I am often asked what is net worth and why knowing it so important to my financial health?
Net worth is a measure of wealth. Specifically, it is the total of what you own minus the total of what you owe. You can calculate your net worth by subtracting your liabilities (debts, loans) from your assets (cash, property, investments). If your assets exceed your liabilities, you will have a positive net worth. If your liabilities exceed your assets then of course you will have a negative net worth.
Let me give you some reasons why knowing your net worth is important.
It’s a Reality Check – Seeing the results of your net worth calculation forces you to confront the realities of where you stand financially. Reviewing your net worth over time can help you to determine where you are and how to get where you want to be. This can give you encouragement when you are heading in the right direction such as reducing debt while increasing assets, and provide a wake-up call if you are not on track.
Identifies Areas of Overspending – Just because you can afford something doesn’t mean you have to buy it. To keep debt from accumulating unnecessarily, consider if something is a need or a want before you make a purchase. To reduce unnecessary spending and debt, your needs should represent the majority of your spending. Keep in mind that you can falsely rationalize a want as a need. That $500 pair of shoes does fulfill a need for footwear, but a less expensive pair will do just fine and keep you headed in the right financial direction.
Encourages Debt Reduction – Reviewing your assets and liabilities can help you develop a plan for paying down debt. When in doubt, crunch the numbers to see if it makes financial sense to pay down a certain debt versus saving the cash, which you might need for emergencies.
Helps with Loan Approval – Lenders are often interested in knowing your net worth when determining whether to approve you for a loan, as it is the best measure of overall financial strength.
Calculating your net worth can be an intimidating experience, particularly if your net worth is low or negative. However, net worth isn’t stagnant. It is simply a number that you can continue to change in the future. If your net worth isn’t where you want, let it motivate you to save and invest more, but spend less. If your net worth calculation shows that you are on track to meet your financial goals, be encouraged and continue what you’re doing. Until next week, stay financially fit!