Know Your Net Worth

Transcript of Podcast Episode 131

In today’s episode, we take a second look at one of our favorite previous programs: Do You Know Your Net Worth?

Simply stated, your net worth is the amount by which your total assets exceed your total liabilities. Another often-used expression is that your net worth is the difference between what you own and what you owe.

Is it really that important to know your net worth? Many people use their net worth as a measuring stick, a target to shoot for at a given age. It is, in essence, a financial report card.

Many younger people, particularly those with substantial college debt, can start out with a negative net worth. In other words, their liabilities are greater than their total assets.

Over time, even a young person with a negative net worth should be able to build their assets and reduce their liabilities. Your net worth provides a snapshot of your financial situation at a particular point in time. It is probably the most accurate measure of wealth. And it can help you figure out what you’re going to need to do to reach your long-term goals.

Focusing on your net worth helps you move your financial focus beyond income alone. And it can put your debt level in proper perspective. For example, you may not be as concerned about your debt going from $60,000 to $70,000 if your assets go from $200,000 to $300,000.

Keep in mind that a one-time snapshot of your net worth isn’t going to tell you that much, other than whether you’re completely off track, but the exercise can be particularly valuable over time. This gives you a much better picture of where you’re going.

It’s often pretty easy to value your liabilities. That’s simply the amount you owe.  Finding a value for certain assets, though, can be difficult, especially when you own real estate. If you own a rental property, it may not be worth it to get an appraisal every year. But it’s generally a good idea to make a conservative estimate of the value of any property you own. That way you avoid overstating your actual wealth.

The same thing applies to a closely held business. Your bagel shop may generate a decent income, but how much money could you realistically get if you had to sell it in a hurry?

For many of us, the biggest source of our net worth is our primary residence. You need to figure out a realistic value for your home, and that means looking at the actual net selling prices—not the asking prices—of comparable homes in your neighborhood.

There are some financial professionals who prefer to focus on net worth without your primary residence. Residential real estate is not the most liquid of assets. In some areas, it takes time, effort and money to sell it. And some people like to point out that even if you do sell your home, there’s a good chance that you’re going to roll the proceeds over into another home.

Once you have everything you need, it’s time to tally up the total. Your net worth is simply the difference between the two numbers.  Don’t be shocked—particularly if you’re a younger individual—if you come up with a negative number. It happens, and there’s no quick way to solve it.

Your net worth will, of course, fluctuate over time. But what’s really important is the overall trend. As you get older, your net worth should increase fairly consistently—as you acquire new assets, as the value of your assets grows, as you pay down your student debt and as the value of your home rises.

How do you know if you’re doing OK? Maybe the quickest way is to figure out your “target” net worth at a particular age. Here’s a simple calculation popularized by Forbes Magazine and others. Take 20 percent your pre-tax income and multiply it by the number of years you’ve been working. Let’s look at an example: say you’re 40 years old and you make $100,000. 20 percent of $100,000 is $20,000. Assume you started working at age 22. 40 minus 22 is 18. So $20,000 times 18 is $360,000, and that would be your target net worth.

Ok, so now what? Are you at or above your target net worth? And what can you do if you’re not? Sometimes it takes actually seeing it in black and white to get you to do something about it. If you’re not where you want to be, there are a few steps you may need to consider, such as adding discipline to your spending, paying down some of those high-interest debts, and just as important, saving and investing more.

Here’s one fairly easy way to save and invest more: set up an automatic deduction from your checking account into an investment account. It doesn’t have to be a lot of money, particularly if you’re young. If you set up a direct deduction of $200 or $300 per month from your checking, the money is already invested before you have the chance to spend it. And if you’re young enough, the miracle of compound interest can have an amazing effect.

Of course, once you retire, your net worth will likely begin to decrease, simply because you don’t have the employment income that helps drive it. We’ll discuss that more in a future episode.

The truth is, like a lot of things in life, the actual process of measuring your net worth will make you more conscious of where you stand financially. And in the long run, it may help you see what you need to do to improve your condition.

This podcast is brought to you by Security Mutual Life Insurance Company of New York, The Company That Cares®. This podcast is designed to provide general information regarding the subject matter covered and is believed to be current as of the date of publication. It is not intended to serve as legal, tax or other financial advice related to individual situations, because each person’s legal, tax and financial situation is different. Specific advice needs to be tailored to your particular situation. Security Mutual and its agents may not give legal or tax advice. Therefore, please consult with your own attorney, tax professional and/or other advisors regarding your specific situation.