Net worth is one way to measure your financial health and stability, in relation to how much debt you have versus what you’ve accumulated in assets. Similar to credit scores, the higher your net worth number is the better, especially if you’re trying to build wealth and create lasting financial security. But how is net worth calculated? And why does net worth matter? This primer offers an overview of why it’s important to know your net worth. Investors who use a financial planner are, statistically speaking, far more likely to reach their goals than investors who don’t.
Net Worth, Explained
Net worth is a term that represents what someone is worth when you add up all of their liabilities and weigh them against all of their assets. In simpler terms, you can think of net worth as being the difference between what you own and what you owe to your creditors.
So why does a person’s net worth matter? It’s simple. Calculating your net worth can give you an idea of how well you’re doing financially at any given time. It can be a useful motivator to continue pursuing your financial goals.
For example, say your goal is to have a net worth of $100,000 by age 35. You’re starting out at age 25 with a net worth of $0, with no debts and no assets. You can use that starting point to figure out how much you need to save and invest each year to reach your $100,000 target in the next decade. In simple terms, it works out to $10,000 a year, which you can then break down by month.
Seeing net worth numbers in black and white can make it easier to create a workable financial plan. A high net worth is a signal that you’ve managed your money well, including saving consistently and minimizing debt.
How to Calculate Net Worth
Net worth is one of the simplest financial calculations you can make. To find your net worth, you first need to know:
- How much you have in assets
- How much you owe in liabilities
Assets are things that have real value. So depending on your age, your assets might include a home, a retirement account, investment accounts, college savings accounts for your kids, land or other real estate you own, bank accounts, vehicles you own and cash. In addition, other assets might include collectibles, heavy machinery and equipment and accounts receivable, debts you are owed.
Liabilities represent your debts. Again, depending on your age and financial situation this may include student loans, credit cards, auto loans, mortgages, personal loans, business loans and lines of credit.
To figure out your net worth you’d add up all your assets, then subtract your liabilities. If you end up with a positive number, that means you own more than you owe and you have a positive net worth. On the other hand, if you come up with a negative number that means you have more debts than assets and you have a negative net worth. There are numerous ways to deal with a negative net worth. Your options often depend on the type of debt you have that is keeping your net worth in negative territory.
What Is a Good Net Worth?
Net worth is subjective so what you consider a good net worth might not be the same as what someone else views as a good net worth. For example, someone in their 20s who’s just getting out of college and starting their first job might be happy to have a net worth of $1,000 if they’re trying to save money while paying off student loans. For someone in their 40s, on the other hand, net worth of $1,000 might be a little panic-inducing if they’re just getting started on saving for retirement.
A common rule of thumb for determining what your net worth should be at any given age is to divide your age by 10, then multiple that by your gross annual income. So if you’re 40 years old making $100,000 a year then you should have a net worth of $400,000.
Another net worth rule of thumb dictates having a net worth of twice your annual salary by age 40. So again, if you’re 40 and making $100,000 a year then your net worth should be $200,000 using this formula. For each subsequent decade, you’d add another two years of income. So by age 50, your net worth would be four times your salary, six times by age 60 and so on.
It’s also important to distinguish between high net worth and ultra-high net worth definitions. High net worth individuals have a net worth of $1 million or more in investable assets. Someone who’s considered to be ultra-high net worth would have $30 million or more in investable assets.
How Can You Increase Your Net Worth?
The simplest answer is for increasing net worth is to focus on two things: increasing your assets while reducing your liabilities.
Increasing the value of your assets can mean different things and it can occur actively or passively. For example, if you own a home it may appreciate in value without you having to do anything at all. On the other hand, if you want to increase the value of bank accounts then you’d have to commit to saving money in them consistently.
Investing can help increase net worth if you’re choosing investments that grow in value. You could invest through an employer-sponsored retirement plan, an individual retirement account and a taxable brokerage account to boost net worth. The key is to choose investments that fit your risk tolerance, timelime and goals.
So if you’re more risk-averse, for example, you may attempt to increase net worth by investing in value stocks that have the potential to appreciate over time. But if you’re comfortable with more risk you may attempt to grow your net worth by day trading stocks for quick profits.
On the liabilities side, you can increase net worth by reducing what you owe. Again, there are different ways to do this. For example, say you and your spouse own two cars, both of which have a car payment. If you can get by with just one vehicle, you could sell the other and pay off the loan, eliminating that liability completely. If you owed more than the car was worth that could help with your net worth.
The other obvious way to reduce liabilities is by paying down your debts. Successfully paying off debt hinges on choosing a financial plan for repayment that works for you and then sticking with it. For instance, you might choose the debt avalanche method, which emphasizes paying off high-interest debts first. You can also speed up debt repayment by reducing the interest rates on loans or credit cards through refinancing or 0% APR balance transfers.
The Bottom Line
Net worth can be a useful way to measure how you’re doing with your money. It can be helpful to review your net worth at least once a year, though if you’re focused on growing wealth you may want to recalculate it month to month. You can also use your net worth as a measuring stick to compare yourself against other people in your age and income range to see if you’re keeping pace with the average net worth.
Tips for Increasing Net Worth
- Keeping investment costs low can help you to grow your portfolio and improve net worth. Choosing the right investments can help. For instance, exchange-traded funds (ETF) or index funds may offer lower expense ratios compared to actively managed mutual funds. You can also save on investment costs by choosing an online brokerage that offers commission-free trades on stocks and ETFs.
- Consider talking to your financial advisor about various ways you might be able to improve your net worth over time. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors in your local area. It takes just a few minutes to get your personalized advisor recommendations online. If you’re ready then get started now.
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