Net Worth: What Is It, and Does It Matter?

You may have heard the term "net worth" used to describe someone's financial situation, but what exactly does it mean? In a nutshell, net worth takes account of not only the savings and other assets an individual, family, or business has, but also how much money it owes.

Think of it this way. Who is richer? Someone with $1 million in savings and real estate assets or someone with $250,000? You may be inclined to say the millionaire, but there's a lot more to the story. And that's where net worth comes in.

In this article, we'll discuss how to calculate your net worth, as well as why it can be important for evaluating your personal finances.

What is net worth?

Net worth is the difference between assets and liabilities. It can be calculated for an individual, an entire family, or for a business. For our purposes, we'll focus on individual net worth, but the general calculation process is the same in all situations.

Before we can get into the calculation process, it's important to know what to include as assets and liabilities.

For net worth purposes, your assets include the balances of your checking and savings accounts, investment accounts, retirement accounts, and the value of any major assets you own, such as your home and car (if you own them). Ideally, you can use a professional appraisal for your home and Kelley Blue Book value for your car, but if you don't have these things, it's fine to estimate if you just want a quick estimate of your net worth.

Anything of significant value such as jewelry, fine art, and collectibles can be included, but it isn't necessary to add up the value of every little thing you own. It's common to include "home furnishings" as one line item, with an estimated resale value of all of the furniture and decorative items in your home.

Liabilities include money you owe. Consider your mortgage loans, auto loans, personal loans, credit card debt, and other situations where you have agreed to pay someone back. You don't have to count small, recurring bills -- for example, your current electric bill doesn't necessarily need to be counted if you want to determine your net worth.

Of course, there are some gray areas in this process, and if you were to ask a few financial professionals to calculate your net worth, you'll likely get a few slightly different results.

Calculating your net worth

Let's consider a simplified example. We'll say that you own the following assets, and these are their values:

• Checking and savings accounts: $20,000
• Brokerage account: $50,000
• Retirement accounts: $250,000
• Value of your primary home: $500,000
• Value of your car: $30,000
• Home furnishings: $50,000
• Jewelry and collectibles: $20,000

Adding these together, we see that the total value of your assets is $920,000. We'll also say that you have the following debts:

• Mortgage: $300,000
• Auto loan: $10,000
• Credit card balances: $5,000
• Home improvement (personal) loan: $30,000

This totals $345,000 in liabilities. To calculate your net worth, you would subtract this number from the total value of your assets, which would give you $575,000.

As mentioned, this is a simplified example. Your assets and liabilities aren't likely to be such round numbers, and there are likely more line items you'll include. But this is the general framework of how you can calculate your own net worth.

Does your net worth matter?

Net worth is perhaps the best numerical representation of how wealthy someone is. Two people with $1 million in the bank can have very different financial situations, and net worth is a way to level the playing field.

To be sure, net worth isn't the only important metric to assess how financially comfortable you are. For example, if you have a $1 million net worth but spend $200,000 per year to maintain your lifestyle, you may not feel as wealthy as someone with a $1 million net worth and who spends just $50,000 on annual expenses.

The bottom line is that net worth can be a smarter way to analyze your financial situation, as opposed to simply considering how much money you have in retirement accounts, how much your home is worth, and the value of other things you own.