TL;DR: Your net worth is the difference between your total assets and total liabilities. Calculate how much you own and subtract how much you owe and the resulting figure is your net worth.
Did you know that Bill Gates has a net worth of £83 billion?
Now, to be clear, this does not mean that Bill Gates can walk up to his local bank and withdraw £83 billion in cold hard cash. Rather, it means that Bill Gates combined assets are valued at £83 billion.
It is clear to realize that net worth is a distinct concept from the amount of money in your bank account.
What Is Net Worth?
In short, net worth is a measure of the total wealth of some entity. The net worth of an entity is defined as the sum total of their assets and liabilities.
When you add up the total value of what your own and subtract the amount that you owe, the remaining number is your net worth. Net worth is an important concept in finances as it used to gauge the financial health of an entity.
If net worth is increasing, that is taken as a sign of good financial health. Alternatively, if net worth is decreasing, that is taken as a sign of poor or decreasing financial health. Net worth can apply to any kind of entity; an individual, company, economic sector or even an entire country.
Net worth is a distinct measurement of financial health that is different from other measurements like home equity, credit card debt, or the size of your income. Your net worth is the most comprehensive measurement of wealth as it accounts for everything you own and everything you owe.
Why Is Net Worth Important?
Net worth is important as it gives a big picture view of your financial situation.
IN theory, your net worth is the amount of money you would have it you sold off all your assets and paid for all your debt.
If this number is negative, it means that you actually owe more than you own. Obviously, that is an undesirable situation. In contrast, if this number is positive, then that means you own enough to cover your debt.
However, even if your net worth is positive, that does not necessarily mean you are in a good financial situation.
Your net worth could be a very low positive number, which means you barely owe enough to cover your existing debts.
If a lot of your money is tied up in properties or other investments, this would mean you would have to sell off all those investments to cover your debts.
In general, the higher your net worth, the better financial shape you are in.
You can also use your net worth to gauge your financial health over time. A positive growth trend of net worth means you are growing more wealthy over time while a negative growth means you are becoming less wealthy.
In some cases tracking your net worth changes over time is a more accurate indicator of your financial health as it tells you if you are growing more wealthy or less wealthy over time, not just how you are doing at one slice of time.
How to Understand Net Worth
Having a positive net worth is not all you need. You could have a high net worth, but nevertheless still have a large amount of debt, which means your wealth will grow more slowly.
What is more important is that your net worth is composed out of a specific ratio of assets to debt. Traditional wisdom holds that you should shoot for no more than a 40% debt-to-asset ratio.
That means that your total debt should never subsume more than 40% of your total assets.
So for example, say your total assets are £150,000.
In this case, you should have no more than £60,000 in debt (40% of £150,000 is £60,000). In other words, when you calculate your total asset, the ideal amount of debt to gold should be no more than 40% of that value. Any more and you run the risk of sliding into depreciating net worth.
The best way to improve your net worth is to decrease your debt while increasing your assets or keeping your assets static.
You can also increase your assets while keeping debt static. In other words, anything you can do to achieve that ideal 40% debt-to-asset ratio is a good way to solidify your net worth.
Also, negative net worth does not necessarily mean you are in bad financial shape.
For example, negative net worth is common among recent graduates who have just started a job, may not have many savings, and still have student debt to pay off.
In this case, negative net worth should not cause you too much stress; as long as your total debt-to-asset ratio consistently decreases, which it should as you get older and build more wealth.
How to Calculate Net Worth
Calculating your net worth is pretty straightforward and simple. All you really need is some scratch paper, a calculator, and a bit of time.
Below, you’ll find a nifty little net worth calculator that we’ve devised to help you gain an overview of your assets.
UK Net Worth Calculator
Step 1. Make a list of your assets and their total value
Your assets include anything you own that is worth some money. This includes obvious things like:
- Your checking and savings account
- The value of any stock you hold
- The value of your house
- The value of your car.
It also includes less obvious things like patents, trademarks, copyrights, goodwill, and brand recognition (so-called “intangible assets).
Technically, you assets everything your own including things like your TV, furniture, musical instruments, etc. However, most people do not account for assets worth less than a certain value.
Some of these assets, like your bank account or savings account, have clear obvious values, but some might require you to do a bit of guesswork.
For example, it can be hard to directly appraise the value of your house or your car. Once you figure out the value of your individual assets, add up all the numbers to get the total value of your assets.
Step 2. Make a list of your debts
Next, you need to make a list of all your debts. Your debt includes any amount of money you own, regardless of the form. This includes things like:
- Credit card balances
- Personal loans
- Student loans
- Auto loans
- Home mortgage
Debt can also include smaller things like gym membership contracts, utility agreements, etc. Unlike your assets, most debts have a clearly defined amount which should not be too hard to find out.
Once you figure out your total individual debts, add them all together to get your total debt.
One quick note, a credit card balance counts as a debt, but your total available credit does not count towards your assets.
This is because credit lines are not assets; they are credit lines. Even if you have a very high credit line and no credit card debt, this line amount does not count towards your total assets.
Step 3. Subtract your total debt from your total assets
The next step is simple. Just take your total assets and subtract the amount of total debt you have. The remaining number is your net worth!
Paul is 38 years old. He has a house worth £220,000 and still owes £90k on the mortgage. He owns a 4-year-old car that is worth about £9,000 but is all paid off. He has £10,000 in savings, £2,000 in credit card balance, £30k in a pension scheme and £10,000 in student loans.
- House: £220,000
- Pension: £30,000
- Car: £9,000
- Savings: £10,000
Total assets: £269,000
- Mortgage: £90,000
- Credit cards: £2,000
- Student loans: £10,000
Total debt: £102,000
So Paul’s total net worth is:
£269,000 – £102,000 = £167,000
Net worth is an important financial concept that you need to understand. To reiterate, your net worth is a comprehensive measure of your total wealth and is calculated by subtracting your total debt from the total value of your assets. All other things being equal, you want your net worth to show continual growth over time while your debt to asset ratio decreases.