What is Your Net Worth? And Which Way Is It Moving?

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What is Your Net WorthDid you realize that you could save up $500 every single month for a year, put it in a super-safe bank account, and still lose money when it comes to your overall net worth?

It took me quite a while to truly understand it, but cash in your bank account and your net worth dollars are two very different things.

What Is Your Net Worth?

So what is a net worth really? I’m sure you already know that wealthy people have a high net worth and poor people have a nearly non-existent net worth, but how is it really calculated? As opposed to many things in life, the net worth calculation is actually very simple.

Net worth = Assets – Liabilities

In other words….

Net Worth = What you own – What you owe

Here’s an example of a typical person’s net worth calculation:

Net Worth

They own a house, a couple of cars, have a meager savings account, a decent start at a retirement fund, and then they have the typical debts: student loans and some credit card debt.

All combined, these people that own a $300,000 and a $40,000 car are really only worth $8,000 all combined?

Yep.

And the sad thing is, this is the typical story. And it’s because people are much too focused on their income and somehow forget all about their actual worth.

Put simply, they buy too much crap with debt.

Is It Truly Growing?

Is your net worth growing? Do you know? How can you find out?

Let’s take a look at the net worth example table one more time. And let’s add one more column for our estimate of what these items will be worth a year from now, and also what we’ll owe on them a year from now.

Net Worth Next Year

As is typical, you can expect the house to grow in value and for your debt balance to go down from year to year, meaning your equity in your home will increase and help grow your overall net worth.

But now let’s look at the other (uglier) side of the net worth equation above. Those stupid cars.

This family decided that they wanted to look uber-wealthy and drive in style with their brand new Chevy Impala with all the bells and whistles. While they might look cool to their neighbors, their buddy “Net Worth” thinks they’re idiots.

They bought the Chevy Impala for $40,000 and took out a $38,000 loan to do it. Before they left the lot, they had equity of $2,000.

One year later, if they tried to sell this very same car (with just a few thousand more miles), they might be able to get $32,000…if they’re lucky. But, they still owe $35,000 on the car note. Their new net worth on this car? Negative $3,000….

After one year of consistent payments, their car actually dragged their net worth down by $5,000.

So did their net worth grow in the above example? Yes. But it was purely because of their house.

What Will Your Net Worth Be in 10 Years?

If you want to be truly wealthy, you’ve got to start thinking about the distant future – at least 10 years in advance.

Will your $40,000 car increase your net worth? Nope – it will almost certainly hold you back.

If you want your net worth to rise (and rise substantially) over the next 10+ years, focus on assets that grow in value:

  • Your primary residence
  • Rental property
  • A business
  • Your retirement fund

Focus On, And Grow, Your Net Worth

If you do absolutely nothing to grow your net worth over the long haul, you’ll likely retire with little and be forced to live frugally for the rest of your life. No vacations, no charitable giving, and certainly no extravagant purchases for yourself.

If, however, you’d like to actually live and give in your older age, then your net worth and its growth should be very important to you.

Need a gauge to see how well you’re doing? TheΒ average millionaire has 7 sources of income. Regular work income, rental income, interest income, dividend income, side business income, and a few miscellaneous sources.

Is it time for you to step it up and grow your net worth?

Want yet another gauge of your net worth? Check out this popular article I put together a few years ago: Net Worth by Age – How Do You Rank?

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11 comments to What is Your Net Worth? And Which Way Is It Moving?

  • This one hit close to home, literally. I had the $60K car neighbors (Look up the cost of the Lexus 400 series). Working parents, 3 kids. As the oldest hit high school, they moved. She told my wife they hadn’t saved for college, and over the next decade, would be putting the 3 boys through college. A downsize would give them some cash and reduce their expenses.

    They both had good jobs, but in hindsight, blew through money on the cars and the country club memberships.

    My own approach to net worth? Don’t count the value of the house. You can’t spend it. You can’t apply the 4% rule to draw money at retirement. It shouldn’t be part of the plan. To be clear, if a reader buys a $200K home with a $150K mortgage, I’d count that as -$150K. When it’s paid off, it goes on the estate sheet, i.e. when you die, the kids get $200K or more from the sale. But today, you are better off ignoring it. This approach also eliminates the constant tinkering with that spreadsheet cell and trying to find the proper value to use. In our case, if we moved a few years from now, I have no idea where we’d go. Odds are, the new house would cost nearly as much as the one we are in now. If not, the extra money we’d keep would then get added to net worth, but not before. (Ideally, of course, we do what the neighbor did. Downsize, add to net worth, reduce expenses, etc. But not to pay for college, and not because we had to.)
    JoeTaxpayer recently posted..Rich Country / Poor People

    • I love counting the house as a negative. This view will show you two things: 1) Your home is not an asset that you can easily cash out and utilize, and 2) a home is not a valid investment and should be purchased in terms of need instead of wants. In other words, buy the house that can fit your family and nothing more. It’s better to invest your money in a business or your 401k over the long haul.

      Great stuff Joe! Your comments are a lot more fun since we stopped talking about the snowball method. πŸ˜‰

  • I’m focusing on increasing and diversifying my income streams. This will increase my net worth by default πŸ™‚

    I’m looking to build my blog into a consulting business…. should be interesting! I’m learning a lot about internet marketing and automation!
    Erik @ The Mastermind Within recently posted..Positive Transformation – Bigger, Faster, Stronger 11

  • whiskey

    I see the argument from both sides. Net worth should/should not include your home. Any more, the way I look at it is this, if you owe $$ on it, its not an asset. Don’t care if its bringing in $$, ie rental property, etc. Yes, yes you can argue the math, potential to bring in cash after sale, leveraging so on and so forth. But its debt. So, until the item is debt free, it should be under liabilities, imo.

  • Nicole

    Tracking net worth is really helpful to someone like me in understanding what debt is doing to my future life at my age. It takes awhile to dig yourself out of debt but it is totally worth it knowing to a degree you have some money safe for life’s trials.

    In my case a house not paid off and underwater (sigh) should not be counted in net worth for sure. Just makes you want to hurry and pay down on it as fast as possible.It is interesting to see my net worth go up while contributing a little to my 401K and pay down debt at the same time.

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