What is net worth? How it can be important indicator of your financial well-being
Net worthis an individual or company's total assets, minus any liabilities or debts.
- Net worth is a snapshot of financial health, and evaluated alongside other measures for a fuller picture.
- Keeping track of your net worth can help put your debts into perspective and help you plan for the future.
If you're looking to gain insights into your financial health, understanding net worth is a must.
Net worth answers the question, "how am I doing financially?" and helps assess whether you're on track to tackle debt and meet wealth-building goals.
It's used by financial advisors to determine what you're doing well and what you should be doing better, but it isn't without its limitations.
What is net worth?
Net worth is the total value of your financial assets minus your liabilities, or debts. In other words, your net worth equals what you own minus what you owe.
Net worth presents an easy way to measure a person or company's financial standing. It's a fairly straightforward formula, calculated by subtracting liabilities from assets, but the real leg work comes from compiling the numbers that make up these two categories.
Understanding net worth
Net worth can be applied to a person, a company, or an entire industry. It's used by professionals to conduct an "as-is analysis," or to determine whether someone has equity and what that equity is worth.
It's also used to track financial progress by comparing annual statements year over year. If net worth grows over time, it means that business overall is growing, which is especially helpful because looking at assets or debt alone do not paint the full picture.
On an individual basis, net worth serves a few key purposes:
- Evaluating where you are financially: Determining your net worth can help answer questions like whether you're saving enough for retirement, what debts you're falling behind on, and whether you have enough money set aside should an emergency hit.
- Identifying problem areas: Calculating your net worth can help you pinpoint where you're falling behind, whether that's in paying off a debt or noting a habit of overspending in other areas.
- Achieving financial goals: As important as it is to establish clear financial goals, it's also important to periodically evaluate whether you're on track to achieve them. Net worth can help you check how close you are to meeting retirement savings goals, and reshape current savings practices if need be.
Financial professionals often look at net worth and cash flows together for a more comprehensive view. The last line on a personal balance sheet depicts net worth, and this metric is straightforward, but not all-encompassing.
"It gives a snapshot in a period of time," says Certified Financial Planner Vladimir Nikitenko.
"The balance sheet lists your assets and liabilities, and that's kind of measuring the financial health of a client, so if I want an easy way to see what position this client or company is in, the easiest thing for me to do is take a look at their balance sheet and their cash flows," says Nikitenko.
Net worth doesn't always directly correlate with cash flow, however, so it's important to distinguish between the two. Someone's net worth can increase from one year to another when they don't have a significant cash flow, so long as they're reducing expenses.
Liquidity, or how much money you have regularly available, is an important factor to consider when measuring financial health. In the instance where someone has a high net worth on paper, but those funds aren't necessarily available, net worth isn't the most accurate representation of wealth.
"If they have a bunch of money in their retirement account but can't pay for a $10,000 emergency, that's a big problem and that's where net worth probably has its biggest limitations," says Nikitenko.
Net worth vs. income
Net worth is not the same as income. Just because an individual earns a high income does not necessarily mean they have a high net worth - and vice versa.
If someone has a high salary but spends money with ease, it's reflected poorly in their net worth. On the flip side, someone who brings home a smaller paycheck but saves or invests most of their money can quickly and effectively grow their net worth.
Ultimately, net worth is made up of assets and liabilities, while income is what you earn from a job or any investments you've made.
Average net worth by age
Americans across all walks and stages of life have different net worths. According to the latest survey by the Federal Reserve, the average net worth of American households is $748,000.
Here's a rundown of the average and median net worth of the head of household, broken down by age, in 2019:
|Age||Average net worth||Median net worth|
|Under the age of 35||$76,300||$13,900|
|75 or more||$977,600||$254,800|
Calculating net worth
Net worth is calculated by adding up your assets and subtracting any liabilities.
- Assets: Assets are what you own, including cash in bank accounts, savings, and retirement accounts. It also includes items like investments, vehicles, and real estate.
- Liabilities: Any money you owe counts as a liability. This includes outstanding student loans, credit card bills, and mortgage payments.
You can calculate your net worth in three steps:
1. Total all liquid assets, like cash and savings, with illiquid assets, or money that can't be as easily converted to cash, like land or a vehicle.
2. Total all liabilities, including debt and outstanding payments, like student loans and medical bills.
3. Subtract liabilities from assets.
Net worth can be either positive, meaning assets exceed liabilities, or negative, with the opposite being true. Positive net worth signals strong financial standing, while negative net worth can be a financial red flag.
To improve net worth, an individual must reduce liabilities while maintaining or growing their assets, or grow their assets while maintaining or reducing liabilities.
What constitutes a high net worth?
High net worth is used in the financial services sphere to refer to someone with wealth that exceeds a certain dollar amount. In reality, the term "high-net-worth individual" is quite relative.
"If you're talking about practices, a high-net-worth client is someone who has over five million in assets," says Nikitenko. "[But] if you're talking about Forbes and the top people listed on there, a high net worth is in the billions, so that's a very very relative term."
Your age group is also considered when determining what qualifies as high net worth. Net worth generally increases with age until it plateaus as older age groups retire and begin spending their retirement savings.
For young professionals, for example, a high net worth could be someone whose assets exceed $500,000. But among retirees, the metric changes because they're expected to have accumulated more by that age and experience level.
The financial takeaway
Net worth is a measure of a person or company's broad financial standing, but is often considered alongside cash flows for a more accurate depiction of wealth. It's used to determine whether someone has equity and what that equity is worth, and can be found by subtracting total liabilities from total assets.
Calculating your net worth can help you better understand your current financial position and how you got there, as well as how you can make better investment moves to build and maintain wealth moving forward.A growth stock is a company expected to rise faster than the overall market, offering bigger gains for investors who don't mind risk Behavioral finance is a science that analyzes why investors often make misguided choices Where to invest when interest rates are low - 6 fixed-rate vehicles that offer the best returns Capital gains are the profits you make from selling your investments, and they can be taxed at lower rates
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