So you’re on the journey to get your financial house in order. You first need to know where you’re starting. You do this by measuring your net worth. Net worth is calculated by adding up your assets and then subtracting your liabilities. A very, very simple example: You have a savings account balance of $10,000 and have a credit card balance of $2,000. Your net worth would be $8,000 ($10,000 in assets minus $2,000 in liabilities). It’s certainly possible to have a negative net worth (think of the recent college graduate with student loan debt but no assets to their name), too.
As you can see, one way to increase your net worth is to increase the value of your assets. Another way to increase your net worth is to decrease the value of your liabilities. Often, though, and especially in the world of personal finance loud mouths, an extreme emphasis is placed on either increasing assets or decreasing liabilities, as if both can’t be accomplished simultaneously. Both can be accomplished together and you’ll find positive movement in your net worth by focusing on both initially in your journey to a healthier financial state.
Here is a screen clip of an Excel spreadsheet I use to track my net worth:
You can download the spreadsheet here. As you enter assets and liabilities, the spreadsheet automatically adds up both categories and automatically updates the resulting net worth value. I update my spreadsheet monthly in order to keep tabs on my financial health and, more importantly, to see if something is out of whack and needs to be addressed. Frequently updating your net worth will provide you with encouragement when you’re taking the right steps and seeing net worth grow, but it will also alert you if you’re slipping into bad habits. It’s better to catch a bad habit a month or two in rather than realizing years later that the bad habit has caused you major financial damage.
Here are some challenges I’ve encountered while tracking net worth:
Challenge 1: Accurately valuing certain assets and liabilities. The value of a given asset or liability may not be black and white. For example, when including a home’s value in net worth calculations, you should use the going market price for your home and avoid using values that may inaccurately inflate or undershoot the actual value. This means that your home’s taxable appraised value may or may not be near the home’s market price (i.e., what you’d get if you sold the home).
Challenge 2: If you have an asset that you’re financing, like a home or a car, make sure to include both the asset and the accompanying loan on your net worth statement. Again, make sure you’re valuing the asset accurately (hint: Kelley Blue Book is a great way to value cars).
Challenge 3: Even though you’re enthusiastic about a collection you have (American Girl dolls, stamps, coins, etc.), they may not be nearly as liquid (i.e., easy to sell) as you think, and they may not be worth nearly as much as you envision. I don’t include collectibles or jewelry in my net worth statement because I don’t see them as liquid assets. This is an arguable point, though. If you choose to include collectibles or hard-to-value items on your net worth statement, try to be accurate with their valuation.
Challenge 4: You’ll encounter ups and downs in your net worth if a sizeable portion of your asses are in volatile categories, like stocks. You’ll notice the ups and downs even more if you track your net worth monthly. This is OK, as stocks (I’m thinking index funds when I say “stocks”) appreciate over long (10+ years) periods of time. Just make sure that if you’re net worth is declining in value that you’re not contributing to this with reckless spending, overloading credit cards, or buying that Corvette you probably can’t afford right now.
Now that you know your net worth, you have a baseline from which to measure progress or regression. If your net worth increases, this shows financial progress. If your net worth decreases, this shows regression, and you should be especially aware of what’s causing the decline. Your goal should be to increase your net worth over time.
Personal Finance Foundation – Part 2 – Coming Soon!