What Is Net Worth?
Having positive net worth means owning more assets than debt you owe. It is possible to have a negative net worth, where you owe more money than assets owned. For example, this can happen when someone takes out a large amount of student loans, but has yet to acquire any meaningful assets. The goal is to have an upward rising personal capital over time.
How to Calculate Net Worth
Think of personal capital as your personal balance sheet. Your income, such as salary, dividends, and investment income, are all part of your personal income statement. Cash within your checking account, which might be from your salary, is part of personal capital, however.
What’s Included in Net WOrth?
Ownership interests in businesses are also included, which generally means a stake in a private company. The value of business ownership should be recorded at market value, which is the value you’d receive if you sold the business today. Personal property, which are assets you use or collect, can also be included in personal capital. This includes assets you use, such as your home, vacation home, automobiles, boats, and jewelry, among other things. Assets you collect may include antiques, coins, or artwork.
To include personal property, the resale value must be able to be reasonably estimated. Investment real estate properties would also be included, although they might be viewed as a business interest/ownership if you own your property in a limited liability company (LLC) or other company structure.
Anything you’re expected to pay should be included in liabilities, which means medical debt, loans against your 401k or IRA, life insurance policy loans, etc. should all be considered as liabilities.
Net Worth vs. Income
Meanwhile, Roger, making $150,000 per year, has saved $100,000 for retirement, has a home valued at $1 million and owns various rental properties valued at $2.5 million. Yet, he owes $900,000 on via the mortgage on his primary home and $2.2 million in debt on the rental properties, as well as $200,000 in credit card debt. Roger’s net worth comes out to $300,000 (or $100,000 + $1 million + $ 2.5 million - $900,000 - $2.2 million - $200,000), which is noticeably less than Charlie, despite the income differential.
While income can tell one story, net worth can tell another, which is why banks and lending institutions generally ask for a detailed accounting of your assets and liabilities when considering a mortgage.
What Should Your Net Worth Be?
The loose rule of thumb is to have half your net income as personal capital by the time you hit 30 years old. There’s some leeway there given time lost to college, but by the time you hit 40, the amount goes to twice your income, and then four times your income by 50. Finally, by the 60 mark, the goal should be to have six times your income. Here’s a quick breakdown of what a target personal capital amount might look like:
Real Estate and Net Worth
Say a homebuyer, call him 25 year old Samuel, takes out a mortgage for $250,000 to purchase a home. The mortgage will be his largest debt ever, but after paying for mortgage for 30 years, he’ll own a home outright that’s worth much more (hopefully) than the purchase price. This will likely be his largest asset when he’s 55 years old and make up a large part of his personal capital.