If you want to know your financial value, forget about your credit score. Instead, the number you really want to know is your net worth. It boils all your money decisions down to one figure that represents your financial standing.
“People are worth a lot more than money,” says Hans Scheil, a certified financial planner and author of “The Complete Cardinal Guide to Planning for and Living in Retirement.” However, that doesn’t mean that net worth isn’t important. “When you apply for a loan or a mortgage, they are going to look at your net worth,” he says.
Fortunately, it’s easy to determine your net worth, and it’s also easy to raise it.
[See: How to Save $1 Million by Retirement.]
Finding your number. The formula for determining net worth is simple. Start by adding up the market value of all your assets. These include your home, cars and the balances in all banking, investment and retirement accounts as well as anything else you own of significant value. Then, subtract from that total amount all the debt you owe, such as credit card debt, mortgage balances and other outstanding loans. The remaining amount is your net worth.
Michael McCloskey, associate professor of risk management and insurance at Temple University, says people might be surprised by the number once they do the calculation. “There are a lot of people who have net worths of a million dollars,” he says.
Older homeowners may have a significant amount of equity in their houses, and even modest savers could have hundreds of thousands in a 401(k), particularly if they work for an employer that makes or matches contributions to the account.
Not all net worth in created equal. Finance experts say there is no universal guideline for how much net worth a family should hold. Instead, the right amount of net worth can depend on a person’s lifestyle and long-range goals. Families living more modestly may not need a net worth in the millions.
What’s more, people should be aware that, from a practical standpoint, not all net worth is the same. In particular, people should be aware of the limitations of holding all their net worth in real estate or other non-liquid assets.
“There are things that have a value that can’t be easily converted to cash,” says Lisa Piergallini, senior vice president and wealth advisor with Bryn Mawr Trust. “Although you can live in a house, it can’t provide food.” As a result, someone’s net worth, even if it’s substantial, may not help them during a financial emergency if it’s based largely on equity in property. Rather than keep one type of asset, families should make an effort to keep some of their value in liquid accounts, such as banking products and investments, where it can be accessed more quickly if needed.
[Read: 3 Ways to Calculate Your Retirement Number.]
Young adults need not worry about being negative. Although everyone should know their net worth, people should keep that number in perspective. “What you are worth is also a product of where you are in life,” McCloskey says. Older workers, who have decades of employment and income behind them, are obviously in a position to be worth more than their younger counterparts.
“Young people in today’s time are carrying a lot of student loan debt,” Scheil says. These individuals may find their net worth is actually negative. “I wouldn’t worry about that too much,” Scheil says. While earning a degree can temporarily create debt that lowers net worth, it should provide opportunities for more income and asset accumulation in the future.
However, net worth becomes increasingly more important as people age. “It becomes very relevant as you move toward retirement,” Scheil says. That’s because once someone retires, they must rely largely on their net worth to maintain their lifestyle.
[See: How to Max Out Your 401(k) in 2018.]
Increasing net worth is easy. For those with minimal net worth, the good news is it isn’t hard to improve the number. “Every time they make a house payment, they are increasing their net worth,” Scheil says. Mortgage payments increase the value of equity as they decrease debt. Other ways to quickly improve net worth include making additional debt payments or increasing contributions to savings or retirement accounts.
To make those extra payments, some people may have to increase their income or cut expenses. “I would recommend first looking at their spending,” Piergallini says. “A lot of times, [people] are shocked by how much has trickled away.” As a result, it may be easier to plug leaks in a budget to save more instead of finding a second or higher-paying job.
Your net worth provides a gauge for your overall financial health. While experts say you shouldn’t stress about hitting a particular number, they do advise checking it regularly to make sure your bottom line is moving in the right direction.
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What’s Your Number? The Ins and Outs of Net Worth originally appeared on usnews.com
