How This 1 Number Makes You Confront Your Financial Situation for a Brighter Future

It can also help you figure out what steps you need to take in order to meet financial goals, like saving for a home.

Jun 15, 2014 at 8:37AM

Net worth is one of those financial terms that gets thrown around a lot in the news or when talking about celebrities. Hugh Hefner's net worth is estimated to be about $43 million, Paul McCartney's is $800 million, Tiger Woods and Magic Johnson each at $500 million, and $200 million for Sandra Bullock. So what does all of that mean and why is it important?

Net worth is simply a calculation of how much a person's assets are worth once their debt is subtracted. While that sounds pretty simple, it can get complicated when some types of investments are involved. However, unlike wealthy celebrities, calculating net worth for most people is a straightforward task and not only provides a snapshot of your financial situation, it is also a great way of evaluating your current financial health. It can also help you figure out what steps you need to take in order to meet financial goals, like saving for a home.

Calculate your assets
To calculate your net worth, you need to know what your assets are. In short, this is all of the cash you have and everything you actually own that has real value, excluding anything that is also held by a bank. If you own a home or car without a loan, these are assets. Cash, money in savings accounts, retirement plans or investments are all assets. Other assets would include fine jewelry or precious metals, antiques, fine art, fully owned vehicles, and collections, such as valuable dolls, books, figurines, stamps, coins, or other collectables.

To clearly understand how these items fit into the grand scheme of net worth, the items would need to be appraised to determine their market value. As a general rule, if an item isn't worth appraising, it probably isn't really an asset.

With a mortgaged home, the amount of equity you have in the home can be considered an asset, even though you can't sell just that part of your home. The amount of equity is based on the home's market value minus how much of your loan is remains to be paid.

If you want to calculate the asset portion of a car you are paying for with an auto loan, it's important to remember the car has likely depreciated since you bought it. Like the market value of the home, the calculation has to be made on what the car is actually worth and subtract what you owe.

These are not assets
Items that aren't really assets are anything you couldn't really sell for much money, like everyday clothing. A fur coat or designer dress might be an exception. The same goes for everyday items like dinnerware, unless of course it's fine china. A $5,000 mountain bike is probably worth counting as an asset, but probably not $100 bike picked up at a discount store.

Your income isn't considered an asset unless it is cash in the bank or under a mattress. Expected wages aren't counted as assets.

Total up all of these figures, and you'll have a clear picture of what you have in assets.

How to calculate debt
Debt can be a little bit tricky to calculate. Do you count what you would have to pay in a lump sum if you were to pay it off today, or by how much the total of all remaining payments equal when added together? You're likely to get two different figures with each approach.

Debt is typically calculated by the exact dollar amount owed at the moment, even though what will really be paid over the long term in payments will be higher as interest accrues.

Debt doesn't include monthly bills unless you're behind on any of those and you owe a company or person money. Paying for services such as insurance aren't really considered debt because it is mostly voluntary and basically counts against any cash assets you have.

Add all of your debt up: the student loans, mortgage, car payments, any installment loans, credit card balances, the $200 you owe Uncle Joe, and anything else you need to repay. This is your total debt.

To calculate your net worth, subtract your total debt from your total assets. Hopefully, that second number is much larger than the first. Remember, calculating your net worth is a valuable starting point to build goals and can help you confront the reality of your finances.

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This article How This One Number Makes You Confront Your Financial Situation for a Brighter Future originally appeared on My Bank Tracker.

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