Why You Need to Know Your Net Worth
Like a business balance sheet, your net worth lists your assets and liabilities in one location. Take your assets, subtract all of your debts, and you will be left with your net worth. Many of us are far too often left with a negative value for our net worth, as we owe more than our assets can cover.
I can remember my first day of undergraduate accounting class. The professor put the fundamental accounting equation on the board. "Assets – liabilities = equity"
The same is true in our own personal lives. Everything we own -- cars, real estate, stocks, bonds, cash, and the like -- are our assets. Every debt we have -- including our mortgage, car loans, student debt, credit card balances and other debt -- make up our liabilities.
What's left is your net worth. So, why is it important to know this figure and to calculate your net worth often?
Your Net Worth Tells You Where You Are
Your net worth is a snapshot of where you are in life, your family's financial health. A negative net worth can quickly show you that you may be over-leveraged, that you have more debt than investments you can sell to pay them off.
If you list every investment and debt that you have, your net worth can quickly show you how much you have saved for certain life events. There are entries on my calculations for my children's 529 College Savings Plans as well as others for retirement accounts, IRAs, 401(k) plans and the like.
Of course, there are many ways that you can impede your net worth. Lifestyle inflation, credit card and student loan debt, no retirement planning and other land mines can decimate your net worth.
Net Worth Guides You To Where You're Going
More importantly than where you are, your net worth can help guide you to where want to go in life. We all have financial goals. Whether it is retiring early or sending our children to college without student loans, calculating your net worth helps you ensure that you're on the right track.
Is your net worth on an upward trend each quarter when you've calculated it? It should inch its way up each month ever so slowly as you pay off debt and continue to routinely invest in the stock market.
If you're adding to your investments through dollar cost averaging and paying off your credit card balances without adding to them, you'll see your net worth start to climb each tie you calculate it.
Calculating Your Net Worth Starts the Conversation
By calculating your net worth, you have a starting point to build a conversation with your spouse or loved ones. Most American families have one adult who typically handles the finances for the household. Reviewing your net worth periodically will help to bring the other spouse into the conversation.
By calculating our net worth regularly, my wife and I sit down to discuss where we are and where we want to go financially with our lives. It's a time for us to re-examine our financial goals and make new ones. Often we don't change our goals. Our net worth confirms that we're on the right track. But, there are times when we reassess things and make changes.
This quarterly meeting is the perfect time for me to help include my wife in the midterm and long-term financial planning and goal setting for our family.
How Does Your Net Worth Compare?
To some, calculating a net worth raises questions. Are you winning? Are you on track with your saving and investing? And how does your net worth rank compared to others?
Only you can answer the first two. According to the Federal Reserve Survey of Consumer Finances, the median net worth of all families was $81,200 in 2013. The average net worth of families in America was $534,600. The median represents the halfway point -- half of all families have higher net worths, half less. The average adds up all those net worths and divides by the number of families. It's so high because of the immense wealth of the 1 percent.
The Fed survey offers other breakdowns. For example, the average net worth for persons age 35-44 was $347,200. Homeowners amassed an average net worth of $783,000, vs. just $70,300 for renters.
You can see a rough calculation on where you stack up against other people your age and income on CNNMoney's Net Worth Calculator. It's a good tool to give you a quick snapshot, but, of course, you should take results from all online calculators with a big grain of salt.
There's a danger to comparing yourself to the Joneses. Instead take time to calculate your net worth every three months. Use it as a baseline to assess your goals. Are you on the right track? Do you need to make adjustments? Tracking your net worth can be a valuable tool to achieve your financial goals.
Where do you stack up against others your age? Is your net worth on track? Do you calculate your net worth regularly? Why not?
Hank Coleman is the publisher of the popular personal finance blog Money Q&A, where he answers readers' tough money questions. Follow him on Twitter @MoneyQandA.