How do you view your net worth?
Do you know your net worth? It’s one of the most important figures in your personal financial picture. It’s the calculation of what you own versus what you owe, or your assets versus your debts. The difference between the two is your net worth.
What is Net Worth?
People generally focus on their personal income statements, which include all of your income from employment, interest, gifts, and the like minus all of your expenses for housing, transportation, food, clothing, entertainment, etc. The rest is your net income or loss for a certain period – usually a week, month, or year.
Net worth looks at your personal balance sheet – what you own versus what you owe – at a specific point in time. It’s the difference between what you own (your “assets”) and what you owe (your “debts” or “Liabilities”) is your net worth.
For example, “Janey” owns a home, has a 401(k) account, a car and some cash worth $236,000. They also have debts of $195,500. If Janey paid off all her debts, she would have $40,500.
This is Janey’s net worth – what you own after paying what you owe to others. Net worth can vary widely. It can even be negative, and often is, especially for younger people just starting and those with student loans, like “Jason.” These are not real people, by the way.
Net worth is a metric for progress
Net worth is a yardstick for measuring progress. This is, where are you today versus where you were a year ago? Did yours go up or down?
Let’s look at Jason’s year-over-year comparison:
Jason’s net worth is negative in 2023, but he has made great progress in the last year, by paying down his credit card, student loans, and car loan by a total of $7,000 and adding another $500 to his bank account. As a result, Jason’s net worth went up by $7,500!
Net worth is a yardstick for measuring progress. This is, where are you today versus where you were a year ago? Did your net worth go up or down?
Let’s look at Jason’s year-over-year comparison:
Jason’s net worth is negative in 2023, but he has made great progress in the last year, by paying down his credit card, student loans, and car loan by a total of $7,000 and adding another $500 to his bank account.As a result, Jason’s net worth went up by $7,500!
Why is new worth important?
Risk and liquidity are two crucial factors to consider when evaluating the potential value of alternative investments,
along with any fees and disclosures that might differ from those of traditional investments.
It’s a key to understanding your overall
financial situation
First, net worth is like a scorecard for how well you’re managing your finances over time. If it’s is higher today than it was last year, that means you have earned more than you spent, or your investments have increased in value, or you’ve paid off some outstanding loans, or some combination of the three. These are good things.
Lenders consider your net worth when
you apply for a loan
Lenders are first interested in your income and expenses to decide whether you make enough money to make the loan payments on time. But they also are interested in your net worth to understand your ability to repay the loan if you experience an interruption to your income from job loss or illness. Someone with a higher net worth is a less risky borrower than one with a low one because they may have other resources to use to make the payments.
It illustrates the composition of your assets and liabilities
Are your assets easily converted to cash if needed, like investments, or are they primarily “fixed,” like cars and real estate? Similarly, not all debts are created equal: debts differ based on their interest rates, repayment schedules, fees, and the purpose of the loan. Borrowing for a home, or to get more education can be very valuable over the long run, even though it involves incurring debt.
The art and science of net worth
We often think about accounting and finance as black-and-white, concrete issues. When we start to dive deeper into net worth, however, we see that things are often not quite so absolute. In the Steven Soderbergh classic film Ocean’s Eleven, there is a wonderful exchange about this topic:
Ilayer: “Why were you in prison?”
Danny: “I stole things”
Player: “You stole things. Like jewels?”
Danny: “Incan Matrimonial Head Masks”
Player: “Any money in those?”
Rusty: “Boatloads. If you can move them. But you can’t.”
Danny: “My fence seemed confident enough”
Rusty: “If you deal in cash, you don’t need a fence.”
Danny: “Some people lack vision.”
The point is that some assets have values that can vary widely, depending on who is valuing those assets and their circumstances. Other assets have a very stable and predictable value. How you think about your assets is very important when you consider your net worth.
Not all net worth factors are equal
Let’s go back to Jason and Janey. Jason and Janey appear to have a net worth of $139,000.
But let’s look closer. Some assets are easy to value. Cash is cash, so $10,000 is worth $10,000. Similarly, mutual funds are an investment that can be easily bought and sold. If those mutual funds are listed at their current market value, then that’s what they are worth. In the case of their other assets, the value greatly depends on the market conditions.
Intangible values are variable
Jason owns a car that he values at $15,000. Most people value their possessions based on what they paid for them. More important than the purchase price in thinking about net worth is what would someone else pay for those assets? In the case of Jason’s car, it’s probably a lot less than $15,000 if Jason wants to trade it in on a new vehicle. Often, the trade-in value is one half or less what the owner paid. It’s also often less than the amount of an associated car loan. So, if Jason’s car is only worth $8,000, for example, and he still owes $14,000 on his car loan, his more realistic net worth is $7,000 lower, bringing his adjusted net worth down to $132,000.
Looking at Janey’s financial situation, we see some big differences from Jason’s. Janey doesn’t have a car, but she did fill her new house with furniture costing $15,000, which she put on her credit card. She also has a vintage collection of Beanie Babies, and based on listings she saw on eBay, she values those at $100,000. While Janey bought good quality furniture, it can be very difficult to sell used furniture, and buyers rarely pay more than 20% of the cost of that furniture. So, while Janey paid $15,000 for the furniture, it’s probably worth no more than $3,000 to a buyer. This reduces Janey’s net worth by $12,000, and she must still pay off the credit card! Ouch.
What’s the value of a Beanie Baby?
Looking at Janey’s Beanie Baby collection, we see that it’s valued at what Janey thinks it is worth based on those eBay listings. While some opportunistic sellersmay list their Beanie Babies on eBay for very high prices, that doesn’t mean anyone will pay those prices. While Janey cherishes her collection, and it gives her great joy, the value of those Beanie Babies if she tried to sell them is likely lower. Much lower.
So, while Jason and Janey appear to have equal net worth, when you look at the market value of the assets, they are quite different, as much as $100,000 different. This is where art trumps the science. When considering yours, it’s fine to consider how much you paid for something, or how much value you place in those assets. But in thinking about your actual wealth, it’s much more important to consider what a third party would pay you for your assets.
Don’t forget about liquidity
This example also highlights another key consideration – liquidity. Both Jason and Janey have $50,000 in equity in their real estate ($300,000 value less $250,000 mortgage). But they can’t easily spend that $50,000 since it is part of their home. While real estate is valuable, it is not easily converted to cash and is considered illiquid.
Final thoughts on net worth
Understanding and tracking your net worth is important to your financial wellness because it offers a quantitative benchmark. Now, you don’t need to be like Scrooge McDuck sitting on his pile of money and counting all the time, but you should update your net worth regularly to see how you’re doing and make adjustments to your spending and investing based on what you learn.
So, be realistic. List your assets and their emotional value to you. List all your debts, too. This approach will give you an accurate picture of your wealth and how it grows.
A final word about those assets that provide emotional value to you. They aren’t bad–in fact, if they provide you with joy, then they are an important element of your financial wellness. Say you have a collection of baseball cards that are valuable to you because they bring back memories of your youth, that’s great. You should keep enjoying that collection and the joy it brings, while understanding that its value likely won’t support you in your later life. And make sure you have some other assets that will pay for your vision of those golden years.
Post Disclaimer
Julep is not a financial institution, financial advisor, or credit repair company, and does not provide credit repair services of any kind. The information provided is for general educational and reference purposes only. The information is not intended to provide legal, tax, or financial advice. We do not propose any guarantee that the information provided will repair or improve your financial profile. Consult the services of a competent licensed professional when You need financial assistance.