How Tracking Net Worth Can Transform Your Finances

Net Worth is the first topic in the YourMoneyNumbers (YMN) series. For more information on the YMN series click here.

What is Net Worth?

Net Worth is simply what you own (your assets) minus what you owe (your liabilities). It is one of the simplest financial values to calculate because it only uses addition and subtraction. Don’t let the simplicity fool you! When you calculate your net worth, you take into account every financial decision or financial challenge you have faced in the past. You take a snapshot of your current financial picture – the good and the bad. Your net worth value is critical in decision making at various stages of your financial life, but more important than the value itself, the trend (e.g., generally increasing, generally decreasing) can provide you feedback to determine if you are on track with your financial plan. Net worth is not sufficient to fully understand your financial health, but it is the first topic in YourMoneyNumbers (YMN) because I believe starting with your net worth provides a strong foundation.

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If you have never calculated your net worth before – this post is definitely for you!!! But – some of you may be thinking – “I know my net worth, but I don’t see how it helps me make decisions.” Please stick this post out and then decide. I “knew” my net worth as well – I’d periodically check it in my Mint.com account and I didn’t use it for much beyond that for many years. Unless you are deliberate about it, it may not automatically help you make better decisions. The key is that I didn’t say that the VALUE of your net worth will transform your finances—but I believe that regularly tracking your net worth can!

Why is calculating and tracking your Net Worth Useful?

Knowing what you have and what you owe

When you add up all your assets and liabilities to calculate net worth, you first get the benefit of having a complete record of your wealth and obligations. Just having all the information in one place can be beneficial. I once found a set of savings bonds in an envelope I had stored for years in one of those little lockbox safes. I had completely forgotten that I had them! I added them into the net worth tracker spreadsheet that I update monthly and now I easily remember that asset.

Net worth reality check

If you have never calculated your net worth before you may be in for a little bit of a reality check – it might be negative! Do not panic! No matter what the value is, the current value alone isn’t going to determine your long term financial success. Your “optimal” net worth value is dependent on many factors: stage of financial life, budget concerns (income/spending), time desired until financial independence, etc. Each person can have wildly varying values for what total net worth is “optimal” for their circumstances. Most people start their financial lives with very little in assets and likely some debt –  hence negative net worth. If this applies to you, put in place a solid financial plan to work towards building up your assets and paying off your debt.  You should then see the net worth trend will be positive and over time your net worth value will grow.

Feedback! Feedback! Feedback!

In my opinion, the most useful thing you gain by monitoring your net-worth is that you create a psychological feedback system for your financial health. (The engineer-side of me just loves a feedback system!)

Once you start tracking your net worth regularly, you may take a pause before making a purchase or financial decision and ask – not only can I afford to make this decision, but do I need to spend this money and is it worth the impact this is going to have on my net worth?

The other side of this coin is – if you are trying to tackle some ambitious financial goals – and are dramatically changing prior financial behaviors to do so – it is going to feel like a sacrifice at times. It may not feel like you are making much progress because your approach is incremental. BUT – guess where that progress is going to show up? Your net worth! Each time you pay-down more of that debt – your net worth will rise compared to where it would have been if you hadn’t made that extra effort. This feedback can give you the confidence that the sacrifices you are making on your way to financial stability or financial independence are worth it!

By looking at your net worth trends, you can catch any financial setbacks early. You can make sure that you are making progress towards your future financial goals– and more importantly be sure that you are not falling behind. In the case of high-interest credit card debt, or even sometimes with student loan debt, this is even more important because if you pay ONLY the minimum payment, your balance may be growing over time. This occurs when the minimum payment does not exceed the interest being charged each month. A downward net worth trend is especially harmful if you have a negative net worth. When dealing with a negative net worth, you want to be laser-focused on achieving a positive trend. Unlike when your net worth is mostly investment assets (that may experience fluctuation outside of your control) when your net worth is dominated by debts, your day-to-day financial decisions are what most directly impact your net worth trend.

Example: How tracking your net worth can help make decisions

If you focus on asset value alone, you may be overly optimistic about your financial health. You may live in a $300K home, but if you have a $250K mortgage you would have a net worth housing value of $50K, not $300K. Over-optimism can easily happen if you are primarily focused on cash flow – basically making sure you have enough to stay out of the red and pay all your bills each month. While paying your bills is very important, just being able to afford all your payments into your budget each month doesn’t guarantee solid financial health.

Imagine a case where someone consistently has $350 “extra” in their monthly budget and they really would like to buy a new car with a car payment of $300 per month. They may feel comfortable making this financial decision. However, if they had been tracking their net worth for those months they would have seen that their net worth had been decreasing for the past 6 months because they don’t have many assets and a credit card debt from 6 months ago was growing and therefore making their net worth reduce each month. By looking at the reason for the net worth decrease, this person would have realized that by only making the minimum payment on that credit card (which wasn’t even covering the interest they were being charged each month) the credit card balance was increasing despite their monthly payments. By knowing this, this person may have thought twice about buying the new car and would re-direct the $350 to eliminate that high-interest rate credit card debt.

How do you Calculate Net Worth?

First: Tally Up Your Assets – What You Own

So – I said calculating net worth is simple – which it is – but I want to be honest — I calculate my net worth in a couple of different ways.

Always start by calculating your total net worth including all of your assets. Those include the values of your house, cars, savings account balances, checking account balances, retirement account balances, cash, savings bonds, 529 accounts, and any other valuable assets you could reasonably sell. Here’s the warning – be conservative about the value of your assets – especially the physical assets like your home, car, jewelry, etc. Be honest with yourself about what you could reasonably expect to sell the asset for in today’s market.

I also choose to calculate a more conservative calculation of net worth that I use to evaluate how close I am to financial independence (the point at which passive income from investments covers all living expenses). This calculation of net worth doesn’t include certain assets like my car value (because it depreciates over time), my home value (because I don’t want to have to sell my home), and my kid’s 529 accounts (because I plan to use that for my children’s education).

Helpful hint: While you are collecting the information on your assets – take a few notes on the interest rates on your checking and savings account and any other assets with a specified return.

Second: Add Up Your Liabilities – What You Owe

So now it comes time to face the numbers. When you tabulate your debt you should include everything! Your mortgage, student loan, auto loan, credit card balance, 401k loan, any personal debt — even the 200 bucks you owe your brother!

Helpful Hint: While collecting information on your debts – please collect the interest rate expressed as the Annual Percentage Rate (APR). These rates will be very useful in prioritizing your financial strategies to improve your financial health.

Moment of Truth: Calculate your Net Worth

Once you sum up your assets and liabilities, you then just subtract your liabilities from your assets and voila – you have your net worth! I suggest creating a spreadsheet similar to the one below (you can do this in a notebook if spreadsheets aren’t your thing). Once a month, collect the balances from each of your accounts. If you use an online aggregate tool like mint.com or Personal Capital, you can just log in to get the account balances. Those tools will tell you your overall net worth for all the accounts you have linked to them, but I believe that taking the time to collect the data on each account balance is a valuable exercise. Not only will you be able to see the overall trend in your net worth, but you will also see the trends for each account balance separately.

I like to plot my net worth against the major components of net worth (Cash, Non-Cash Assets, Consumer Debt) so I can see what is driving changes to my overall net worth value.

How often should I calculate and track my net worth

If you are just beginning to take control of your budget or focusing on aggressively attacking a financial goal – monthly monitoring of net worth can provide you huge benefits. If you are in a very stable financial health position and you can live within your budget easily and have automated your savings/investing, quarterly may be more appropriate (unless you are like me and just enjoy checking in each month). I would caution you to extend longer than that, because you may not be able to see the impact of some financial decisions you are making and lose the benefits of monitoring for trends.

What Now — How can I transform my finances??

Here’s an example of the type of chart you can create to track your net worth.

Observations for this example:

• The net worth trend is rising overall.
• Analysis for the drop in February — this was driven by non-cash assets (like a dip in the stock market) – not due to taking on additional liabilities.
• Analysis for the drop in December –Cash savings spent on a holiday trip that was planned.
• Liabilities are trending downwards.
• Consumer debt is trending downwards.
• Cash is a very small percentage of total assets – will be discussed in a future YMN Topic: Liquidity.

For the Net Worth Topic of YourMoneyNumbers, do not focus on the overall value of your net worth or comparing yourself to others. The most important thing here is to get in the habit of tracking your net worth, making sure you understand any drops and how your financial choices impact it, and if it is trending in a positive direction to support your goals. You want to see the trend going up. BUT — if a lot of your net worth is tied up in naturally fluctuating assets — stocks let’s say — and the market is down, don’t panic too much if your net worth is down. Just watch the trend over time. If you are making choices that drive your net worth down – purchasing a luxury depreciating item—like a new fancy car or boat – you need to ensure that the choice is 1) aligned with your values and 2) doesn’t disrupt your other financial goals.

If you use a sinking fund to save for a big family vacation – when you purchase the tickets and go on that family vacation, your net worth may take a step back. BUT it was planned, came out of savings, and aligned with your values. In this case, there isn’t a need to worry about the dip since your budgeting approach will replenish that fund over time.

I strongly suggest that everyone do an annual comparison to where you were a year prior. This can be very empowering to see how much your efforts over the year have made a difference in your overall net worth. The month-to-month trend analysis can be good, but sometimes the differences are subtle. By looking at your progress over the year – you can see the total impact of your financial decisions for the year. 

Now Take Control

Congratulations! By simply calculating your net worth and tracking it over time you will be provided with valuable feedback to see if your financial health is stable and moving in a positive direction. This is like having a compass – you know what direction you are moving in – but not necessarily where you will end up or how long it will take to get there.

Before we can get to the YMN Topics that help you figure out your financial path and destination, we have to tackle YourMoneyNumbers Topic #2: Budget. See you in the next Post!

Let’s discuss in the comments below:

• Do you already evaluate your net worth? How often do you look at it? How does it help you make better financial decisions?
• If you don’t already track your net worth, did this post convince you to start? What other net worth questions do you have?

Click here for the collector post of all the YourMoneyNumbers Topics

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