Net worth is the true measure of how you are managing your wealth. But many people make flagrant mistakes in their calculations or choose to juice up their assessment to feel good. This post explains how to calculate your net worth in the right way.
Companies track their wealth diligently. They are obliged by law and they do so through their balance sheet statements. The balance sheet is one of the tools a company uses to know whether they are doing well and if they are creating value for their owners.
You should know your net worth. Because you should know whether you are doing well and if you are creating wealth. And ideally, you should know how you benchmark versus other people your age and area. The idea is not to benchmark out of jealousy, vanity or voyeurism. It should more be like a gentle nudge that keeps you focused on attaining the goals that are relevant to you. In the end it does not really matter whether others have more or less. But it matters to know if you are doing well. Keep those blinders off.
Here under find a short list of the average net worth of an adult in 9 countries (source):
|Country||Avg Net Worth 2016 in x1000 USD||Median Net Worth 2016 in x1000 USD|
How do you stack up?
How to calculate your net worth?
How do you define net worth? Simply by taking all the assets you own and subtracting all your liabilities. If you own more than you owe, congrats. If however you owe more money than you own assets, time to kick into panic mode and start planning your way out of this mess.
When doing this kind of exercise one always has to keep in mind a few guiding principles:
- Materiality: it is only useful to measure items that matter ( don’t spend 30 min gathering your change when you are calculating your net worth)
- Reliable: get a clear idea of what is really happening and leave out all the vanity measures that might make us feel good, but really do not shed a light on our financial situation.
- Conservatism: when making a choice on how to account for something, always choose the conservative option.
Assets – Liabilities = Net worth. Seems simple enough, but I thought it would still be wise to clarify even further and list all the asset classes and debt you need to take into account and give you insight in how to appraise or valuate your net worth.
Add up all your assets
I’ve listed all the major asset classes from the most liquid to the least liquid (= as in most difficult to turn into cash money).
This needs no further explanation. Simply add up all the amounts that you have on checking accounts, savings accounts, money market accounts, term accounts, etc…
This includes your portfolio of financial products (stocks, bonds, mutual funds, structured products, …), valued at the current market rate. Here too, all one needs to do is add up the amounts that you have on your investment accounts.
This is easy enough for publicly traded assets. If you happen to own shares in a private company, valuating becomes harder. Two routes can be taken here. Valuating at market value (i.e. based on what external investors might think your share of this company is worth) or valuating at book value (i.e. looking at the balance sheet company). There is no general right answer on this. And this topic deserves an entire blog post of its own and multiple books have been written on the topic. So for this exercise I’ll assume that if you have a share in a private company, you have a clear idea what it is worth. Now take that amount and deduct 10% of it. This amount counts towards your net worth. I would recommend to use a safety margin on this asset class to take into account of your net worth.
Jewelry, art, antiques, … you get the idea. If you own any, I would again consider a safety margin on what you think is a realistic valuation. You need to valuate in such a way that you are 99% confident that you could sell that asset within 3 months at your valuation.
Why do I recommend this? Your net worth gives you an indication of what kind of money you would have if a major emergency would occur. If you own a piece of art that you think is worth a 100k, but you would need to wait a year to find a buyer at that price tag, well… that wouldn’t be very useful in the case of an emergency. If to unload that piece of art fast, you could only fetch 50k for it within the next 3 months, that gives you an exact idea on how you should value this belonging in your net worth.
Anything with a motor used for transportation of people or goods goes in this category (so no, your lawnmower does not go into this category). Again take a safe approach to valuating your belongings. For most vehicles, boats, trucks etc… you can easily look up what that belonging would fetch on the market. Once again, in case of doubt… take a safety margin.
I deliberately keep pension funds separated from the financial assets, because they are very illiquid. You have to wait up until the legal age to starts withdrawing from them and if you still decide to cash them out early, your government will serve itself a very nice cut first!
I do not valuate my pension funds at the balance amount, but I deduct the tax rate I am expecting to pay at the age of 65 when I must cash my pension funds out. In Belgium that tax rate is about 20%. I only account for 80% of the balance in my retirement accounts.
Most people will never own this asset class. This contains items such as patents, rights, etc… These are assets that can be valuated and produce an income. If you do own this asset class, you probably have a very accurate idea of what its worth, but unless you are a famous musician, writer or inventor, I would not take this into account. As the right produces income add it to your income streams. these make for excellent passive income.
Houses, lands, anything that does not move and needs a deed to be bought or sold applies here. This category too is relatively easy to appraise by looking up values online. Now personally, unless you are using a qualified surveyor, I would be cautious with looking things up online and making an extrapolation. There is a difference between what people advertise a property for and what it gets sold for. I would use the purchase price of your property as a starting point and inflate the price slightly over time. Basically my rule of thumb would be to not make any drastic changes in appraising your real estate, unless you are very confident that market conditions have changed dramatically.
Same applies for everyone that feels they have bought below the market price. Newsflash! Unless there was a major market imperfection that you know how to take advantage of, you have bought at market price. As a matter of fact, you bought at the highest price anybody was willing/capable to pay for that property at that given time. The seller would have probably sold to a higher bidder if she/he could. So even if you think you bought a great deal, calculate your real estate assets at purchase price and review the valuation periodically.
And that is it for all the major asset classes to take into account of your net worth.
What about your other belongings?
No. You don’t consider furniture, clothing, the sweet TV set you bought last month, state-of the art golf clubs or other items the like. The reason is simply because they lose in value so fast and they should not be of any major significance in your net worth composition. If they are a significant part of your net worth, please raise your hand to your face and give yourself a little tap on the cheek: you’ve got work to do.
And you do not consider insurance either. In monetary terms I am worth more dead than I am alive. But that is completely irrelevant to your net worth calculation.
Add up all your Liabilities
Ranking from most urgent to least urgent.
Credit card debt
Simply pull out your monthly statement and consider the balance on your credit card.
Any debt not supported by a collateral (vehicle, property, etc). You should consider the balance of the principal. Basically, if you had to write a check today to clear your personal debt (excluding fees and interest), how much would that be? If you borrowed money to finance appliances or your studies, they will usually fall under this category.
Car loans (or other vehicles/boats /etc…)
Again looking at the outstanding principal on your on car credit.
Mortgage (and other loans with real estate as a collateral)
Pull out your payment schedule and find out what is the principal amount you owe on your real estate (not including interest).
Why do people mistake their net worth?
Pull all that data together in a spreadsheet or an online tool. Add up all your assets. Add up all your debt. Subtract your debt from your assets. It really is that simple.
But even with the few guidelines I handed, you can easily imagine dozens of way to estimate your net worth. But making a mistake or overestimating your key financial indicator is setting yourself up for living in denial, confident that you are on top of your finances when this is really not the case.
Your personal balance sheet
Another way to look at it is like your personal balance sheet. Without kicking off an Accounting 101 course you could look at your balance sheet in the following way:
- An asset column
- A column that indicates the source of these assets:
- Debt: this boils down to you not owning the asset. You are just borrowing until you pay your debt back. The source of this asset is debt. So your debtee owns it.
- Net worth: this portion of your wealth is sourced by you. Congrats!
So? Did you calculate your net worth? Any surprises? Share below in the comment section.