- Date : 04/08/2021
- Read: 5 mins
Understanding your net worth gives a comprehensive picture of your financial situation and helps you plan better for different short- and long-term goals.
Tracking your net worth over a period of time is a great way to understand your financial health and see the progress you have made with money management. Read on to find out how you can calculate this.
What is net worth?
Personal net worth is an inventory of all your assets and liabilities. If you add up the value of everything you own and subtract everything you owe, it will give you an indication of a net positive or negative net worth.
A positive net worth is something that you build over time with inheritance, prudent savings, and investments. However, it is common for young professionals with student loans, entrepreneurs, or people who have just taken up a big mortgage to have a negative net worth. As you pay off these loans or recover costs, your net worth should gradually move out of the red.
How to calculate your net worth?
The first time you undertake the exercise, it will probably take a long time as you would need to collate information on every major financial investment and its current market value. You would also have to determine if you want to calculate just your personal net worth or that of your family. So, create a spreadsheet and log all the entries under key heads.
The first step is categorise all your assets (A):
- Liquid assets: Includes cash in hand and cash equivalents including savings account balance, certificate of deposit, money market investments, treasury bills, etc.
- Investments: Market value of asset classes such as bonds, annuities, mutual funds, stocks, corpus in retirement accounts, cash value of life insurance, other alternative assets.
- Tangible assets: All types of real estate including land, house, shops, commercial premises, vacation homes, etc. Other physical assets like gold and precious jewellery, art and antiques, collectibles, cars, home technology, furniture and fittings.
Intangible assets: Intangible assets include value of any copyrights, patent, trademark or brand, goodwill and/or intellectual property.
Next, you need to classify all outstanding loans and liabilities (L):
- Secured debt: This refers to debt that is backed by collateral or a guarantor; e.g. outstanding mortgage, auto loan, business loans, student loan, etc.
- Unsecured debt: This category includes personal loans, credit card dues, unpaid taxes and other liabilities. It is important you learn to become debt-free quickly to increase your net worth.
The sum of all secured and unsecured debt represents your total outstanding liability. Subtract the value of all your liabilities from the value of your assets to get your net worth.
Your total Net Worth = All assets (A) – All liabilities (L)
Factors to keep in mind
Some entries – such as a house or car – can be both an asset and a liability if you have availed of a loan. In such a scenario, the market value of the house or the depreciated value of the car will go in the asset category and the outstanding mortgage or loan will go in the secured liability section. This will help you track the value of the asset as well as what you owe on it.
When valuing certain assets that may be subject to volatility or perceived pricing, it is recommended to take a conservative approach. For example, getting art and antiques valued is challenging unless you get a professional assessor to do so. Even then, you should probably estimate them at about 70% of the assessment value, considering its saleable worth remains unpredictable.
Why is knowing your net worth important?
- Understanding what is your net worth gives a comprehensive picture of your financial situation.
- It ensures all your financial data is readily available in one place.
- It aids in better planning for different short- and long-term goals.
- Reviewing your net worth statement on an annual basis sets a financial benchmark and allows you to assess your progress.
- It could help present a stronger case when looking for a major loan or an international visa.
- It helps prioritise repayment of high-cost debt or evaluate refinance options.
- It acts as encouragement to save and invest more.
What should be your ideal net worth?
Every person has a different earning potential, different set of expenses and lifestyle; hence, there is no magic number that dictates what the benchmark should be. However, authors of the book ‘The Millionaire Next Door’ Thomas Stanley and William Danko, have come up with a formula that helps set the expectation of savings and investment basis your age and income.
Net Worth = (Age x Pre-tax income) / 10
For example, if you are a 30-year-old professional with a CTC of Rs 12,00,000, then the total value of all your savings and assets should be 30 x 12,00,000 / 10 = Rs 36,00,000
The net-worth estimates may not work for those who are very young (limited earning potential) and those who are very old (lack of steady income). However, it can provide a benchmark for those in the age bracket of 25 to 55 years.