When discussing wealth, we often refer to income. Income, however, isn't the best way to define your financial stability. The more accurate way of defining your wealth is by knowing your net worth. This is because net worth considers not only what you have, but also what you owe. For instance, the money you borrowed to spend for a trip counts as a liability and not an asset. Net worth also accounts for not only your financial assets, but your material assets as well. After all, there is wealth beyond money .
The media uses the term "net worth" a lot when describing celebrities, and other members of the ultra wealthy. Of course, nobody's worth as a person is defined by their wealth. In monetary terms, though, everybody has a net worth. For the Jeff Bezos' of the world, their net worth can be in the hundreds of billions. For a person in debt, their net worth might be -$10,000. By calculating your net worth, you can take a step towards assessing your financial health.
How to calculate net worth
Net worth = assets - liabilities
- Assets include everything a company or individual owns that has economic value, meaning it has financial benefits now or in the future. Great examples of this is are land and collector's items because they increase in value overtime, providing financial benefits in the future. An asset can be bought or generated through multiple streams of income.
- Liabilities account for everything a company or individual owes through loans, mortgages, deferred revenues, bonds, warranties, and accrued expenses.
Example 1:
Assets:
- $50,000 in ETFs
- $20,000 in a savings account
- $5,000 in a checking account
Total assets: $75,000
Liabilities:
- $15,000 mortgage
- $5,000 car loan
- $5,000 in credit card debt
Total liabilities: $25,000
Net worth = $75,000 - $25,000
Net worth = $50,000
Example 2:
Assets:
- $20,000 in a savings account
- $5,000 in a checking account
- $10,000 in personal possessions (such as jewelry, art, etc.)
Total assets: $35,000
Liabilities:
- $30,000 mortgage
- $5,000 car loan
- $10,000 in credit card debt
Total liabilities: $25,000
Net worth = $35,000 - $45,000
Net worth = -$10,000
Based on the formula, we can infer that people who have a higher net worth despite an average income probably have a diverse set of high value assets and fewer liabilities. Those who have a higher income but lower net worth possibly rely on a single stream of income and have more liabilities.
For establishments, the balance sheet would look a lot more detailed. Below is AT&T's 2020 balance sheet for reference. The liabilities are divided into current and long term to show where the company should focus on in terms of s hort term financial obligations.
How investing can build your net worth
When we learn to understand the importance of net worth, we realise that traditional income alone is usually not enough to achieve financial independence. The key to improving your net value is by diversifying your assets and minimising your liabilities. This doesn't mean you should drastically change your spending habits or buy collector's items today. However, you can create a diverse portfolio of ETFs, or exchange-traded funds.
What is ETF?
An exchange-traded fund is a pool of multiple assets in one investment security. Investing in an ETF then diversifies your asset portfolio by default. Because of the rapid advancement of online investing in the past three years, it's become easier and cheaper to invest in ETFs today. Now, there are many online brokerages (like Pearler!) who offer ETF investing options.
Unlike mutual and closed-end funds, ETFs have a daily transparency report in the form of daily portfolio holdings. This allows investors to see the assets and aggregate liabilities any time. For other types of investments, you can expect this type of report quarterly only. Moreover, ETFs can be managed passively, granting investors the flexibility to execute their strategies compared to active funds.
While all investments carry findings, investing in ETFs has historically been a popular way to increase net worth. Again, net worth is not a measure of a person's value as a human, but a good indicator of financial health. And by measuring yours, you can better keep track of your financial goals.
