How to Calculate your Net Worth

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Simply put, the net worth of an individual is the amount by which his assets exceeds his liabilities. In business terms, the net worth is also known as the book value.

Why does it matter? The net worth is the single most important number to estimate an investor’s ability to retire early. Income is important, the Savings Rate is important but they both contribute to the same goal : increasing the net worth.

Assets & liabilities

There are slightly different ways to calculate Net Worth and the version below is the most intuitive. Take a spreadsheet and list on one side all your assets. In that case, assets would be anything of value:

  • Bank accounts (checking & savings),
  • Certificates of Deposit (CDs),
  • 401k,
  • Company stocks,
  • Brokerage account,
  • Car(s),
  • Primary Residence’s market value*,
  • Secondary Residences values.

I do not typically include lifestyle assets like cars, jewelry and such in my own calculations because they are not investable assets and because they don’t represent much anyway. It would also normally make no sense to build a net worth accumulating cars or jewelry so I typically exclude them from the assets list.

On the other side of your spreadsheet are the liabilities. Everything that represents “owed” money should be listed:

  • Credit card debt,
  • Student loan,
  • Car loans,
  • Primary Residence’s pending mortgage*,
  • Secondary Residences mortgages.

* Note: including or excluding the primary residence in the asset/liability calculation is source of much debate but they both serve different purposes. For the individual investor, it does make sense to include the primary residence, however for the government, it is usually excluded.

Why you should include your house in your Net Worth

The house often represents one of the biggest investments someone will make and so it would make little sense to exclude it from the Net Worth calculation. If the house value increases on the market, so does the Net Worth. As the mortgage repayments progress, the liabilities decrease and the Net Worth increase.

I would include the primary residence value and pending mortgage in my Net Worth calculations.

However, strange things happen when someone transitions from being a renter to a home-owner: his net worth decreases and sometimes goes negative. Let’s look at Joe’s net worth while he is a renter:

  • assets : 100k$ of savings
  • liabilities: 0$

In this case, Joe’s net worth = 100 – 0 = 100k$

Now Joe decides to purchase a home worth 200k$, with a 4% mortgage over 30 years and a 20% downpayment. In total, this mortgage will cost 275k$.

  • assets : 60k$ of savings + home value of 200k$
  • liabilities: 275k$ of pending mortgage

Now, Joe’s net worth = 260-275 = -15k$

Joe’s decision to become a home-owner effectively reduces his net worth in the short term. Does it make sense to say that an owner has a lower net worth than a renter ? Or when taking an international perspective, does it make sense that an American home-owner has a lower net worth than an Ethiopian renter?

As such, to be able to compare net worth across individuals or countries, the primary residence is typically excluded from the calculations. In the eyes of the US government for example, a millionaire is someone with a net worth of at least 1M$, excluding its primary residence as explained by the Securities and Exchange Commission.

This is why it is OK to include your primary residence in your own calculations, as it provides a strong incentive to grow your net worth. However, when used to compare individuals’ net worth, the approach sometimes need to be tweaked to avoid bias.

Dear readers, do you calculate your net worth on a regular basis? What types of non-traditional assets do you include in your own calculations?

Nick – Money Miner

Photo credits: Oliver Berghold

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4 COMMENTS

  1. I don’t really worry much about our net worth, to be honest. I do a monthly financial statement on my blog, but never include net worth. A lot of our net worth is tied into real estate, which goes up and down. Also, I see the point you make about the primary residence being considered an asset or liability. Our net worth would be substantially less if we subtracted the mortgage we owe, but if we rented, our rent would be a lot more than the mortgage we pay and the rent wouldn’t be considered a liability. So I’d probably not consider the house debt as a liability because I would have to pay the monthly cost anyway, in order to have a roof over my head. But for all intents and purposes I see why you’d calculate that debt as a liability, and I might add a net worth calculation as well to some point to my blog. Just that I’m more concerned with the cash flow right now 🙂

  2. Felix – I would agree with you that cash flow is super important and that’s something I am working on myself. As net worth goes, it seems that it depends on everyone’s preference, and it is probably OK as long as it is not totally ignored.
    In effect, including the primary residence in the net worth calculation offers a better representation of the size of the “pending commitments” and how much freedom there really is: if I need 1M$ to retire, I would much prefer consider 1M$ net worth, primary residence & liabilities included, than excluded.
    Thanks for the thoughts, always good to see things from a different perspective!

  3. In my calculations, the primary house value and loan is excluded. The main reason is already given above: one needs to live somewhere. It is true that selling would free up the saved equity, on the other side, the mortgage is lower than renting.
    Another reason not to use is, is that the house can not generate income while I live in there (I exclude reverse mortgage as an option).
    I have my number in my mind, and this should only be accounted for by assets that I can sell with no impact on my life.

    IF one day I decide to sell the house and life elsewhere, than the impact will be seen.

    • Hi Amber – lots of good points here!
      You would have a very good control on your finances already if you have this number in mind, so congrats!
      I calculate our net worth as an indication of where our finances are at a point in time, but what I now value most is the trend.
      As long as your calculation remains consistent and it helps you make decision to reach your goal, you’ll do great!

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