In this article, we will be examining one of the most basic but important personal finance topics – Net worth.
Have you ever calculated what would be left if today you took the money from all your savings, sold everything you owned, and paid off all your debts?
Would you be alarmed to find out that you have lesser assets than your debts (liabilities)? How long could you survive on this money without working (theoretically of course)? This is precisely the calculation of your net worth.
Your net worth is what you would be left with if you exchange all your properties for cash and also clear all your deficits.
When you want to know what your financial situation is and thus be able to establish your financial objectives in the short and long term, it is essential to know your net worth.
In the following, you’ll find a detailed explanation of what net worth is, how it is calculated, and how it’s helpful to you.
- What exactly is this net worth thing?
- Calculating your net worth: Step by Step procedure
- Why Knowing Your Net Worth Matters
- How often should you update your net worth?
What exactly is this net worth thing?
Net worth is a metric that helps you to know what your financial situation is and what is the difference between your assets and your debts.
The calculation formula is as follows:
Net worth = Assets – Debts
The category of assets includes all the money you have in cash, accounts, deposits, funds, stocks, etc, as well as other assets such as houses, cars, pension plans, and emergency funds.
Debts include mortgages, student loans, car loans, money that you may owe relatives, and even loan apps. In short, everything that they have lent you and that you have to return.
Calculating your net worth: Step by Step procedure
Follow the following steps to easily calculate your net worth:
Step 1: Calculate the total value of your assets
To calculate the value of your assets you have to know what their sale value is today.
Here it does not matter how much you bought each of them for, but their sale value as of today.
For example, it is easy to know how much money you have in your bank – you just have to check your account balance on your mobile phone or at the extreme, go to your bank. But, it is not so easy to know what the sale value of your own house is today.
That is why it is better that you mark a value objectively, and do not overvalue your assets. You can easily want to give your properties more value than they have because you have an emotional bond with them.
So, when valuing your assets, try to be conservative as much as possible. For your home, you can determine its exact value by comparing it to similar homes in your area that have sold recently or by consulting with a qualified real estate professional – to help you calculate realistic equity.
So, how do you begin to calculate your assets?
Start by calculating the amount of money you have in cash and your bank accounts.
Also add the money from your investments, insurance, retirement funds, and all the money that you can redeem at any time.
Next, value the worth of your real estate properties – personal use and those that you have as an investment – and all the businesses that you have.
Finally, and independently, calculate the value of all your whims(luxuries) like your car, fashion items, gadgets, etc.
Step 2: Calculate the value of your liabilities
After you’ve calculated your assets, it’s time to start collecting information about your liabilities. Calculating the value of your liabilities is easier. For bank loans, you can request information on how much money is needed to pay all your debts.
Review all your debts and add together how much money you need to pay off your mortgages, and personal loans…
Don’t forget the loans you got from your family or friends. You should write down everything you should return sooner or later.
Step 3: Calculate your personal net worth
As mentioned earlier, the formula is a subtraction of your liabilities from your assets.
If the difference between your assets and your liabilities is positive, it means that you have more assets than liabilities. And your net worth is positive. That is, you can pay your debts with what you already have.
If the difference between your assets and your liabilities is negative, it means that your debts are greater than what you already own. And your net worth is negative.
Why Knowing Your Net Worth Matters
Most people think that it’s only the people in the wealthy class like Aliko Dangote, Femi Otedola, etc that need to know their net worth. This is not true! Anyone who is serious about their financial life needs to know their net worth.
In general, reviewing your net worth statements over time forces you to face the realities of your financial situation. It helps you determine where you are and how to get to where you want to be.
Also, it can encourage you when you’re headed in the right direction (i.e. reducing your debts while increasing your assets) and give you a red flag if you’re not on the right track. To get you on the right track, you need the following:
- Spend wisely
Knowing your net worth is important because it can help you identify areas where you are spending too much money. Just because you can afford something doesn’t mean you have to buy it.
To avoid going into unnecessary debt, ask yourself if you need or want something before you buy it. To reduce unnecessary expenses and debt, your needs should be the majority of expenses. (Remember, you can mistake a need for want. A 50, 000 naira pair of shoes would satisfy your want, but a cheaper pair might also do the trick and keep you in the right financial direction.)
- Debt refund
Reviewing your assets and liabilities can help you develop a debt repayment plan.
Many people make the mistake of confusing income with wealth. If you earn even very large sums of money, but your savings are close to zero and on top of that you have a lot of debt, the truth is cruel: you are poor (financially speaking of course).
Likewise, your colleague at work may give you the impression of being wealthy and in top financial health because he lives in a nice house, goes on vacation regularly, and drives a high-end car. It doesn’t mean anything if, behind all that, he has a mounting debt to allow him this lifestyle. He’s not rich, he’s in debt.
Calculating your net worth will help open your eyes and bring some clarity to your financial situation. And if you discover you have more debts, you can quickly find a solution!
- Save and invest
Your net worth numbers can motivate you to save and invest money. If your net worth statement shows you’re on track to meet your financial goals, it can encourage you to keep going.
Conversely, if your net worth indicates that you can improve (for example, over time your assets decrease and your liabilities increase), this may motivate you to start taking a more aggressive approach to saving and investing your money.
How often should you update your net worth?
It is important to perform this calculation regularly. Once a year is a minimum and once a quarter is ideal.
You should know that the value of various items is not static. The value of Real Estate, currencies or stocks, or other investments fluctuates constantly. The amount of money that was invested five years ago may not be equal to the amount obtained if you decided to sell it today.
This is why it is important to monitor the value of our possessions to know how to make appropriate decisions.
Knowing how to calculate your net worth is not just enough. Ensure you do that regularly to be able to track how your net worth changes over time. Also, don’t compare your net worth to someone else’s.
I would very much like it if you haven’t already, that you take some minutes or a few hours to calculate your net worth. You will discover the truth about your financial status.