Have you ever read a headline that says something like, “Celebrity X has a net worth of $1.5 million”? When I was a kid, I used to hear things like this and think, wow, they have $1.5 million in cash in a safe somewhere. When I got to be an adult, I realized how silly that was and thought they obviously had the $1.5 million in cash in a bank. For the record, neither of those is true. Net worth is actually the total value of all of your assets minus the sum of all of your debts. Assets can be things like cash, property, stocks, bonds, retirement accounts, jewelry, cars, etc. Debts are any money you owe. This would include your mortgage, car loans, credit card balances, student loans, home equity loans, personal loans, that $25 you owe your cousin, etc. The difference between the sum value of what you have and the sum of what you owe is your net worth.
Net Worth = Total Assets – Total Debts
Net worth is probably the most important metric in personal finance. It’s way more important than how much you make. When I talk about improving your financial health, I’m really talking about increasing your net worth. Your net worth is so important because the higher your net worth, the more likely it is that you can stop doing things in life because you have to and start doing things in life because you want to. If you have a lot and don’t owe a lot, you give yourself more choice in life. That choice could be as simple as splurging on a nice meal, it could be taking a dream vacation, it could be donating to a cause you believe in, or it could be as big as quitting your job to pursue doing something you love because you don’t have to do something simply for the money anymore.
In the celebrity X example above, no celebrity X doesn’t have $1.5 million sitting in cash somewhere. More likely, they have homes, cars, investments, and other property that adds up to some value greater than $1.5. million. Then on the flip side, they very likely owe money on mortgage(s), car loans, etc. When those debts are subtracted from the value of their assets, they are left with a total of $1.5 million. In other words, if they liquidated (or sold) everything they had and used that money to pay off everything they owed, they would then actually have $1.5 million in cash. But that wouldn’t really be practical to sell everything because then they’d be homeless with a bunch of cash. Not really ideal.
Don’t be fooled, though. High income is not necessarily equal to high net worth. There are plenty of people with 6, 7, even 8 figure incomes that rack up just as much debt as (or more than) what they’re bringing in so their net worth is close to zero…or worse. This means that even though they are making a whole lot of money, in order to maintain that lifestyle, they can’t stop working, not even for a little bit. They are chained to a paycheck. Conversely, lower incomes do not have to mean low net worth. If you can lower your expenses and save more, you increase your net worth. Then, if you can earn more on top of that, you’re accelerating that net worth growth even faster.
Do you know your net worth? If not, let’s take some time to figure this out because this will help you create a baseline for reaching your financial goals. You can’t measure how you’re doing if you don’t know where you started. Heads up, this exercise will probably take 2-3 hours, but it’s critical and will be something you’ll use for the remainder of your financial journey. You can calculate your net worth by hand using paper or a spreadsheet, but that’s a relatively painful process and it only gives you a static picture, meaning it will only show you your net worth once. If you want to check it again in 6 months, you’d have to do it all over again. So, to make the process easier and dynamic so that my net worth is automatically tracked for me, I use Mint. Mint is a free online tool that allows you to connect your different banking, investment, credit card and loan accounts. It keeps the accounts synched up so you have one place you can go to see all of your assets and all of your debts. The best part about Mint is that it takes the information from your accounts and calculates your net worth for you. Here are the steps you should take:
