What is Net worth?
In simple terms, your net worth represents the summation of all your tangible and intangible assets minus your liabilities. By liabilities, any ‘debt’ in the form of loans (car loan, house loan, student loans, gold loan, etc), pending credit card payments, etc has to be subtracted from your total assets. By this, you will derive your actual worth or your overall share of the wealth that you have accumulated by now. Before getting into the investment basics, it is important to know your net worth so that you can consider your investment-related decisions accordingly.
Put differently, you can consider all of your properties, investments, land, building, and other assets as your total worth. But this is not completely accurate because there might be loans on certain assets. Hence, to derive the true net worth, it is important to take out all the liabilities from your assets to calculate your net worth.
How to calculate net worth?
Let’s calculate the net worth of Mr ‘X’ to find out how you can calculate your net worth.
Let’s assume Mr. X is 30 years old with a bank balance of Rs 8,00,000 and Rs 9,00,000 in investments in his brokerage and mutual fund portfolio. He owns a house worth 30 lakh out of which Rs 15 lakh was taken as a loan that’s still unsettled. He also owns 4 lakh worth of gold and silver, and a car worth 4 lakh. Apart from these, he uses a credit card where he has to pay a total of 1 lakh by the end of the current month.
In this case, to calculate the net worth of Mr. X, first, let us add all his assets.
8 lakh + 9 lakh + 30 lakh + 4 lakh + 4 lakh = 55 lakh.
So the combined assets that Mr. X owns are worth Rs 55 lakh, but this is not his final net worth. To get his actual net worth let’s subtract the liabilities from his assets.
55 lakh- 15 lakh -1 lakh (loan and outstanding credit card bill) = 39 Lakh.
Therefore, the ‘net worth’ of Mr. X comes out to be Rs 39 lakh. In this way, you can calculate your net worth easily. Now let’s understand the importance of knowing your net worth.
Why is knowing your net worth important ?
Just like the results of an examination are valuable to ascertain your performance in a particular field, calculating your net worth is important to judge your financial standing. Calculating your net worth regularly will help you to measure your overall progress towards your financial goals. And will also encourage you to take appropriate steps to tweak the instruments that are responsible to help you reach your goal. Here are some points that explain why knowing your net worth is beneficial to you.
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Indication of your financial stability
The primary benefit of calculating your net worth is, you get to perceive how financially stable you are currently. Calculating your net worth state your net amount of savings to date and also the combined amount of debt that you have taken. By recognizing these, you will be capable to take the required steps to accomplish your next goal. Be it purchasing a house, repayment of a loan, planning to own an asset, etc.
Maintaining a healthy ratio for debt
One of the critical factors in your net worth is the total amount of debt that you have. Debt can be beneficial at times, but you should always aim to keep your debt levels low to maintain a positive net worth. If you have too many loans against your assets, you take the risk of having a negative net worth. Henceforth by calculating your net worth, you can not only find out the total portion of debt in your net worth but equally take the required steps to reduce it to an optimal level.
Motivator to save and invest more
Calculating your net worth portrays a clear picture of all the investments that you have made to date. It also helps you compare your total growth on a quarter on a quarter or year on year basis, to find out your progress. Identifying your realistic position in your wealth creation journey acts as a motivator so that you fulfill your financial goals by saving and investing more. By knowing your breakup of investments, you can diversify further by investing in international markets and other assets.
In a nutshell, your net worth is the sum total of all the money you have earned till date minus your expenses. Your total savings and investments that you have made by far get reflected in your net worth. By knowing your net worth, you can judge if you are going on the right path financially and also find out the necessary edits that you require to be on the right track. Because of this, it is important you check your net worth once or twice a year so that you stay updated and motivated in your wealth creation journey.