Mon 25 Jun, 2018
How to Calculate Your Net Worth
Do you know what your net worth is? It’s an interesting question, and one that many Australians couldn’t accurately answer. Knowing and understanding your net worth, and why it’s important, is a great way to stay on top of your finances. Taking control of your own financial position is the only way to truly know whether you’re in the red or the black – and here’s how you do just that.
What is a Net Worth?
Your net worth is essentially your overall financial position, taking into account your assets and your liabilities – sort of like your ‘net profit’ if your life were a business balance sheet.
Why is it Important?
It’s important to understand your net worth in order to grow it. Knowing where you and your money stand also prevents you from making financial mistakes – you shouldn’t rely on banks and brokers to explain your financial situation for you. Lenders may offer your credit on a plate, leading you to assume you can afford it. Unfortunately, this is a common downfall. People can take out huge personal loans, car loans and even home loans on the assumption that their approval means they’re financially sound. In reality, they could be playing with fire.
How Do I Calculate My Net Worth?
Calculating your net worth involves careful attention to detail. Grab a pen and make the following lists:
- Current assets are assets that can be readily exchanged for cash, without losing their value. This includes shares, term deposits, cash in savings/everyday accounts and any money that is due to you within the coming 12 months. That might be a settled tax refund or a loan to a family member that will be paid back soon.
- Non-current assets are assets that are not easily exchanged for cash without losing value. This includes property, including the one you live in, collectables, furniture, and sometimes cars and tech. Be careful here, as while you might be able to quickly sell online, it might lose value in the process. Think about how quickly you can obtain the true value of an item.
- Income-producing assets are assets that generate income without being sold. For example, rental income from investment properties, share dividends and interest on other assets. Count these at the current market value.
- Current liabilities are liabilities that are due within the next 12 months. That could be credit card repayments, tax bills, household bills or the settlement of short-term loans.
- Non-current liabilities are those due in more than 12 months. That could include your home loan, HECS debt and other longer-term repayments.
While the division of current and non-current assets and liabilities is not entirely necessary to work out your base net worth, it’s a valuable tool in understanding your liquidity.
Nuts of wisdom: liquidity refers to how much cash you have available in the short term. For example having $100,000 equity in a property is an illiquid asset, as obtaining that equity would mean putting the property on the market and executing the legal procedures associated with selling real estate. $100,000 in savings in the bank, however, is a liquid asset, as you can access it at any time.
The Difference Between the Two
Your net worth is your total assets less your total liabilities. As we said, current and non-current isn’t entirely important when calculating your base net worth, but it’s useful to know.
Let’s take a look at a basic example:
Emma is 31. She graduated from university 9 years ago, and has $18,600 worth of HECS debt remaining. She owns a property with her partner that is worth $400,000, and a home loan with a remaining balance of $322,853. She has $12,100 in a savings account, $2,000 in a term deposit and $952 in her everyday transaction account.
She has a car worth around $6,500, a new computer worth $2,000, an engagement ring worth $1500 and a small amount of furniture of low resale value.
Let’s look at her personal balance sheet:
|Current Assets||Non-Current Assets||Income-Producing Assets|
|Property Market Value||$400,000|
|Annual Interest from Savings||$421|
Total Assets: $467,873
|Current Liabilities||Non-Current Liabilities|
|Tax Bill Due in October||$400|
|Credit Card Balance||$2,134|
Total Liabilities: $343,807
Total assets less total liabilities = $124,066
Emma’s net worth: $124,066
How to Increase Your Net Worth
Increasing your net worth is all about reducing your liabilities and increasing your assets. If you’re paying down a home loan, you’re gradually chipping away at your net worth. Your loan balance is going down, and your equity in the property is going up.
Smart investing can also help you increase your net worth. For example, investing in a property that increases in value can make a big difference to your net worth before you even make any repayments. Of course, there are no guarantees with this style of investment.
Set short term goals and create budgets accordingly. You might set a goal to pay off your credit card within the next 12 months. Doing so would reduce your current liabilities and therefore boost your net worth. Instead, you could look to move some of your current assets into non-current assets by purchasing shares or property. While this decreases your liquidity, you may obtain better returns and increase your net worth faster.
Nuts of wisdom: you’re more likely to achieve your savings or budgeting goals if you put a deadline on them. For example, saving $5,000 is a goal, but by saying ‘I will save $5,000 by December 2018’ gives you more incentive to get there. When you do, set a new goal.
When Not to Focus on Net Worth
Your net worth is certainly important and worth understanding, but it isn’t an entirely clear picture of your financial position. For example, a large home loan may paint a picture of a low net worth, when in reality a home to live in is an essential part of your life, and shouldn’t be sacrificed just for the sake of net worth.
Thinking of increasing your net worth by saving for retirement? Speak to our experts today to see if a self managed super fund is right for you!