One of the most important metrics for tracking financial progress is net worth. I write about my net worth, or a modified form of it, every month when I report my balances. By watching my net worth change over time — usually increasing from month to month but occasionally decreasing — I can get a fairly decent picture of my financial health.
What is net worth?
Net worth is the financial value of all your assets, everything you own, subtracted by the financial value of all your liabilities, everything you owe. Finance gurus are familiar with this formula:
Net Worth = Assets – Liabilities
The equation works as well for individuals as it does for businesses. There should be no question of what is included in the net worth calculation. It starts out simple. Your bank accounts are assets and your credit card accounts are liabilities. These are easy to include in your net worth calculation because the values of these accounts are expressed in dollars and cents at any moment. You could at any point check your accounts online to get an up-to-the-minute balance.
Investments are assets as well. Generally, investments are held in shares, so a calculation may be necessary to convert your shares to a dollar amount that you can include in your net worth calculation, based on the value of those shares. If your investment is a stock traded frequently, you can generally place a value easily. If your investment is something more complicated like a business partnership, then there might be some wiggle room when coming up with a value for your net worth calculation.
Your house is an asset. Its anticipated sale value, even if you don’t plan on selling, should be included as an asset, while the value of your mortgage if you have one should be included as a liability. Your net worth includes all assets and all liabilities, so if you own a home, you must include your house and its mortgage.
Here’s more discussion about how to calculate your net worth.
How is net worth useful?
You might find that a true net worth calculation doesn’t provide you with useful information all of the time. For example, a true net worth calculation includes the value of everything you own. That includes your television, furniture, car, coin collection, and light bulbs. Since I use my net worth to track my financial progress over time, I’m not concerned about the value of most of the things I own. Including the liquidation value of my electronic equipment would skew my net worth slightly and in such a way that it would reduce the usefulness of my net worth.
I include the value of my car in my net worth, not because I plan on selling it but because it was once associated with a loan. The value of the loan is considered a liability, and it was important to me to reduce that liability as quickly as possible. By including the loan in my net worth, I could track my progress as I eliminated that debt and the effect of the remaining balance on my total financial picture. To include the automobile loan, it made sense for me to include the value of the car (which I check once in a while using the private sale price listed on edmunds.com). After paying off the loan, I left the car in my net worth calculation for the sake of continuity.
It’s this personal continuity that is important. As long as you maintain the same formula from month to month and year to year, it doesn’t matter what you include in your net worth calculation as long as it makes sense to you.
Net worth is an internal metric
Net worth is best used as a tool to compare your progress over time, particularly if you insure it is calculated the same way every month. While some aspects of your net worth you may view as beyond your control, like the performance of the stock market, there is enough information in the numbers to give you a good picture of the results of your everyday financial decisions. There is something interesting about the idea of being able to compare your net worth with those of other people, but there are a few reasons why it’s best to keep your net worth an internal metric.
A quick online search can provide broader statistics so you can compare your net worth with a large population of people in your income range or age range. These comparisons are meaningless, however. Age groups can include a variety of education levels, particularly at the lower end of the spectrum. At the other end, you may be grouping retirees in with CEOs. If you’re comparing your net worth with people with similar incomes, you don’t know whether this income is a full year’s salary, pension, or dividends from investments.
Different people are faced with different situations. If you’re 22, making $40,000 in your first year as a teacher, dealing with student loans, single, and living at home with your parents, what benefit is there in comparing your net worth with another 22-year-old, making $40,000 in his fourth year in a factory, married with one child, owning a home and dealing with a mortgage?
That’s why technologies like NetworthIQ are popular. You can compare yourself with people like yourself to get an idea of where you stand among your peers. NetworthIQ does a good job of encouraging people to calculate net worth in a similar manner and groups members among different dimensions to ensure meaningful comparisons. This gets you closer to being able to compare your net worth with others, but there is still no guarantee that people are providing true information.
As I was one of the first people to blog about my personal net worth and track my finances online in blog form, I think it’s great that tools like NetworthIQ exist now. I’m also slightly interested in blogger comparisons like this one from last year, but they have very little real value beyond voyeurism.
I prefer not to worry myself about other people and focus on my own progress. My goal is to keep my finances moving forward, which usually means showing an increase in net worth each month, and other people’s finances have absolutely no bearing on my progress. By publishing my financial reports each month, I keep myself accountable to the public, and this inspires me to make decent financial decisions. Depending on your psychological tendencies, comparing yourself with others could provide you with motivation to improve your financial condition or it could leave you frustrated with your own situation.
This motivation can be helpful, but don’t look for too much meaning in person-to-person or person-to-average comparisons.
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