Using Your Net Worth as a Financial Compass

If someone were to ask you how much money you make, most likely, you could answer off the top of your head. But what if someone asked you how much you were worth? Many people underestimate the importance of calculating and tracking their net worth. According to the California Society of CPAs (www.calcpa.org), keeping track of your net worth is like having a financial compass, leading you on the right path to building wealth.

Calculating net worth
Net worth is the value of all your assets minus your liabilities. It is a snapshot of your current financial situation‹what you own less what you owe‹at a given time. To calculate your net worth, begin by adding up the value of all of your assets. Start with your primary residence and add the value of your vacation home and any other real estate you own. To determine the current market value of your property, research recent sales of similar properties in your area or consult with a real estate agent.

Next, add in the current value of your investments including stocks, bonds, and mutual fund shares, as well as retirement accounts you hold. You can determine the current market value of your investments by checking the newspaper, financial Web sites, or by reviewing your account statements. Include any money you have on hand or in checking or savings accounts, CDs, government securities and U.S. Savings Bonds. Next, add in the cash value of any insurance policies you own. Finally, estimate the current market value of your personal possessions, including furniture, cars, boats, and valuable antiques, jewelry, furs and artwork.

On the liabilities side, start with the balance on your mortgage and then add any outstanding amounts owed on car or consumer loans, home equity loans, student loans and credit cards. If you have borrowed against a life insurance policy or your investment portfolio, include those balances as well. Finally, factor in any money you owe in taxes.

Subtract your total liabilities from your total assets and you'll arrive at your net worth. If your assets are worth more than your liabilities, you have a positive net worth. If your liabilities exceed your assets, your net worth is negative.

What does it all mean?
CPAs say you should calculate your net worth at least once a year. Each year, the net worth figure you calculate serves as a benchmark for future years. When looking at your bottom line, the important question is not so much whether your net income is positive or negative, but whether it has improved.

To get more value out of your net worth statement, you may want to dig a little deeper. For example, if you determine that your net worth is increasing, the next question you may want to address is whether it is growing faster than the annual rate of inflation. To do that, you need to compare the percentage of increase of your net worth with the rate of inflation in your area. If the percentage of growth in your net worth is lower, it means that, while your net worth is growing, it is not growing fast enough to outpace inflation. In other words, you are falling behind in terms of purchasing power. (You can find out the local inflation rate by calling the nearest office of the Bureau of Labor Statistics or visiting www.bls.gov.)

Another question concerns liquidity. You might want to examine your assets to determine whether you have a good balance between assets that are tied up and those that are liquid and can easily be converted into cash. Real estate, jewelry, antiques and the like can be hard to tap if you need to raise cash quickly. The right allocation for you depends on your age, income and personal situation. It also depends on how well you are insured. For example, if you become ill or injured and cannot work but you are covered by disability insurance, your need for ready cash may be lower since disability payments can make up part of the income shortfall.

The ratio of long-term debt to short-term debt is another factor that warrants your attention since some kinds of debt are better than other kinds. For example, a long-term debt such as a mortgage that is used to finance the purchase of an asset that will grow in value is preferable to a lot of short-term debt for restaurant meals, clothes and other items that are now barely a memory.

In essence, your net worth represents the success with which you are converting income into assets. If you're not satisfied with your net worth growth, you may want to consult a CPA for financial planning advice.