If you’re a working adult, you probably have a good idea of your regular income as well as the household bills you need to pay each month. Managing that flow of cash in and out of your bank account is one of the first steps on the path toward saving and investing.
But many people have a difficult time understanding another basic financial concept, called net worth, that is also important for your long-term planning. Knowing your net worth can help you make good decisions about making a major purchase like a home, a vehicle or a college education. It can also give you a much better idea of when you could be able to retire, and how to structure your financial estate later in life.
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Calculating your net worth is basically a three-step process. First, you add up all your personal assets, starting with the balances on your checking, savings and investing accounts. For example, you might have $1,000 in your checking/debit account, $4,000 in a savings or money market account and $25,000 in mutual funds, stocks, bonds or other assets.
Then, you look at your other financial assets, such as your 401(k) retirement plan, IRA, SEP-IRA or other tax-deferred account. If you have paid premiums on a universal or whole life insurance policy, you may have built up a cash value in that policy that could be tapped if necessary. Let’s say, you have another $25,000 in your retirement plan and a $5,000 value in your life policy.
In addition to these financial assets, you may own a home, a car or truck, a boat or recreational vehicle. These personal assets typically have a market value that can increase over time, such as a home, or decrease with use, such as a car or boat. However, it’s relatively easy to determine their current value with a little online research. For instance, your home might be worth $300,000 if you sold it today, while your car might have a value of $10,000.
You also need to review your other personal assets, such as jewelry, furniture, artwork, computers and other valuables and estimate their current value. To keep things simple, let’s assume these assets are worth $10,000.
Now, you have enough information to determine the approximate value of all your financial and personal assets. In this example, the total would be $370,000.
However, your assets are only half the story when it comes to calculating net worth. You also need to consider all your debts and loans, such as a mortgage, automobile loan or lease, student education loans and credit card balances.
Let’s say you still have a $255,000 balance on your home mortgage and a $5,000 balance on your car loan. You also have about $5,000 in credit card debt. Finally, you have a $5,000 property tax payment on your home that needs to be paid in the next three months.
Adding up all those financial obligations gives you a total debt of $264,000.
Finally, you’re ready to calculate your net worth, by subtracting your total debt from your total assets. In this example, you would take $370,000 in assets minus $270,000 in debt for a net worth of $100,000.
It’s a good idea to go through these calculations every year or whenever there’s been a significant change in your financial life, such as paying off a mortgage, leasing a new vehicle or investing in a home renovation project.
If your net worth shows an increase from year to year, you are on a positive financial path that could lead to a comfortable retirement. But if your net worth is declining, you should consult with a financial advisor and discuss what steps you can take to reverse that trend.
In either case, understanding your net worth can help you make better plans for your future.
Andrew Menachem, CIMA, is a wealth adviser at The Menachem Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS. Morgan Stanley Smith Barney LLC. member SIPC.