What Is Net Worth & Why Does It Matter?

Net worth is a simple calculation that gives you an overview of your financial health and your wealth. The simple equation is assets minus liabilities, or in other words, what you own minus what you owe. The higher your net worth, the wealthier you are.

The equation written out would look like:

assets – liabilities = net worth

Why is net worth important?

OK, so that sounds like boring math, so what’s the big deal about it anyway? Here are four reasons why knowing your net worth is important.

1. Net worth is one of the most accurate measures of wealth.

Net worth is important because it is one of the best indicators of wealth. Think of it as the big picture of your finances.

When it comes to net worth, bigger is better. Positive net worths are good, and the larger they get, the wealthier you are. It is entirely possible, and quite common, to have a negative net worth. 

In order to retire, you need to have a positive net worth and enough assets to provide income to support your lifestyle while you’re not working.  A negative net worth means that you need an active income from a job to pay your debts every month.

2. Net worth helps you track your financial progress

Knowing your net worth right now helps you understand if you are wealthy at this moment. Tracking the trajectory of your net worth over time helps you see if you are becoming wealthier or poorer. 

By tracking your net worth, you can measure your financial progress from month to month and year to year. If your net worth is increasing, you’re improving your finances and moving forward. If your net worth is decreasing, your finances have taken a turn and you have some improvements to make.

3. Net worth moves the focus beyond income

If you only look at one aspect of your finances, like your income, you might think, “hey, I’m doing really well, I make a lot of money.” But without considering your expenses, it’s actually impossible to tell if you’re doing well, because you don’t know how much of that money that you’re earning is left over at the end of the month.

Would you agree that someone who makes $100,000 a year is wealthy? How about when I tell you that they spend $150,000 a year? Now, you might not think so.

4. Net worth puts your assets and liabilities into perspective

Net worth helps you put your whole financial situation into perspective. It prevents over-emphasizing the value of your assets as a measure of wealth. If you have $500,000 in assets, but ignore that you’re $450,000 in debt, you’re not seeing the full picture of your wealth. 

It’s not either number that is important by itself, but the difference between the two. The same goes for putting debt in perspective. If you have $50,000 of liabilities, but $500,000 in assets, your debt is not as extreme as you might have thought by looking at that number alone. 

Assets vs. Liabilities

Let’s dive into those terms, assets and liabilities, because defining them will help you calculate your net worth.

According to Robert Kiyosaki, the author of Rich Dad, Poor Dad, assets are anything that put money in your pocket. Liabilities are anything that take money out of your pocket.

Simple, right? This helps differentiate between things that seem like assets, such as houses or cars, but are actually liabilities costing you money in the form of a debt payment or other overhead expenses every month.

Assets

• Liquid Assets: These include the cash in your wallet, money in the bank, certificates of deposit, money market accounts, and any other cash equivalents.
• Investments: This includes investments like stocks, bonds, and commodities inside retirement plans like 401ks, 403bs, traditional IRAs, Roth IRAs, or taxable investment accounts.
• Real Estate Investments: If you own real estate that you are renting for income, this is an asset, because it is putting money in your pocket. See below for primary residences.

Liabilities

• Houses: Primary residences cost you money, they don’t earn you money. You spend money every month on your mortgage, taxes, and insurance plus repairs and maintenance. Even if you own your house outright, it is costing you money on a monthly basis for taxes, insurance, repairs and maintenance. Vacation properties or second homes are the same way. Unless you are earning more money on your house than you spend on it, your house is a liability. I discuss some ways you can earn money on your primary residence (to turn it into an asset) in Episode 37.
• Cars: Cars cost lots of money to operate and maintain. You have to insure them, do maintenance, pay for gas, and more. It’s pretty clear that cars take money out of your pocket, even before you consider factors like depreciation, which is where the value of the car decreases over time. This article covers ways to save money on transportation. 
• Boats, ATVs, and other big toys: Just like a car, there are costs to keeping, operating, insuring and maintaining these belongings. And, many people get installment loans to pay for these toys, which means they are carrying debt which is a liability.
• Credit card balances: Fashion, jewelry, and furniture are often items that people might think of as assets, but they are in fact liabilities. And, they are often purchased on credit cards. Whatever else you buy with your credit card, including subscriptions, groceries, and gas, is bought on credit, and you have to pay it back from your cash assets, so credit card balances are considered liabilities.
• Student loans, business loans, personal loans, and payday loans: All types of debts are liabilities, because they take money out of your pocket. Other liabilities might include tax liabilities or medical debt.