Money tip – Calculate your net worth
Are you wealthy? The answer to this question really depends on how you define wealth? Does wealth mean that you have a certain amount of money? Does wealth mean that you drive a fancy car or live in a big house? Does wealth mean that you have achieved financial independence?
According to Thomas Stanley and William Danko, authors of the best sellers The Millionaire Next Door and Millionaire’s Mind, wealth can be determined by the following formula:
Take your age and multiply it by your gross household income from all sources. Divide by ten (10). This is what your net worth should be.
This is one definition of wealth but not the only definition of wealth. For most people, the most common way to determine your wealth is determining something called your net worth.
What is net worth?
The definition of net worth is very simple. Your net worth is equal to all of your assets less all of your liabilities. It can be complicated depending on what you define as an asset and what you consider a liability. For example, is your $1,000 big screen TV considered an asset? More importantly, should it be used to calculate your overall net worth?
For the purpose of retirement planning and wealth planning, I would argue that you should not consider the TV as part of your financial net worth. In my mind, your financial net worth is slightly different than your total net worth because you only want to consider assets that may be used as a retirement asset or truly relevant to your financial wealth.
Knowing your net worth is a very important aspect of personal finance. How can you know if you are getting ahead financially if you have no way to track or measure your wealth? If you want to have a benchmark for wealth, retirement or financial fitness, make sure your starting point is your net worth.
I equate knowing your net worth for wealth management to knowing your weight for weight management. Creating a net worth statement is a basic skill you should know and practice regularly.
How to calculate your worth?
Down below, I will give you a list of tools and resources to help you figure out your net worth but really all you need is a pen and paper.
Take a piece of paper and draw a line down the middle of the page from top to bottom. On the left side of the page write down all the assets that you think contribute positively to your financial well-being (not depreciating assets). On the other side of the page, list all your debts or liabilities. At the bottom of the page, take your total assets and subtract your total liabilities and you will have your net worth.
Once you have this starting point, every year, you should redo this calculation to see if you are moving in the right direction. Understanding your net worth is the starting point to financial planning and wealth management.
Personalize your net worth statement
There is no shortage of tools and resources out there to help you figure out your worth. In my opinion, use the one that works best for you.
Here’s a link to a net worth statement I give out to people who attend my financial workshops or want to come see me for financial help. It’s designed to be the best or the worst but a great starting point.
Here’s a link to an excel spreadsheets. There’s nothing fancy about these worksheets but that’s really the point. It does not have to be fancy. Incidentally, this is the spreadsheet I’ve been using for years (the long term tab). My net worth spreadsheet is personalized for my needs and I would encourage you to do the same for yourself. Take this template and personalize it to your assets and liabilities.
For those of you that prefer links to online calculators, try this one from TaxTips.ca –http://www.taxtips.ca/calculators/networth.htm
Personallym I don’t use online calculators to calculate my net worth so if anyone wants to share a tool they use and find helpful, please share in the comments.
Why is net worth important?
In the process of financial or retirement planning, it is especially important to have a measuring stick. In the area of health and fitness, we use weight as a benchmark. If we are overweight, we try to lose some by eating better or exercising more.
In financial planning, net worth is one of the most commonly used benchmarks. Your goal in retirement planning should be remarkably simple – While you are in the accumulation phase, your goal should be to increase your net worth every year.
Two ways to increase net worth
Most often, when we think of increasing net worth, we think of accumulating assets. There is no question that one of the ways to increase your net worth is simply to accumulate more assets. Forced savings plans are one of the best ways to systematically accumulate assets to add to your net worth. Assets like mutual funds, stocks, real estate, GICs are all assets that help build up the asset side of the net worth equation.
Sometimes the other side of the equation is forgotten when it comes to increasing net worth. It is important to keep in mind that reducing debt will also contribute to your net worth positively. Paying down debt like mortgages, lines of credit and credit cards will all reduce liabilities and enhance your net worth. It is also worth mentioning that going into debt is not good for your net worth unless the money is used to enhance your assets. For example, buying real estate is good even though you have to go into debt to do it. However, buying a big screen TV on your credit card would not be considered a positive contribution to your net worth. I know some of you may jokingly disagree but remember your TV is a depreciating asset for personal use. Few experts would consider a TV a solid retirement asset.
So, do you know your net worth? I ask this question of people every single day and more often than not, people have to think pretty hard about what is their net worth. If you want to have a benchmark for wealth, retirement or financial fitness, make sure your starting point is your net worth.
If you’ve never tracked your worth, it’s time to get started. Using any of the strategies above, make it a priority to complete your net worth statement.
For those of you who are more seasoned at this, help others by sharing he tools, calculators and strategies your use to calculate your net worth.
If you have any doubts about how to calculate your net worth, consult a financial advisor for help.