Does Net Worth Matter? Understanding Its Impact on Your Finances
- Factors such as income, debts, savings and investments, real estate, and budgeting play a role in net worth.
- A higher net worth usually means a higher financial strength and a lower net worth typically implies higher financial weakness.
- Your net worth indicates your financial wellbeing, but it doesn’t always reveal how successful you are.
- Net worth fluctuates. If your net worth isn’t what you want, you can take steps to improve it and turn your financial situation around.
Your bank account balance is just one part of your financial health. Net worth is a better indicator of where you stand financially. Whether you’re a young professional, nearing retirement, or anywhere in between, understanding it can help you meet your short and long-term financial goals.
Net worth explains how much money or assets you have once you subtract your debts. A variety of factors, like your income, debts, savings and investments, real estate, and budgeting all play a role in your net worth. Below, we’ll dive deep into what net worth is, how to calculate it, and what you can do to improve it over time.
What Is Net Worth?
Net worth is essentially a snapshot of your financial health. It indicates the value of your assets (everything you own) minus your liabilities (everything you owe). “By tracking your net worth over time, you can assess progress toward your financial goals and make adjustments as needed,” said Robert Johnson, finance professor at Creighton University’s Heider College of Business.
If your net worth is increasing over time, you’re doing a good job at repaying your debts and contributing to your savings. On the flipside, if your net worth is decreasing, it might be time to reduce your spending, boost your income, and pay off debt.
Ideally, your net worth will improve as you get older and have had the chance to grow your income and investments and minimize your liabilities. Of course, job loss, challenging economic conditions, high-interest debt, and other scenarios can interfere with your ability to increase your net worth.
What are assets?
Assets refer to what you own. Here are several examples of common assets that you’ll include when you calculate your net worth:
- Savings: Cash and money in checking and savings accounts, including high-yield savings accounts and money market accounts, are part of your net worth.
- Investments: A variety of investment vehicles, such as 401(k)s, IRAs, CDs, 529 accounts, annuities, and savings bonds, will influence your net worth.
- Real estate: If you own your home or other types of properties like vacation homes or rentals, you may include them in your net worth calculation.
- Personal property: Valuables, such as your car, motorcycle, or boat, jewelry, fine art, furniture, and gold coins, can also impact your net worth.
What are liabilities?
Anything you owe to another individual or lender counts as a liability. Common liabilities include:
- Personal loans and credit cards: While personal loans and credit cards can help you cover unexpected and planned expenses, these products lower your net worth until you repay them.
- Mortgages: While your actual home or property may be viewed as an asset, your mortgage balance is considered a liability.
- Car loans: If you financed your vehicle(s), auto loans are part of your liabilities.
- Student loans: Both private and federal student loans are debts that may raise your earning potential but also increase your liabilities.
- Home equity loans: If you tap into your home equity through a home equity loan or home equity line of credit (HELOC), it’s essential to include the debt toward your liabilities until you repay it.
- Bills: Outstanding or recurring bills, like rent payments (if you’re not a homeowner), medical bills, and utility bills, can all play a role in your net worth.
Remember:
A positive net worth means your assets exceed your debts. A negative net worth means you owe more than you own.
How to Calculate Your Net Worth
It’s a good idea to calculate your net worth on a regular basis, ideally every quarter or every six months. This way, you’ll always have an idea of where you stand financially and understand what you need to do to meet your financial goals.
Steps to finding your net worth
Fortunately, it’s easy to calculate your net worth using this net worth formula:
Assets – Liabilities = Net Worth
Follow these four steps:
- List your assets
First, jot down all of your assets, including but not limited to your checking and saving accounts, investments, real estate, collectibles, and other valuables you own.
- Find the value of your assets
Then, assign a value to each asset. While this is straightforward for cash in your bank accounts, statements, appraisals, and online tools can help you understand the value of other assets, such as your retirement accounts and properties.
- Add up your liabilities
Now, it’s time to list your liabilities, such as credit card and loan balances, auto loans, mortgages, and other debts you owe.
- Subtract your liabilities from your assets
Lastly, take the value of your liabilities and deduct them from the value of your assets. The figure you come up with is your net worth.
Let’s say you have $500,000 in assets and $200,000 in liabilities. In this example, your net worth is $300,000 ($500,000-$200,000).
Does Net Worth Matter?
The million dollar question is, “Does net worth matter?” The truth is yes, as your net worth is more than an arbitrary number. According to Johnson, it describes your current financial health or weakness. “A higher net worth implies higher financial strength and a lower net worth implies higher financial weakness,” he said.
Why it matters
Here are several reasons your net worth is important:
Provides a snapshot of your financial position.
Identifying your net worth forces you to take a close look at your finances. It clearly defines your assets and liabilities, making it easier to pinpoint what you’re doing well and what you need to improve. Once you know your net worth, you’ll no longer have to play a guessing game. You’ll be able to make confident financial decisions.
Helps track financial progress over time.
While your net worth indicates your current financial picture, it also allows you to keep tabs on how your finances fluctuate over time, especially if you get a large raise or up your savings game, for example. It can be exciting to watch your net worth increase. On the other hand, it’s helpful to know when it goes down so you make the adjustments that get you back on track.
Guides goal-setting for saving, investing, and retirement.
Chances are you have a variety of short and long-term financial goals. Whether you want to buy a home, build an emergency fund, pay off debt, pay for your child’s college, retire, or anything else, your net worth is important. You can use it to gauge your success and make changes as needed.
Encourages better budgeting and debt repayment.
Understanding your net worth can give you an idea on how your spending habits and debts affect your overall finances. If your assets outweigh your liabilities, you’re likely in good shape. However, if your liabilities exceed your assets, you may need to evaluate your budget and design a debt repayment plan.
When it doesn’t tell the full story
When it comes to personal financial health, your net worth is only one piece of the puzzle as it doesn’t reflect your monthly income or expenses. Also, it may appear negative during certain stages of your life, such as when you’re paying off your student loan or starting to repay your mortgage balance. In addition, it doesn’t account for market fluctuations or changes in the economy, which are out of your control.
According to Johnson, you should consider your earning potential in addition to your net worth. “For instance, someone just graduating from medical school may have low (or even negative) net worth, yet can have very strong future earnings prospects and can actually be in a solid financial position overall,” he explained.
Johnson also emphasised that not all assets are created equal, meaning each asset can affect your net worth in different ways. “For instance, if one has $1 million in Treasury bills that is much more certain than someone who has collectibles with an appraised value of $1 million. Financial analysts refer to this as liquidity and assets that are more easily turned into cash are preferred,” he said.
At the end of the day, you need to look at all pieces of the puzzle: your net worth, income, expenses, asset types, economic conditions, and more. By doing so, you can get a more accurate idea of your financial stability.
Net Worth by the Numbers
While a positive net worth is ideal, there is no set figure for what your net worth should be. Your situation, goals, and preferences are unique. However, it might be beneficial to compare your net worth to others in a similar place.
Net worth over the years
As you can see from the chart below, the median net worth of all American households was an estimated $192,700 in 2022, according to the Federal Reserve. This is a 37% increase from 2019 when the average net worth was $141,140.
In general, household net worth has gone up over the years. Shockingly, however, net worth dipped by almost 40% from 2007 to 2010, likely due to the collapse of the housing market and high unemployment rates.
Here’s a closer look at how net worth has changed from 1989 to 2022:
U.S. Median Net Worth by Year
Net worth according to age
Data from the Federal Reserve Survey of Consumer Finances proves that net worth tends to rise with age. This is no surprise, as a 65-year-old has had more time to excel in their career and grow their investments than a 35-year-old.
This chart highlights the average net worth by age:
Important:
Median net worth gives a better sense of what’s typical. Averages can be skewed by very wealthy individuals.
How to Improve Your Net Worth
Fortunately, you have a lot of control over your net worth. There are a number of ways to increase this figure, such as:
Grow your assets
To boost your assets, ramp up your savings and investments. If you’re only adding money to your savings account when you feel like it, for example, enroll in automatic paycheck deductions. This way, you can automate your savings and ensure you allocate a portion of each paycheck towards your savings.
If you only contribute 3% of your income to your 401(k), try to increase your contributions to 5% or 10%. Also, be mindful of the types of assets you invest in. Real estate is an appreciating asset and often a good move, while cars are depreciating assets that may set you back.
Reduce your liabilities
High-interest debt, such as credit card debt and payday loans, can seriously damage your net worth. That’s why it’s a good idea to pay it down first through a debt repayment strategy such as the debt snowball, debt avalanche, or debt consolidation. If possible, avoid taking on new loans and refinance your mortgage, student loans, or other debts to potentially save on interest and lower your monthly payments.
Build smart habits
If you don’t have a budget, it’s well worth your time to create one using a method like the pay-yourself-first budget, zero-based budget, and 50/30/20 budget. Do your best to stick to your budget and whenever possible, live below your means. Depending on your situation, looking for alternative income sources through side gigs, selling unwanted items, or weekend jobs may also make sense.
Common Misconceptions About Net Worth
These days, there are many misconceptions about net worth, such as:
“I make six figures, so my net worth must be high.”
A six-figure income is nice but doesn’t guarantee a high net worth. Just because someone earns six figures doesn’t mean they’re responsible with money. In fact, it’s not uncommon for high earners to overspend due to the desire for a certain lifestyle. You may earn $80,000 and have a higher net worth than someone of your age who earns $250,000 because you’ve made it a priority to grow your assets and reduce liabilities.
“Net worth equals success.”
Your net worth indicates your financial wellbeing, but it doesn’t always reveal how successful you are. The reality is that living a life you love is often more important than your net worth. Consider this: There are countless individuals with a high net worth who aren’t necessarily happy or fulfilled with their careers or lifestyles. Success is subjective and your net worth doesn’t necessarily define it.
“If my net worth is low now, it always will be.“
You’ll find that your net worth fluctuates over time. When you’re younger and just getting started in your career, it will likely be lower than when you’re a bit older and have a few decades of work experience under your belt. If your net worth isn’t where you want it to be, you can always take steps to improve it and turn your financial situation around.
Knowing Your Net Worth Is Just One Smart Money Move
Your net worth is not just a figure. It reflects your overall financial health. If you calculate it, track it over time, and work to increase it, you can set yourself up for a stable financial future. No matter your age or stage of life, your net worth may give you the clarity you need to meet (or exceed) your goals and lead the life you desire.
