I was just watching Scrubs on Amazon Prime when I realized I am watching shows on an enterprise founded by the world’s richest man – Jeff Bezos at a latest net worth pegged at around $90 billion. Recall the last “richest man” list that you might have read about in a business newspaper or magazine. The only unit used to define wealth is “net worth”.For a long time I used to think of net worth as a badge given to rich people. I thought if you are rich you get a net worth to your name. Click To Tweet
Funnily enough, even while studying MBA I did not really get any clarity about net worth and how can and should people calculate it for themselves.
It’s only off-late while studying for Certified Financial Planner and reading through the net worth tracking movement in the Personal Finance blogosphere that I have understood the real meaning and the importance of net worth.
Why is net worth important?
Net worth, as the term suggests is an indicator of what a person is worth. If you look at only the assets or the liabilities, you could end up getting a warped picture.
In banks, one of the often-used terminologies is HNI or “high net-worth individual”. I am pretty sure very few people even in banks in India understand how to really use this term. It is mostly interchangeably used with assets which could be a mistake.
Let’s look at an example: There is a top management employee who is the customer of a bank. He has assets worth Rs. 6 crores (approx. $1 million) which easily tags him as an ultra high net worth individual. However, most of the big assets are leveraged, with the Rs. 5 Crore house being recently purchased and mortgaged. In this case, while the guy might be pegged as a high net-worth individual considering his assets, his net worth in effect might be much lesser.
How to calculate net worth?
In formula terms, the calculation for net worth is pretty simple, given by Assets – Liabilities.
Where a lot of us get stuck is to really understand the definition of assets and liabilities. Assets can be defined as objects in your financial portfolio that have an intrinsic value or provide you with income. If you have a car in your garage, and you decide to sell it tomorrow, the value at which you can potentially sell it becomes the asset value of your car.
Assets come in two variants – tangible with a specific value attached to them and the intangible where the current market value needs to be estimated.
Tangible assets include cash, bank deposits and even equity holdings as the market can tell you exactly what you will get at the point of net worth calculation.
Intangible assets are in most cases the less liquid assets like your house, car, gold etc. The valuation of these assets varies from time to time and with each individual case. However, an estimated ball-park figure is all that you require to get your assets list ready.
For real estate, websites like Magic Bricks and 99 Acres can help with giving a sale value for similar houses in your area. For cars, you can either take the value from second-hand vehicle aggregators like gaadi.com or use a formula for depreciation. However, depreciation generally accounts for only the first 5 years of a cars’ life whereas cars older than that also get a price in the market.
Liabilities is synonymous with debts for an individual net worth calculation. Simply, check the principal outstanding on any debt that you might be paying off, be it on your credit card or for your home or car. The idea is that if you sell all your assets, you would also need to pay all your debtors. You would pay them the principal amount. Whatever is left then becomes your net worth.
If you are looking for accuracy in your net worth calculation, know the repayment terms of your lender to put the right amount for liabilities. While most home loans today have zero repayment charges, some lenders charge a 5% of the principal amount as a penalty if you pay them before the repayment period is up. In that case, add the 5% to that debt.
There is considerable debate on whether a self-occupied house should be included at all in the net worth calculation. The argument forwarded is the fact that it is an asset that people would really not sell, which negates any intrinsic or market value it might have. While the argument has some strength to it, a lot of us do not stay in one house forever. We can easily look to change it as the situation demands and putting the asset value in the net worth calculation just makes the picture complete.
Individual or household net worth
As a married couple, there are a lot of assets and liabilities belonging jointly to the household. What should be done in that case?
I am a staunch believer in financial independence in a marriage. While it is good to have an idea of a household net worth, individual net worth is as important. For most couples, there is merit in checking for individual net worth as a lot of us do have separate bank accounts and maybe some other assets as well. Simply take half value of your joint assets for each or a pre-decided value.
In all the news surrounding the Virat Anushka wedding, to me, one of the interesting pieces of information was that the couple is jointly worth Rs. 600 Crore ($100 Million). That’s one couple where individual net worth would be as, if not more, important than the household net worth.
Frequency of tracking net worth
Now, this is a question where the answer varies with the person. There are enough Personal Finance bloggers who publish the movement in their individual net worth for their readers to see. My first brush with this movement was at J. Money’s blog – Budgets are Sexy. I believe they have done a lot for the regular folks in educating them and making people realize the importance of net worth.
However, it would only the value of liquid assets that changes over a period of one month and a minor change in your outstanding debts. Personally, I believe a quarterly evaluation of an individuals’ net worth might be a more realistic version.
How does net worth change with age
For a long time, I refused to calculate my net worth. It has come across as a highly depressing and disappointing figure.
However, the point remains that in your youth, you are busy building assets, some of which might come saddled with debt. This could be the house or your own self in the job market (student loan).
Tracking net worth over the years gives a clear picture of the movement of it with your age and the only trend there should be up.
How to build net worth
It is a simple equation here:
Assets – Liabilities = Net worth
Now, if you want to boost the final figure of net worth, there are 2 things you can do – increase your assets or reduce your liabilities.
To increase your assets, ensure you start young to give yourself the benefit of time. Saving and investing every month is another useful trick because that helps with the small ticket investing.
If you want to attack the other front, you could aggressively repay your debt to reduce your liabilities. Go for the quick kills like credit card debt or car loan to bring that figure down.
I have realized that with most scary terms, once you break them down to their fundamentals, they are not really that difficult to grasp. I hope I was able to do just that for what was once a scary term for me – net worth.
If doubts persist or you have questions, do email me at firstname.lastname@example.org or drop a comment below.