This may sound like a simple question but I find that a lot of people struggle to understand what is net worth. It’s not their fault. I went through years of education so I could learn how to make money for everyone but myself. In my Commerce degree I was taught all sorts of finance jargon but no one explained to me what is net worth and why it is so important to my future well being?
The biggest recommendation I can give my readers is to never stop learning and self educate on matters of personal finance. Ultimately, no one has your best interest in mind but you. Lets look at what is net worth.
Net Worth Definition
Net worth is nothing but:
- your personal balance sheet
- statement of position outlining your assets and liabilities
- somewhere you can see everything you own and everything you owe
- summary of your financial situation
- a reality check
- your scoresheet
Don’t be fooled by the simplicity of its concept. It is one of the most powerful tools in your financial journey and my favorite one. Understanding what is net worth will go a long way in your financial journey.
Why Is It So Important To Track Your Net Worth
1. Provides a reality check – When my wife started to fix our finances, the first thing she did was to prepare our net worth statement. It literally opened my eyes. I was having a relatively successful career and had a false sense of security that I was on track to a wealthy retirement. Well, that fantasy quickly evaporated when my net worth statement showed a net liability position of around $50-60K. Once we knew what we were worth, it was much easier to accept that we needed to make changes if we wanted to reach our goals. Without a net worth statement there is no way of knowing how you are tracking in your financial journey.
2. Sets a starting position – What is the first thing you do when you get lost on the road, in the shopping mall or anywhere else ? You try to figure out your current location. Without that its impossible to work out the route to your destination. Its the same with net worth. Once I found out that all I had in my balance sheet was debt, it was easy to figure out that a plan was needed to repay my debt and start acquiring assets.
3. Helps in re-setting priorities, goals and strategise – Do you know how much debt you have across all products, or which is the most expensive debt ? Which one should you pay first ? How about your assets – are they income generating or growth assets ? A net worth statement provides answers to these questions and helps you in setting priorities such as which loan to pay off first or how to restructure assets to suit your financial goals. I am currently investing for growth and am comfortable with having less passive income over the near term so I can grow my asset base. Without a constant review of my net worth I will not be able to stay within my preferred portfolio allocation.
4. Track Performance – If you are into the sport of money (my favorite sport), then net worth is how you keep score. I update my statement religiously every month and I have been doing it for the last 7 years. Without a net worth position you would have no way to measure your progress.
5. It makes you feel accomplished – This is my favorite one. Nothing beats the sense of accomplishment I get when I look back at my net worth statements over the years. Some periods have been great and some not so – but its wonderful to see how far I have come. It fills you with self confidence when you see what you can achieve with a little determination, and it positively impacts on other areas of your life too.
How To Prepare A Net Worth Statement
A simple example of a net worth statement is provided below. You can keep it as straight forward or as elaborate you want. The most important thing is that it should provide you a summary of all your financial assets and liabilities. I made this sample sheet in Microsoft Excel.
Make sure to use only financial assets in your statement. Don’t use things like clothing, furniture etc. as they are considered lifestyle assets. They will not provide you with income in the future. You might be able to sell them on eBay for a few dollars but that’s about it.
Some people like to include their Motor Vehicle in their asset column. I personally don’t do it. Cars are depreciating assets and unless you are using them in your own business to generate revenue, I would not use them in the net worth statement. Even if you decide to use them, its not the end of the world. The important thing is to be consistent in what you are including from one period to another.
The first step in my financial transformation was understanding and figuring out what is net worth. It all started with that simple spreadsheet my wife drew up some 7-8 years ago. It provided us with a starting position from which we were able to map out our future direction. I hope this article provides you with some of the basics and importance of tracking your own net worth. So if you haven’t been tracking your net worth – Start Now! It will make all the difference.
What do you include in your net worth statement ? Tell us by leaving a comment below.