How (And Why) to Calculate Your Net Worth
Dear New Frugal You,
How do I figure out my net worth? I have four different 401(k)s -- that's easy enough, I get statements, and I know the stocks within the 401(k) fluctuate in value. But what about my house I've lived in for 15 years, my car I've driven for three, the contents of the house, etc
-Eric
Dear Eric,
Good question. And one that more people should be asking. So let's see if we can't answer your question and help others to see why they should be asking it, too!
We'll begin by defining our terms. "Net worth" is used in the accounting and financial world. Its purpose is to determine how much a person or company is worth when all the assets and liabilities are taken into account. For our purposes here, we'll focus on the personal side.
For instance, if you wanted to know John Doe's net worth, you'd first have to decide how much all the stuff he owned was worth, in dollars, putting a price tag on everything. Those are his assets.
Then you'd total all the money he owed. Mortgages, lines of credit, auto/student/personal loans and credit card debt. Those are his liabilities.
Finally you'd subtract what John owed from what he owned. The answer is John's net worth.
One other thing before we get to your question, Eric. Why would anyone want to know what their net worth is? Most of us are happy if we can pay our bills and have a little left over at the end of the month. How would knowing my net worth be useful?
There are a couple of different reasons why you might want to know. It could be that you're applying for a loan and need to provide details about your financial life. Often that's the only time that people will calculate their net worth.
But, as a personal finance tool, net worth is very helpful. It's a great measure of financial health. By comparing your net worth on an annual basis you can get a really good feel for your financial well-being. If your net worth is rising each year, you're probably in good financial health. If you're net worth is shrinking, you'll want to take a closer look at your finances to see what's wrong.
You can also use your net worth to help you reach your long-term goals. For instance, suppose you used a retirement calculator to determine that you needed a net worth at retirement of say $750,000 and you're 30 years away from retirement. By recalculating your goal and your net worth each year, you can make sure that you won't get to age 65 and realize that you won't have enough to live on.
OK, now that you're convinced of the need to periodically calculate net worth, let's finally answer your question: How do you decide what things are worth?
Begin by knowing why you're calculating net worth. That will help you decide how much care to take in calculating it.
For instance, if you're applying for a mortgage you'll want to have your home appraised to get a good idea of what it's worth. On the other hand, if you're just measuring how well you're doing against your retirement savings goal, a simple guesstimate based on other recent home sales in your neighborhood would be sufficient.
As you point out, Eric, your financial accounts are fairly easy. Retirement, savings and investment accounts all give you an ending balance.
For your car, you can visit Kelley Blue Book. They've been providing auto values for decades. Just plug in some information about make, model, year and mileage and they'll give you a number.
Your possessions are a little more complicated. If you want to do a thorough job, check out the Casualty, Disaster, and Theft Loss Workbook that the IRS has assembled. Don't be discouraged. It's not as intimidating as it looks, and at the end of the process, you'll have an organized dossier showing the prices of your possessions. A simpler, although less-accurate method, would be going from room to room and tallying how much you think everything is worth.
Liabilities shouldn't be too difficult to determine. Mortgages, auto loans and credit card accounts should either send you a statement with your balance or have a balance available if you give them a call or check your account online.
Don't get overly hung up about the valuation method. Yes, you want to be accurate if you're asking someone to loan you money, but if it's for your own use, being consistent in your method is probably more important. Since you're mostly interested in the comparison from year to year, if the error is the same in both years, it cancels out.
The big advantage to tracking your net worth is that it forces you to face your financial reality. If you're not saving enough for retirement -- or you're going backward -- you'll know. And then you have the choice whether you're willing to make necessary changes.