Remember when was the last time your parents got your report card from the class teacher? As though it was a judgment day that everyone had to go through every year. A report card spelled out all your exam grades and behavior which essentially tracked your academic progress over the years. And calculating your net worth is just as important. It’s the simplest form of measurement to evaluate your financial health.
But the difference is that now you’ve to take charge of your own net worth. That’s the very first step that you should start doing during your transition to adulthood. Bet your school teacher didn’t teach you, huh?
What is Net Worth?
Many people always have the misconception that high income equals to high net worth. By definition, net worth is the difference between your assets and liabilities.
Net worth = assets – liabilities
Your net worth gives you an overview of your financial situation. It basically measures your personal wealth at any point in time.
Why Your Net Worth is Important?
Before explaining on how to calculate your net worth, let me share with you why it matters.
1. Track Your Financial Progress
Net worth gives a snapshot of your financial situation which helps track your financial progress. Everyone may have different financial goals based on individual circumstances. It could be saving a 6-month emergency fund, paying off a student loan, retirement planning or anything else. But all these bits and pieces form part of the equation that derives your net worth.
Though it’s just a number, your net worth captures all the efforts that you’ve put in to meet certain financial goals. You may have been working your ass off day and night to work towards financial independence. But without knowing your net worth, you won’t even know whether you’re on the right track or not.
Calculating your net worth on a periodic basis also gives you a moment of realisation. It can be a strong encouragement that tells you, “Job well done!” Or, it could be a trigger that sends you an important message. “It’s time to act now!”
2. Avoid Over-Leveraged
Knowing your own net worth can also help you avoid being over-leveraged. You’ll refrain from taking on too much debt to the extent that it might cause a financial catastrophe to yourself.
There’s a popular Chinese saying, if you don’t have such a big head, don’t wear such a big hat.
Most savvy investors, if not all, are well aware of the power of leverage to grow wealth. Investors are leveraged when they buy assets using borrowed funds to make profits. To put it simply, using leverage is like taking others money to make more money. This is particularly apparent in real-estate investing.
It’s increasingly common that many people become over-leveraged when they’re blindfolded by greed and money. It may seem wealthy to own a few houses. But chances are, they’re owing millions to the banks at the same time. Worse still, it could lead them to financial distress or bankruptcy easily when they fail to make repayments on time.
Your net worth summarises all your assets and liabilities. By taking a glance, you’ll know if you’ve sufficient assets to cover your debts with some breathing room.
3. Make Life Decisions
You may be surprised that keeping your net worth in mind can actually affect your life decisions significantly.
Many argue that money is not everything in life. But the ugly truth is that passion alone doesn’t pay the bills. Deep down, you may have the wildest dreams that you want to chase after since young.
However, you’re not sure whether you should get out of your comfort zone or not. Perhaps, it’s too harsh to put the blame on yourself.
Who doesn’t want to be a successful entrepreneur?
Who doesn’t want a job that he/she is truly passionate about?
But rationally, do you think you can manage a business well if you don’t even have your own finances in control? Passion will not be your priority either if you’re the sole breadwinner of your family.
The good thing about knowing your net worth is that it gives you a clear perspective about your financial situation. And with that in mind, you can have peace of mind when choosing your paths in life. It could be anything like a job change, starting a business, relocation, etc.
How to Calculate Your Net Worth?
Calculating your net worth is just simple math.
Step 1: List down your assets and their values
An asset is something that of value which you personally own and can be converted into cash. Assets may take different forms, but the common ones are categorised as follows:
Liquid assets – Cash, stock investments, fixed deposits, unit trust investments, ASNB fixed price funds, etc.
Long-term assets – EPF savings, real-estate investments, PRS contributions, etc.
It has been long debated that whether primary residence should be considered for the purpose of calculating net worth. Because even if you sell it off for cash, wouldn’t you buy another one to stay? Unless you want to downgrade your lifestyle and get a cheaper house. No freaking way!
While cars are typically considered as assets, personally I won’t consider them to calculate my net worth as well. From the economic perspective, not only cars are depreciating assets that lose value over time, they also require maintenance that eats up my net worth.
Step 2: List down your liabilities
A liability is something that you owe and have to settle it with either your cash or assets when the obligation arises. Your personal liabilities generally include mortgages, car loans, student loans, credit card debts, etc.
Step 3: Calculate your net worth
Simply subtract your total liabilities from your total assets, the resulting number is your net worth.
You can calculate your net worth easily using this net worth online calculator. Or, you can also do it manually using an Excel worksheet. It’s advisable to calculate your net worth at least once a year.
There are only two ways to increase your net worth, either to increase your income or to save more. You should always invest early to grow your wealth through the power of compounding. (Related: 5 ways to save more money, Invest in P2P lending to grow your wealth)
Don’t be panic if you have a negative net worth. The number is just a benchmark to evaluate your financial health from time to time. Looking at it alone doesn’t tell whether you are good or bad in managing your finances.
A young professional graduate could have a substantial amount of student loan, but his/her earning power would be much higher than the non-professionals over time.
More importantly, use your net worth to keep track of your financial progress. It helps you re-focus on your financial goals and make sure you’re heading in the right direction.