What Does Net Worth Mean?

by Neal Frankle, CFP ®

Your personal net worth is something that is very easy to calculate. But what does net worth mean? And how do you use this information? Both are good questions. First let’s learn how to calculate your personal net worth. Then we’ll consider how to use it.

What is your personal net worth?

This is simply a number that represents the value of what you have accumulated less what you owe at some point in time. If your assets are worth $300,000 but you owe $100,000 you’re personal net worth is $200,000. Congratulations. You are going in the right direction. You can increase your net worth by:

  1. Saving More
  2. Investing Better
  3. Spending Less
  4. Earning More
  5. Getting Rid of Debt

These are the steps most of us undertake in order to assure long-term financial security.

If your assets are worth $4 gazillion but you owe $5 gazillion, you have a net worth of negative $1 gazillion. This is ugly. Very ugly. You can still use the same 5 tactics listed above to improve your situation. But I recommend you do so in overdrive.

Which would you rather have, a net worth of $100,000 or a negative net worth of $1 gazillion? Of course, most people choose the former.

So keep in mind that having a great deal of assets is fine but having a positive net worth is far more important when we talk about having enough money to retire. Comprendo?

How to Determine Your Personal Net Worth

Again, this is really a snap. First list all your assets and what you could sell them for. (Personally, I don’t recommend including assets that depreciate like cars. That’s because they lose value quickly and may not be worth much unless they are collectibles.) Then make a list of what you owe. Here’s an example of a hypothetical personal net worth statement:

 

So in our example, this person has a positive net worth of $446,500 less $172,400 or $274,100. This is good and the person involved here should be proud of what she’s accomplished. But this isn’t where the story ends. Far from it.

How to Use This Information The Right Way

Let me assume that it’s important to you that you grow your net worth. Take a minute and think about why this is so. If you are like most people I know, this is important to you because you want to retire someday. You realize that the greater your assets and the lower your liabilities, the greater cash flow you’re going to have.

If this is how you think, you are right. And what this boils down to is that your net worth is important mainly because you can generate income from it at some point. If you have a negative net worth like the person with the gazillions, you won’t generate any positive income. That’s because the debts you have on your assets probably far out-weigh any income those assets generate. Having a negative net worth is a one-way ticket to the poor house friend. Don’t try this at home – or anywhere else.

In our example, this person has a net worth of $274,000 right now. If she liquidates her assets and invests that money (and earns 4%), she’s going to have a little less than $11,000 a year to live on. This is far better than a sharp stick in the eye but it isn’t enough to live on.

Why Your Net Worth Isn’t Anything To Worry About Even if It’s Very Low

If you use any one of the online retirement calculators, they may tell you that you need several million dollars in net worth in order to retire. This news is really depressing and it’s about this time that many people just give up. But don’t be troubled.

In most cases, your net worth isn’t all that important. And even if you think it is, you can take steps (starting tomorrow) to make it so.

Why tomorrow? Because that’s when I’m going to explain how to make your net worth irrelevant and still have the cash flow you need to retire worry-free.

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{ 2 comments… read them below or add one }

jnew April 11, 2013 at 1:14 PM

I agree with JoeTaxpayer.

When I deal with my personal finances (regarding retirement calculations), I deduct the value of my house from NETWORTH calculations as well. Why– ?because retirement planning is all about income replacement and the house will not generate any income for me when I retire. I anticipate selling my home which is paid off– and buying another home for the same or less dollars in a sunny location. It definitely will be helpful not to have a mortgage– but it will not throw off cash to replace my salary.

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JoeTaxpayer April 10, 2013 at 6:46 PM

When I look at my net worth, I eliminate the house value, but not the mortgage. For example, $500K in retirement, a $400K home with a $100K mortgage. I tally this as $400K net worth.
Why? Because the house is not a cash generating asset to provide retirement income. For those whose house is a candidate for downsizing, they may very well pull a bit of money out, but I’d prefer not to count on it.
So, all things consider, my net worth is what I’d have in addition to the fully paid off house. I don’t see the car as an asset on your list, it’s not on mine either.

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