Thursday, October 11, 2012

Net Worth Explained

Yesterday, I showed a friend of mine this blog, and she sent me back an enthusiastic email about the topic and praise for a few of my posts. But - she had one question: “How does one calculate net worth? I have investments, life insurance, etc. I think I'm still in the hole though, because of ridiculous student debt.” Amen, sistah, on the student loan debt! Welcome to the (not-so) exclusive club.

I realize I didn’t go into great depth about how I calculate net worth in the post where I announced that I finally had a POSITIVE net worth. I’ll address the specifics right now. NOTE: I've simplified the spreadsheet for the purpose of this post. My own document is slightly different.

Calculating Your Net Worth
From our friends over at Wikipedia, net worth “refers to an individual's net economic position; similarly, it uses the value of all assets (long term assets) minus the value of all liabilities.” In mathematical terms, net worth = (assets - liabilities).

Therefore, in order to calculate net worth, one needs to add up all of their assets and then add up all of their liabilities. Let’s tackle assets first.

Assets are any accounts or items that have value. If you needed to come up with $1,000 tomorrow, where would you get it? A savings account? A checking account? Sell some of your belongings or take out money from your retirement account? For the record, I advocate that you NEVER take a loan out on your retirement accounts. However, that account is still considered an asset and it must be included here. I also don’t include the maximum amount in a cash advance you could get from your credit card - that is not an asset because that money does not exist in liquid form until you take out a loan for it.

So, let’s review. The following are examples of assets: savings accounts, checking accounts, retirement accounts (401k, Roth IRA, Traditional IRA), valuable belongings (i.e. cars and electronics), and other investments (money markets, stocks, bonds, etc..). Here is an example of my “assets” column in my net worth spreadsheet:

Now on to liabilities. A liability is anything that you OWE. The most common of these are loans - student loans, car loans, a mortgage, and the most evil of them all: credit card debt. I do not include monthly payments such as rent and utilities on my liabilities because those have to be paid monthly and will not go away. I wouldn’t be opposed if someone chose to add a line item for their monthly rent as that is, in effect, a liability similar to a mortgage payment. Right now the only liabilities I have are my two outstanding student loans. Here is an example of my “debts” (aka liabilities) column in my net worth spreadsheet:

Now that I have a total number for both my assets and debts (liabilities), I find the difference between the two, which is my net worth. Here is what this looks like in Excel:

From these calculations, I have a positive net worth of $572.56!

I’ve also decided to calculate the percent change, but that isn’t a requirement for determining your net worth. Here is the Excel formula for that if you wish to use it: =(this month's net worth - last month's net worth)/ last month's net worth. Or in this spreadsheet: =(C19-B19)/B19.

And there you have it! I hope this was clear. As Forrest Gump would say, “Mama always had a way of explaining things so I could understand them.” I hope I did half as well as Mama with this post!

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