Before you can understand the state of your personal finances, you need to determine net worth. Without knowing where you stand, it’s difficult to create a strategy to reach your financial goals.
Net worth is a number that represents your total assets minus your total liabilities. Below, let’s define these and other terms, as well as discuss strategies to improve your personal finances and determine net worth.
What Is an Asset?
Assets can be anything that you own with a monetary value, including your home, your car, your business, the cash value of a life insurance policy, your 401(k) or Roth IRA, all your checking and savings accounts, your stock portfolio, etc. You can also include personal items into your net worth, as well, such as jewelry, valuable art, collectibles, furniture, and anything else that can be liquidated into cash should an emergency arise. In the financial world, these are called tangible assets.
It should be noted that beyond the items listed above, every individual also has a certain number of intangible assets. These are things that unquestionably have worth, but are difficult to put a dollar value on. Trademarks, patents, and other forms of intellectual property are considered intangible assets. So is brand recognition associated with a successful, well known business. Even your personal skills, relationships, and community reputation can fall under this umbrella if they are valuable to you. Including intangible assets into your net worth analysis is complicated, so do it only if you believe they will significantly boost your net worth. If you need help, consult a qualified professional who specializes in intangible asset valuation.
What Is a Liability?
While assets are what you own, liabilities are what you owe. These can include outstanding credit card debt, student loans, car loans, your mortgage, and any back taxes you might have on file. Sometimes liabilities can decrease or cancel out your assets. A home valued at $250,000, for example, could represent a significant portion of your net worth. However, if you still owe $200,000 on the mortgage, you can only contribute $50,000 of your home’s value to your total net worth.
Strategies for Improving your Net Worth
1. Eliminate Liabilities First
An individual can increase their net worth in one of two ways: accumulate more assets or eliminate liabilities. But remember, assets will not contribute to your net worth if you must borrow money to acquire them. When you factor in the interest rates required to borrow money, such purchases might even decrease your net worth over time. Set your sights on repaying what you owe until your net worth is a positive number, and then move on to acquiring additional assets.
2. Increase Your Income
To jump start your journey toward a positive net worth, you should also consider ways to increase your monthly income. This can include negotiating for a higher salary, finding a second job, or committing to one or two “side gigs” that can help pay off your liabilities faster. An extra $30 a week for one side gig doesn’t sound like a lot, but that small sum can turn into $1,560 a year with a little dedication.
3. Invest Wisely
When the time comes to start accumulating assets, try to steer clear of purchases that will quickly depreciate. Furniture, for example, is necessary for any household, but the price you pay will not be reflected in your total net worth. Avoiding all depreciating investments is an unrealistic proposition (most of us need a vehicle, even though its value decreases the moment we drive it off the car lot), but try to balance necessary investments with ones that will generate you additional income long term. Your home is the most obvious example, as home value appreciates over time — especially if it’s located in an area experiencing significant growth. Stocks, bonds, and similar investments are also income-generating options, but do not make any bold moves without consulting a professional broker. Many people associate playing the stock market with gambling for a reason; without a proper investment strategy, it can cost you dearly.
Be Thorough in Your Analysis to Determine Net Worth
Calculating your net worth may sound simple, but the more time you spend taking stock of your assets and liabilities, the better off you will be. Organize your financial information in a single location to easily access later. And don’t forget to keep your portfolio up-to-date; if you open a new 401(k) or invest in a rental property, make sure to document it. Not only will this help you achieve your financial goals, but if something should happen to you, an up-to-date portfolio will ease the burden on your loved ones.
