Why is Understanding Net Worth Important?

Calculating Personal Net Liabilities Can Serve Many Functions

Nov 3, 2009 Natalia Jones

The net worth figure is the key to several personal finance issues. Figure it out and the rest will fall into place.

Net worth is simply an estimate of the value of an individual’s portfolio of assets after taking into consideration all that is owed. Simply put, it tells an individual what they are worth.

Why is it Important to Calculate Net Worth?

Every individual should have an idea of their net worth. This figure is arguably one of the most important in any financial plan because;

It gives an idea of the current financial forecast so it is easier to estimate future needs. If net worth is calculated it is a simple process to figure out the balance needed for upcoming goals.
It takes the guesswork out of protecting assets. The calculation of net worth involves listing assets against liabilities. This makes it easy to come up with a figure for insurance purposes.
It compiles a list of all outstanding debt obligations in one place. This can be an eye-opening experience and often leads to intense motivation to bring debt balances down. Realizing a goal of reducing debt is made easier by drawing up a table of net worth.
It provides an easy measure of personal financial health. Generally speaking, if total assets surpass debt obligations things are looking good.

How is Net Worth Calculated?

Net worth is actually basic math. It is found by subtracting all debt or liabilities from all assets both fixed and current. The resulting figure can be either positive, if assets are greater than liabilities, or negative, if the opposite is true. Read How is Net Worth Calculated for a more detailed analysis.

Is There an Ideal Net Worth?

There is no one-size-fits-all solution for individual net worth. It may be interesting to compare one individual’s net worth to that of another of the same age, but this comparison might reveal vastly different figures because of different lifestyle choices.

The Millionaire Next Door authors, Stanley and Danko, submit the following formula as an attempt to average net worth figures for individuals according to age:

Net Worth = Age * Pretax Income ÷ 10

This is not a perfect measure though because it gives inflated values for younger individuals, while simultaneously producing somewhat low figures for older people who are more likely to have accumulated wealth. It should not be completely discredited though, because it does provide a ballpark figure that can be used as a yardstick.

Building Net Worth

Even if you are not close to the peer average in the net worth category there is no need to throw in the towel. There are some simple steps any individual can take to help accelerate the growth of their net worth. Check them out here.

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Calculating Net Worth is Important