Why Net Worth Is Important
Different numbers mean different things – obviously – yet depending on what stage of life you’re in, the value or importance of a number can be drastically different.
As a kid in grade school, it might have been your PIN for the school cafeteria. It was likely your SAT scores and GPA as you were applying to colleges, and in college, probably still your GPA as you were looking to land your first job.
Then, the rubber meets the road as you’re packing your bags for the lovely world of actual bills and adulting. In this stage, the numbers get a little more tricky and may potentially determine the entire state of your financial independence *no pressure*.
As an adult, two numbers become notable: credit score and net worth. Today we’ll focus on one, your net worth, and leave credit score for another article.
While you’re likely familiar with the term net worth, it’s probably not something you hear talked about in the real world.
Depending on how you think about money and progress on your journey to financial independence, you’ll come to realize it’s something that’s way more relevant than you might initially think.
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There are several reasons for this but most importantly, understanding your net worth provides a snapshot of your overall financial health and ultimately helps you build your wealth.
Before the why, it’s essential to understand the what.
In this case, it comes down to two things: assets and liabilities, or to simplify it, what you own vs. what you owe. Your net worth is merely a calculation of the two – assets minus liabilities.
Assets – Liabilities = Net Worth
Assets are things we own that appreciate and grow in value, such as stocks, real estate, cash, etc. Then you have liabilities, such as credit card debt, student loan debt, car loans, etc.
If you have a 401(k) with a $50,000 value and a savings account with $15,000, but your credit card and student loans total $45,000 of debt, your net worth equals $20,000.
$50,000 + $15,000 – $45,000 = $20,000
We highly recommend a couple of tools that can help make keeping track of your net worth easy. Personal Capital and Tiller Money.
With the ‘what’ understood, let’s look at why it’s important to know your net worth. First, tracking progress leads to better results. Seriously, this is proven in practically any scenario.
What gets measured… gets improved.
Your net worth is no different.
As you’re tracking your net worth, growing your income, and thinking of making bigger purchases… you’ll begin to notice a trend. And depending on if you’re making sound financial decisions or bad ones, that trend could be positive or negative.
This is a pretty telling indicator of if you’re putting money towards assets or liabilities.
Another way I like to think of net worth and tracking changes to it, is to ask yourself, how does a financial transaction impact your bottom line?
I don’t care how disciplined you are with your finances, we all have our vices.
Whether that’s traveling, good food, or shopping, ask yourself, when you tally up all the numbers after buying yourself that new pair of shoes or a new bag, where is your money really going?
Large corporations refer to this as their P&L statement — profit and losses.
You decide which side of the coin you want to be on, but I’ll let you in on a secret: on one side, there’s a ton of wealth, and on the other, it just looks like a ton of wealth. This leads us to our next point.
What does money look like to you? After understanding how net worth is broken down, you’ll be surprised to know who the higher net worth individuals are vs. those who appear to be wealthy.
The Psychology of Money – What you see isn’t always what you get.
I’m sure you’ve seen the infamous infographics of the man or woman wearing the $10 t-shirt, $20 jeans, and $30 shoes, standing next to the person who’s wearing the latest designer clothes, flashy watch, and jewelry worth thousands with all the other trappings of wealth.
It usually appears with a one-liner that says the person with the $50 outfit is a millionaire and the person wearing all the designer items is broke. Sound familiar?
The problem with this scenario is that it’s completely subjective, it could be true, and sometimes it’s not.
Some folks can wear a regular shirt that you’d have no idea was $500-$600 because there isn’t a logo to be found. Ask Mark Zuckerberg about Brunello Cucinelli.
The point that we’re making here is this: you can’t know someone’s financial worth until you look at the numbers.
You may not know the numbers for others, but guess what? You can certainly know them for yourself.
Here’s a quick look at the numbers of 2 different people who work the same job, making roughly $80,000/yr.
- Owns a 2008 Honda Accord ($8,000)
- Lives in a $200,000 home, with $40,000 left on the mortgage ($160,000)
- Invests in index funds + ETFs ($23,000)
- Has cash saved away for a rainy day ($6,000)
- No student loan debt
- Drives a 2020 C class Mercedes Benz ($30,000 owed)
- Lives in a $450,000 home, with $400,000 left on the mortgage ($50,000)
- Credit card debt ($12,000)
- Student loan debt ($24,000)
- $2,000 saved
One of them is worth almost $200K, and the other has a negative net worth of -$14,000, but judging by both of their lifestyles, you’d never know it from the surface view.
Understanding your net worth puts things into perspective and exposes reality by stripping what can only be seen on the exterior.
If you’re looking to improve your financial situation, I highly encourage you to begin tracking your net worth. This puts things in black and white and allows you to see what your dollars are going towards, assets or liabilities.
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Additionally, as you’re calculating your net worth, a few things will come to light that are also important, such as your debt-to-income (DTI) ratio. Banks will review it to determine your eligibility for a loan.
You’ll also grow smarter about your track towards retirement.
Since we no longer live in an age where we can depend on others to help fund our later years as a reward for staying at a job or company for a certain number of years, your retirement is on you.
You’re accountable for knowing when you want to retire and how much you’d like to retire with.
Learning about your net worth will illuminate these things and hopefully encourage you to either get more aggressive about saving/investing or prove to you that you’re right on track. Either way, it helps.
Your net worth shouldn’t be a number that scares you; it should be something you’re conscious of and actively working to improve.
Once you start tracking it and learning more about your finances, I’m sure you’ll enjoy watching it grow as you continue on the journey of building wealth. From there, enjoy the fruits of your labor.