Your net worth is your net worth

Yes, no fancy quote today like “Your net worth is your network” or “When your self-worth goes up, your net worth goes up with it.”

Nope, your net worth is your net worth, that’s it. No need to sugarcoat it.

Your net worth gives you a good idea of your overall wealth and the health of your financial situation. For example if you have plenty of debt, and own very little, your net worth would be negative, which means your financial situation is not good. I don’t care how much money you are making and how big your salary or your car is. If your net worth is low or negative, it means you are not wealthy. Even though you might think you are…

So how do we calculate our net worth?

The basic definition is quite simple: Net Worth = Assets – Liabilities

For individuals, there are some things you need to know before starting to calculate your net worth.

First, you need to value only REAL assets.
Most people think of their car, their TV or even their new BBQ as an asset. It is however very wrong. It is very rewarding to consider yourself as a business when looking at your finances. This is why using the financial accounting definition of an asset is much more helpful: “An asset is an economic resource. Anything tangible or intangible that can be owned or controlled to produce value and that is held to have positive economic value is considered an asset.”

To put it simply:

An asset is something that increases its value over time and that generates cash flow.
For our purpose we will consider that anything you own that will likely increase its value over time OR that generates cash flows is an asset.
Examples are: cash, stocks, bonds, real estate, shop ownership, life insurance, retirement plans, artwork, jewelry…

The second biggest mistake is to include your primary residence in your calculation.
Why? Well any way you look at it, your home is a liability. Even if you own your home, you need to pay your mortgage back or cover all the costs of repairs, insurance, maintenance, taxes and so on.
So instead of putting money in your pocket, your home costs you money every day you live in it.
We could maybe argue that if we sell the property with a profit, we would then make some money right?
The problem with this argument is that because you are living in your home, you cannot leave it and sell it when you want. Not only is it very illiquid, it also means that you first need to find another place to live in. And guess what? Yup, this costs money as well. So I strongly recommend you to include only the other properties you own in your calculations, because they are the ones that can bring you money without having to sleep outside.
Robert Kiyosaki the author from “Rich Dad, Poor Dad” sums it up well in this 2 minutes video.

Finally you need to make adjustments:

• Any taxable account will be taxed according to the capital gains tax in your country and this should be accounted for. If you live in Denmark, you will have to deduct around 40%, 35% in France, 28% in UK and USA and if you are lucky and live in Belgium or New Zealand that would be 0%.

• Retirement accounts and any individual retirement account or fund will also need to be adjusted according to your tax bracket. Why? Because most of these accounts allow you to deduct your contributions from your tax declaration but they are not exempted from taxation when you take it out in retirement. Some of them work the other way around, so make sure to check what kind of an adjustment you should make. (Usually between 15% and 28%)

• Any jewelry or art you own should be discounted with the “pessimistic look” ratio, which is at least around 50%. (The “pessimistic look” ratio is a secret ninja technique used by most smart buyers)

Now let’s talk about liabilities.

Anything that takes money out of your pocket on a regular basis is a liability.
Examples are such as: your mortgage, your credit card balances, your student loans and basically any kind of debt you have. Don’t forget to include medical bills, personal loans, taxes due and any outstanding bills.

As Robert Kiyosaki explained earlier, even things you own could be a liability: a house, a boat you have to maintain, a car that needs repairs and insurance, and so on.

Here is an example of what a net worth calculation look like:

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So now, what does it mean?

If you are a decent human being, you should have calculated your net worth and you now have a nice looking positive or negative number in front of you. This gives you a good idea of how well you are doing right now with your finances.
This does not mean you are better than your neighbour or more stupid than your friend and it does not mean it will stay the same forever.
Please don’t use it as a way to compare yourself with others or to pity yourself. This is just a scoreboard, an indicator of how well your finances are doing.

What’s important is how you will use this information:

What is your next step?
Are you surprised by this number or did you think it would be lower or higher than it is?
How much net worth would you like to have in one year, ten years?

The biggest surprise for many people is to realize that although their income has been increasing over time, their net worth is still very low.

This is because of something called “Life Inflation”: the more money people earn, the more money they tend to spend. And even if it their lifestyle is improving and they are making more money, their assets don’t outgrow their liabilities.

The problem with Life Inflation is that if something stops their primary source of income, most people would not be able to afford the same kind of lifestyle and would usually suffer from it.
Being aware of this concept allows us to save and invest more toward our assets and build our net worth steadily over time. Having a positive net worth gives you more financial freedom and allows you to become more and more independent from your main source of income. If you are working on building your net worth, you will have more flexible choices in your career and in your life, and you will be more prepared to whatever comes next.

If you want to improve your financial goals, here is what you can do right now:
Calculate your net worth
Write down how much net worth you would like to have in 1 year
Write down 3 ways you could decrease your liabilities
Write down 3 ways you could increase your assets

Let me know if you have any comments or questions about your net worth.

http://money-management-advice.weebly.com/articles/your-net-worth-is-your-net-worth

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