Net worth is a valuable tool for analyzing your current financial situation, setting realistic goals and measuring progress along the way. Essentially, net worth is a measure of all of your assets minus your liabilities. Net worth can either be positive or negative. A negative net worth in early adulthood is common. Once your initial net worth statement is developed, updates and reassessment are relatively easy.
The true value of net worth is its revealing ability. Some individuals tend to surround themselves with nice things and convince themselves that they are well off. Despite the facade, by analyzing net worth we often find that this is not always the case.
An individual may “have” a lot of things, but own very little. For example, if an individual rents a very nice house, leases an expensive car, has no investment assets, neglects retirement plans and spends the majority of their income instead of saving, their net worth is probably minimal, possibly even negative. No real assets exist.
Net worth calculations are relatively easy, but great care must be taken to remain conservative and avoid inflating values. This will skew the resulting data. As with all areas of financial planning, net worth is garbage in, garbage out. If you’re going to use inaccurate data, you might as well not waste your time. Using inaccurate data can develop a false sense of security and will blind us to the reality.
To reiterate, net worth is computed by subtracting liabilities from assets. Though simple, this is a powerful tool for managing finances and planning for the future. Net worth combined with cash flow are the cumulative result of all of the financial decisions we make. We can lie to ourselves about our spending, but the numbers will always let us know whether or not we’re doing the right thing.