What is Net Worth?
An easy definition for net worth is that it is a simple calculation where you add up all the things you OWN which is also called an “Asset” and minus the total of everything you still OWE also known as a “Liability“.
Net Worth = Assets – Liabilities
How to Determine Net Worth
Items like your house value, current value of cars if sold today (remember cars depreciate over time meaning they will always be worth less in the future), any investments you have which could be TFSA’s, RRSP’s, stocks, bonds, work or private pensions or cash in the bank are all assets. Assets can be liquid cash or less liquid items such as bricks and mortar (house), less liquid items would have to be sold to generate cash.
What Is A Liability?
Then, add up all the things you still owe money on like your mortgage, car loan, line of credit etc. All these are called Liabilities which simply means, you are still liable for them. In other words they still need to be paid whether you have a job or not.
After working out what my Net Worth is, what’s it gonna do for me?
Calculating your net worth will give you a general idea of your financial well-being. If you OWE more than you OWN it’s showing you that you are in what’s called “Negative Equity.”
Generally negative equity is not desirable for the simple fact that if you had to sell everything tomorrow and live in a cardboard box, you’d still owe money to someone or other.
You’ve racked up $20,000 in debt and have decided to do a consolidation loan where the debt gets added to the mortgage. The original mortgage was for $190,000 and the house is worth $200,000. Now you’re in a state of negative equity on the house.
If you get into dire straits and sell the house to clear more debt you’ll still be $5,000 short; not to mention it will cost you 5% or $10,000 to sell it (real estate agent) and the lawyers costs. Now, selling the house still leaves you with at least $15,000 in debt. So what else do you want sell?
Tallying up a statement of net worth on a regular basis can also indicate if you’re spending more than you earn as your negative equity will increase. Think of your personal finances as a business; you don’t want to operate at a loss, you want to make a profit.
For the most part the majority of people’s net worth should increase over time due to paying down the mortgage and due to the increase in property value.
Our personal finances may be different if we had better cars, or maybe if we had a bigger house but that wasn’t our goal to have more than we could afford. Living below your means is one key strategy of budgeting and how we were able to save enough to become mortgage free in 2013. Understanding personal net worth is worth the time you spend investing in your future.
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