This tutorial covers the definition of net worth and how to track it. Net worth can be a helpful metric to track your progress towards achieving financial freedom.

What is Net Worth?

You calculate net worth as all the valuables you have minus all debts. The valuables are also called assets. Here is list of examples for assets:

• cash
• real estate
• bonds
• stocks
• house
• private investments

To be an asset, an item must have some current or future economic value. If it does not, it cannot be an asset. For instance, you may own an old car with a broken engine. Unless you know for certain its market value and someone can buy it, the car cannot be an asset.

Related

As for debts, they are also referred to as liabilities. A liability is something you owe and must pay now or in the future. Examples of liabilities include:

• credit card debt
• mortgage
• car loans

Net Worth = Assets – Liabilities

Why Net Worth Is Useful?

Here are my top reasons why net worth can be a useful metric for achieving financial freedom.

1. Net Worth As a Retirement Readiness Indicator

Net worth can tell if you are saving enough for your retirement. People retire with a certain nest egg and that nest egg gets measured by the net worth. Thus, the savings you have either on your savings account or 401(k) account do not provide a complete picture.

Suppose you are thinking of retiring with $1,000,000 in your brokerage account. But, your student debt/mortgage/personal loans amount to $800,000. In this case, you may have to delay your retirement until the debt load becomes less excessive.

2. Net Worth as Emergency Funds Indicator

Net worth can also show you how much money you have to spend in case of a financial emergency. For instance, if you need to do a major house repair, net worth can tell you if you can afford this expenditure.

3. Net Worth as an Asset/Liability Growth Indicator

Finally, if you track net worth on a regular basis, you can tell how your assets and liabilities perform. For instance, you can tell if a particular credit card debt is getting out of hand. Or, maybe your checking account balance has been flat because you spent too much on drinks.

Net worth calculations aggregate all assets and liabilities. For this reason, it can provide not only a big picture of finances, but also a line-by-line analysis.

Net Worth vs. Income

Here is a question. Does high income equate to high net worth? The answer is not necessarily. The relationship between net worth and income for a given year can be summed by the following formula:

Net Worth₂₀₂₃ = Net Worth₂₀₂₂ + (Income₂₀₂₃ – Expenses₂₀₂₃)

Income minus expenses for a given year is what we know as savings. In simple terms, your net worth is equal to your net worth balance from previous year plus your savings in the current year.

The terms savings is often misused. Many refer to their checking account balance as savings. In reality, savings is what you set aside in a given year after you pay for all your expenses from your income.

For example, in 2023, you earned $100,000 and spent $80,000. Your savings are $20,000 and your savings rate is 20% ($20,000/100,000), which is a lot by American standards. In case you wonder, the average personal saving rate for the past 20 years was about 7%.

High income does not translate into growth of net worth if your expenses are out of control. Moreover, savings can be negative if expenses exceed income in a given year. Negative savings mean that you either dipped into your checking account or took on more debt.

Thus, you can view net worth as a condensed version of your lifetime savings streams. To grow your net worth, you must grow your income and keep expenses down to generate savings. That is the only way.

How to Calculate Net Worth in Real Life?

The net worth calculations can be easy or very complicated depending on your situation. It all comes down to what qualifies as an asset/liability and how difficult to price or to value each item.

We created a tracking sheet that lets you calculate your net worth, budget, track expenses and income. You can read more at How to Turn Google Sheets into a Free Budget App.

Here is how you calculate your net worth:

1. Aggregate All Your Assets

First, add up all your assets that you possess. Here is a sample list:

• checking accounts
• savings accounts
• investment brokerage accounts
• IRA
• real estate
• stocks
• bonds
• ETFs
• crypto
• gold, art, other collectibles
• house (primary residence)
• car
• Investments in real estate
• investment in private companies

This is by no means an exhaustive list and you may need to add other assets as needed. Certain assets could be hard to measure though. For instance, investments in real estate and private companies are not easy to value. Moreover, they can be illiquid. This means they are not easy to sell and may produce smaller proceeds than anticipated.

2. Aggregate Your Liabilities

Next are your liabilities:

• student debt
• mortgage
• credit card debt
• car loan
• personal loans
• federal or state tax liability
• any unpaid bills (utilities, rent, etc)

3. Subtract Liabilities from Assets

After you perused through your financial records, subtract liabilities from your assets to arrive to your net worth. In principle, once you start tracking your net worth, it should change with how much you save each year.

Should You Track of Net Worth?

Net worth is just a number with its own flaws. The main reason to measure net worth in the first place is to determine when you are ready to retire. If you fit into a standard retiree profile with savings and mortgage, then it may make sense. But what if you invested in real estate for its rental income and have no intention to sell it? Then, net worth is not so useful.

House is an Asset?

Also, including a house as an asset in your net worth calculations can be questionable too. Many argue that a house is not really an asset. It only saves you rent in return for paying mortgage, repairs, insurance and taxes. Many, including Robert Kiyosaki, argue that a primary residence should be viewed as a liability.

A primary residence house may qualify as an asset if you have a definite intention to sell it. But, what if you have no intention to sell it? Then, sadly, it only qualifies as a liability.

What can make a primary house an asset is when you rent rooms or use it as a place of work. Other than that, it is a place of personal enjoyment, maintenance and repairs. It is also a source of lucrative interest and property taxes that you must pay to your bank and county.

The same thing applies to a car. While you can include it as part of your net worth, you are unlikely to sell and consume its proceeds. A personal car is a necessity for many to get around, especially in the United States. Thus, selling your car will likely decrease your standard of living.

Calculate Liquid Assets and Liabilities

To mitigate the above-described problems, you can calculate your liquid net worth first. Then, you can add illiquid/questionable net assets, if necessary. Here are the suggested formulas for such calculations:

Liquid Net Worth = Assets (brokerage, checking, savings) – credit card debt, personal loans, student loan balance.

After that, you can compute your illiquid net worth by adding everything else:

Total Net Worth = Liquid Net Worth + Illiquid Assets (private companies holdings, real estate, primary house, car) – Illiquid Liabilities (mortgage, car loan)

Net Worth Takeaways

Net worth calculations are fraught with issues. But, the most important question is how much net worth is enough for retirement? And this will be a topic for another article. Using net worth for determining your retirement date can be a flawed exercise.

A better option is to use a hybrid approach. This approach considers liquid assets, passive income and expenses in their totality. This can tell how much you have in liquid funds and passive income to cover expenses in retirement.