Wednesday, April 13, 2011

Net Worth: What Is It And How Do You Calculate?

Have you ever heard people talking about their net worth? Net worth is something that millions of people calculate every year, but why? Is calculating it easy? We will get into the why a bit later but calculating your net worth really isn’t all that hard. It just takes a bit of time, some scratch paper, and a calculator.

First, make a list of all of your assets. This includes savings, your current checking and savings account balances, any bonds you might have, the total value of any stock holdings you might have, your home, and your automobiles. I usually don’t include any physical assets less valuable than a car, but you can do this if you wish.

I usually make a list that says ASSETS in big letters at the top. Underneath that, on the left, I list what the asset is and on the far right, I list the value of that asset so that the decimal points of all of the assets line up. This makes the calculation of your total value much easier.

Once you’ve listed every asset you can think of, write TOTAL in big letters over on the left, then add up the numbers. Once you have this total, you’ve got the total value of your assets.

Now, make a list of all of your debts. You should list all of your credit card balances, personal loans, student loans, auto loans, home loans, and so forth. Much like with the assets list, I recommend a big header that says DEBTS, with each debt listed below that on the left side and the amount of the debt over on the right, with the decimals lined up for easy figuring.

Once you’ve listed all of your debts, write TOTAL in big letters on the left, then add up all of the debt numbers. This total is the total amount of all of your debts.

Once you have these two numbers, the net worth calculation is simple. Take your total assets and subtract from that your total debt. The resulting number is your net worth.

What does a negative net worth mean? Some people panic when they calculate their net worth and discover that it is negative. This is usually the result of a young earner with a substantial amount of student loans and also a loan on a rapidly depreciating automobile. Why is your net worth negative? You simply haven’t earned enough money yet to overcome the weight of the debt. Don’t worry, it will come.

How can I make it bigger? Every time you make one of those debts smaller or one of those assets larger, your net worth will increase. So, you can increase your net worth by paying off your debts, saving and investing money, and reducing your spending.

On the other hand, your net worth goes down when you spend money on “small” things, such as clothes, food, and even interest on loans. Whenever you buy something frivolous, your net worth goes down.

I find it useful to calculate my net worth every month. My goal each month is to increase my net worth over the previous month, which means my expenses for the month was less than my income. I use the excess to pay down debts or increase personal savings.

The usefulness of the net worth formula might not be beneficial now, but later down the road it can help you budget for buying a home, vehicle, or any big purchase.

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