What is Net Worth and Why is it Important?

What is Net Worth and Why is it Important?

Some people base their financial health solely on having a big paycheck, by having little to no debt, or by how much money is in their bank account.  While these approaches aren’t inherently wrong, understanding and tracking your net worth over a period of time can provide clearer insight on whether your financial health is trending up or down and can help you track your progress toward reaching financial goals.

What is net worth?

Net worth is a metric that can provide a snapshot of your overall financial health at any point in time. Your net worth is simply the difference between the total value of what you own (assets) and what you owe (liabilities).  A positive net worth means that you have more assets than liabilities and a negative net worth means you have more liabilities than assets.  Therefore, the goal is to have a positive net worth.  The higher your net worth, the healthier your finances are. The lower your net worth, the less healthy your finances are.

What are considered assets?

Assets are anything that you own that are of value and can be classified as liquid or illiquid. Liquid assets can easily be converted into cash such as with the balances in your bank accounts or in stocks and bonds. Illiquid assets will take some time and energy to convert into cash such as with the equity in your home or car, artwork that you own or precious jewelry. Depending on your age, balances in retirement accounts can be considered a liquid or illiquid asset because of the taxes and penalties that may be charged if you draw on them too early.  If you increase the value of your assets while maintaining or reducing your liabilities, your net worth will increase.

What are considered liabilities?

Liabilities are another way to describe your debts.  They are anything that you owe money on such as the balance on your car or home loan, credit card balances, student loans, etc. As you pay these items off, it decreases your liabilities (if you aren’t taking on new debts), and should increase your overall net worth.

What should your net worth be?

First things first, you should always strive for a positive net worth.  Beyond that, there is no set standard for what your net worth should be.  Everyone’s financial situation and goals are different.  However, it may be helpful to understand what your net worth is compared to others in your age group. According to NerdWallet, these are average net worth values by age group in the United States:

Why is understanding and tracking net worth important?

At any point in time, you could be working toward a variety of financial goals:  paying down credit card debt; increasing your emergency savings fund; planning for retirement; paying down your mortgage; saving for your child’s college education; saving for (or paying off) a vacation; paying off medical bills; managing a daily budget; etc.  If you focus each of these goals in a vacuum, it is difficult to get a clear picture of your overall financial well-being. It’s easy to focus on one goal while inadvertently sabotaging another goal. Doing so could have a null to negative impact on your net worth.

For example, let’s say in January you calculated your net worth to be $19,000. You have $20,000 in equity in your home, $4,000 in savings and $5,000 in debts.  You made it your goal to increase your net worth within the next year by increasing your savings balance to $5,000.  After paying all of your bills, you have $100 left each month to put toward your goal. Within 10 months your savings balance reaches $5,000, congratulations!   Also during that time your home equity increased by $1,000.  However, you inadvertently increased your credit card spending and now your total debt balance is $7,000. In this scenario, only focusing on increasing your savings and not keeping your credit card spending in-check had a null effect on your net worth. Meaning, you did not increase your overall financial health by achieving your savings goal.

Let’s consider the same example but assume that you were able to keep your credit card spending in-check and even managed to pay it down by $500. In this example, your net worth increased by $2,500! Increasing your savings while simultaneously being mindful of your debt had a positive effect on your financial health.

While you still need to be mindful of other indicators of financial health such as managing or improving your credit score and living within a solid budget, net worth tells a holistic story about how many aspects of your finances are working together. Ideally, savings would always increase while debts would decrease.  But that may not always the case. There may be periods when your savings is lacking but debt gets paid down faster, or vice versa. That’s okay.  As long as your net worth continues to trend upward over time, your financial health will continue to improve.

A Personal Banker at FNBO can help you with checking, savings and loan accounts that can help you meet your financial goals.  Stop by a branch today or visit us at FNBO.com.