When it comes to personal finance, the ultimate goal for many people is financial independence. Financial independence is when you have enough money to do whatever you want in life and have control over your time. You can stop working if you want or cut back to part time. You can travel as you desire and afford to have incredible experiences with the people you love. In order to get to this state of financial independence you must be diligent with your finances and save/invest money in a smart way. Before you start investing money or begin your journey to financial independence, you must first figure out your starting point and calculate your net worth. Here’s how:
Step 1: Understand what net worth is
Your net worth is a number that tells you how much money you have. It takes into account the cash in your account and the things you own that you could sell for money. It subtracts any debts or loans you owe to others. In other words, your net worth is your assets (the things you have that are worth money) minus your liabilities (your debts).
Contrary to popular belief, your net worth is not how much money you make. Many people who make a lot of money assume they are “rich” but that may not be the case. There are those who make a lot of money but still have a low net worth (because they spend most of what they make and have a lot of debt). In contrast, there are those who make a “small” amount of money but have a high net worth (because they keep their expenses low and save/invest most of the money they earn). Knowing your net worth helps you know where you are starting from as you begin your financial independence journey.
Step 2: Make a list of your assets
The first thing to do to determine your net worth is to make a list of your assets. Assets are things that you have or own that are worth money. They usually fall into these 3 categories: Cash you have on hand (in a checking or savings account), investments you have (in stocks, real estate, or other currencies), and possessions you own that you can sell for money. In order to calculate your net worth, get out a sheet of paper (or open a file on your computer or phone). Write down all of your assets on one side of the paper and write down the value of each asset on the other side of the paper.
Some examples of things that can go on your list of assets are: the amount of cash you have on hand and in a checking/savings account. You also want to list investments you have in the stock market along with any investment money you have in your work retirement accounts (like a 401K or an IRA). If you have a home (or homes), write it down along with its estimated value. If you have a business, write down it down along with its approximate value. If you have expensive jewelry, a car that you own (leases do not count), or other things like furniture and equipment you can sell, then add those things to your list along with the estimated value of each of them.
Step 3: Make a list of your liabilities
Now that you have your list of assets you need to make a list of your liabilities. Remember, liabilities are things that take away your money. They are the debts you owe and loans you have. Things like credit card debt, car loans, house mortgages, student loans, business loans, medical bills, and other outstanding debts/bills are all examples of liabilities. As you make this list, be sure you are clear on what truly counts as a liability vs an asset, keeping in mind that some things like a car or a home may be examples of both.
If you have a home, the total value of your home will be listed under the asset column along with the amount of how much money the home is worth. If you do not own your home outright and are still making mortgage payments, then you would list your home again in the liability section and write down the total amount of the mortgage you have left to repay. For example, let’s say you bought a home last year. The purchase price was $180,000, you paid $20,000 as a down payment, took out a $160,000 mortgage to cover the rest of the cost, and that the value of your home has now increased to $200,000. In this example, you’d list the home in the asset column for its current value of $200,000 (because that is how much you could get for the home if you were to sell it). You’d then list your house mortgage in the liability column and write down the total amount of the mortgage you have left, which may be around $160,000. My point? Your liabilities column should list all of your current debts and loans (including your mortgage).
Step 4: Subtract your liabilities from your assets to determine your net worth
In order to calculate your current net worth, add up the total value of your assets and the total value of your liabilities. Then, subtract the total amount of your liabilities from the total amount of your assets. The number you get is your net worth. For example, if all of your assets equal $200,000 and all of your liabilities equal $150,000, then your net worth is assets ($200,000) minus liabilities ($150,000) which equals $50,000. For some people, doing that calculation may be quite surprising.
Don’t be alarmed if your net worth is negative. Many young professionals have a high amount of student loans or a large mortgage on their home that adds a substantial amount to the liabilities’ column. If the total amount of your liabilities is bigger than the total amount of your assets, then you have a negative net worth and a much longer road to travel to become financially independent. But don’t be discouraged. Calculating your net worth is good to get a baseline of where you are. Now that you know where you are you can determine how to move forward.
Step 5: Find ways to increase your net worth
Regardless of where you are starting from you can always get better. You can increase your net worth by buying more assets (or increasing the current value of the assets you already have). You can also increase your net worth by lowering your liabilities and paying off the debt/loans that you have. Take a look at your spending plan or monthly budget to identify ways you can increase your net worth. Perhaps you can start investing a larger amount from each check into your work retirement account? Maybe you can open a Roth IRA and start investing additional money on your own? You can decide to save more money from each check into your checking account by spending less or purchase other investments like real estates that increase in value. If you have debt and loans, you can try to make extra payments or larger payments each month to decrease the amount of money you owe at a faster rate. Regardless of which method you choose, make it a goal to increase your net worth. Choose one strategy to focus on over the next few months then recalculate your net worth after that time to see how much progress you’ve made.
My point? Calculate your net worth so you have a starting place on your journey to financial independence. One you have a starting point, identify a couple ways you can increase your net worth over the next few months.