Newsflash: You can’t measure a person’s wealth based on how they look. To put it another way, “Just because you bought that crap doesn’t make you rich.”
New cars, swank threads, and blingin’ handbags don’t make you a baller. They make you broke. Haulin’ 6 figs doesn’t mean you’re a Rockefeller. It just gives you the opportunity to build wealth quickly. No matter what you make, what you buy, or what you drive, the only things that really matter are how much you spend, save, and invest.
Since you can’t accurately measure financial success by appearances, how do you know if somebody is actually rich? More importantly, how do you track your own financial progress? It’s called “Net Worth” yo! And, it’s about to get real.
Why Knowing Your Net Worth Is Important
Your net worth is the most important financial number you can know. It’s the one figure that provides a true measure of your current financial health. By comparing the value of everything you own to the amount of money you owe, you can clearly see whether you’re building actual wealth or digging yourself deeper into debt.
Think of your net worth like a GPS for your finances. Your current net worth depicts exactly where you stand at this very moment. But, more importantly, tracking your net worth helps you understand where you’re going. It tracks whether your financial decisions are leading you in the right direction. Are you saving and investing enough? Are you spending too much? Knowing your net worth helps you decide.
Ideally, your net worth should grow steadily over time. By monitoring it, you’re able to gauge whether you’re getting richer, poorer, or more in debt..ier.
How to Determine Your Net Worth
Calculating your net worth is actually pretty simple. Just take the value of everything you own (assets) and subtract the total amount of debt that you owe (liabilities). The resulting number is your net worth. Here’s the equation:
Assets – Liabilities = Net Worth
Boom! Piece of cake, right? Well…not so fast.
What’s an Asset?
Determining your liabilities is easy. In almost all cases, your liabilities are equal to the amount of debt you owe. Do you owe $1,500 in credit card debt? That’s a liability. Still have 5 grand to pay on your car? Yep, that’s a liability. Student loans killing your budget? Liability.
See also: Should I Refinance My Student Loans?
Calculating the value of your assets can get a little trickier. Basically, anything you own that has value can be considered an asset. Determining the value of cash is no sweat. Just look at your bank balance and you’re good to go! But things get a little more complex when you own assets whose values change over time.
For instance, if you own your home, it’s an asset. However, home values go up and down, so the amount you paid for the house may no longer be considered its true market value. Before you can calculate your net worth, you need to determine a fair market price for the house.
Any investments you own are also considered an asset. Obviously, the value of stock market investments are constantly changing. Thus, your true net worth is bouncing up and down along with these market fluctuations. Don’t panic. What you want is to see your net worth growing gradually over a long period of time. Short-term fluctuations due to investment gains and losses isn’t a big deal. Major fluctuations due to accruing new debt is.
Err on the Conservative
Personally, I like to be a little conservative when calculating my net worth. Rather than including values for declining assets, like vehicles, I usually leave them out. The junkers I drive aren’t worth much anyway. However, if you have a valuable classic car collection, you’ll want to include the market values of those cars in your net worth.
It’s important to remember, unless you only own cash and cash equivalents, your net worth is always going to be an estimate. Still, you want to be as accurate as possible in order to get a clear picture of your financial health.
The key to maintaining accuracy is being honest – and realistic – about your market values. It’s not doing you any good to over-inflate an assets value just to create some warm fuzzies. Remember, you’re not trying to keep up with the Joneses here. All you want is an accurate number so that you can track your financial progress.
You also need to be consistent with what you include in your calculations. If you don’t include your Beanie Baby collection in one calculation, you can’t include it in the next. You’ll throw your numbers off and won’t be able to accurately gauge your progress.
Using a Net Worth Tracker
Because my bank balances and portfolio values are constantly changing, I prefer using a net worth tracker to stay on top of my numbers. Personally, I think Personal Capital’s program is great. It monitors all of my accounts in one place, which saves me a ton of time from doing it by hand.
Personal Capital’s free Net Worth Tracker takes about 10 minutes to get set up. Just fill in the value of your assets (real estate, vehicles, etc.), link your investment accounts to the system, and the software does the rest. You’ll see your net worth clearly listed at the top of your dashboard, complete with a nifty graph that measures how your net worth has changed over time. To learn more about Personal Capital’s free money tools, click here to read our complete review.
Money might only be a tool to help you achieve your dreams, but obtaining the freedom you crave is almost impossible without it. Tracking your net worth is the best way to measure whether or not you’re meeting your wealth building goals.
So, how do you measure financial success? I measure it by net worth. Get started tracking yours today!