, I check my progress. By doing it at the same time each month, you can compare apples to apples, because the ebb and flow of your monthly budget can skew the numbers. You might have more money at the beginning of one month from a paycheck just received than you had at the middle of another month after it was spent paying bills.
Speaking of budgeting, Mint helps you form a monthly budget and alerts you when you veer from it. They also display a graph of your net worth progress over time to help you visualize it.
Using any of these platforms helps take the work out of calculating your net worth, which makes it more likely that you’ll actually track your progress each month. And tracking your progress matters, because it keeps building wealth front-of-mind and tangible, which helps keep you on course for your long-term financial goals.
While a valuable metric, net worth is just one tool in your financial arsenal.
Complement net worth checkups with budget analysis and tracking software, and form a financial plan that incorporates short-term and long-term financial goals like buying a home and retirement. Make a budget with Tiller or Personal Capital to accomplish these goals and use net worth checkups to make sure you’re on track to meet them.
As you build your net worth, also aim to build passive income streams. With enough passive income, you no longer rely on your day job to cover your living expenses. And when you no longer need your 9-to-5 job to survive, it opens up a whole new world of options for your work, your family life, where you live, and your lifestyle more broadly.