Freedom Life Planning

The Ultimate Guide to Financial Planning

How to Calculate Net Worth and Why This is Important

If there is one number that represents your current financial health and status it is your net worth. Your net worth is more important than your current income level when evaluating your financial health. What is your net worth? It is basically what you are worth in dollars (or any other currency). It is also one of two numbers that can tell you if you are financially independent or if you are on your way to reaching it. The second number is your monthly or annual spending. How do these two numbers relate? Well if you follow the advice on this website about investing, once your net worth reaches a certain multiple of your annual or monthly spending, you have obtained financial independence and can retire if you choose to do so!




What is this multiple? The 4% financial independence or retirement savings rule allows you to calculate that. The 4% rule goes as follows: You can safely withdraw 4% from your investments on Year 1, and then increase this withdrawal amount each year by inflation for subsequent years. Your investments will then have a very strong chance of lasting the rest of your life while providing you with a fixed income. To know how much net worth you need to retire or obtain financial independence, you must first know your spending. If you need help with that, check out this article on making a budget.

Once you have your spending down, you need to apply the inverse of the 4% rule. The math works out to 25x your annual spending or 300x your monthly spending. See the table below for a few examples.

Monthly Spending Annual Spending Net Worth Needed
$ 1,000 $ 12,000 $ 300,000
$ 1,500 $ 18,000 $ 450,000
$ 2,000 $ 24,000 $ 600,000
$ 2,500 $ 30,000 $ 750,000
$ 3,000 $ 36,000 $ 900,000
$ 3,500 $ 42,000 $ 1,050,000
$ 4,000 $ 48,000 $ 1,200,000
$ 5,000 $ 60,000 $ 1,500,000
$ 6,000 $ 72,000 $ 1,800,000
$ 7,000 $ 84,000 $ 2,100,000
$ 8,000 $ 96,000 $ 2,400,000
$ 9,000 $ 108,000 $ 2,700,000
$ 10,000 $ 120,000 $ 3,000,000
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So it is clear if you are making a financial plan, setting a net worth target is crucial. But you also need to know what your current net worth is and how do you calculate it. Your net worth is the value of all your assets minus all your liabilities (or debts). I recommend starting a spreadsheet to help with this calculation if you want to do it manually. For an automatic calculation, websites such as mint.com can help with determining it and tracking it over time to see your progress.

Net Worth = Total Assets – Total Liabilities

Total Assets

Your assets are everything you own. Physical and in bank accounts. To get an accurate picture of your net worth you need to think hard and list all your physical assets and all your bank accounts. Here is a list of most of these items:

Physical Assets (use current estimated value, not what you paid): Your Home, car(s) (not if it is a lease), furniture, recreational vehicles, cottages owned, vacation homes owned, jewelry, anything in your home(s) that you can likely sell.

Financial Assets: All your savings and checking account balances, your investment accounts (registered and unregistered), your company pension accounts and any other financial account with value.

Add all these items up and your have your total assets value. Don’t get too excited yet, this is not your net worth. You still need to subtract your liabilities to obtain your net worth.



Total Liabilities

Your liabilities are everything you owe, short term and long term. To determine your total liabilities, add up your mortgage(s), lines of credit balances (not your credit limit), current credit card balances and any other loan balances that you still have. That means furniture purchases you financed, car payments remaining, and personal loans owed to family.

 

Tracking and Monitoring Your Net Worth

The first time you do this calculation, I recommend doing it manually by hand or in a spreadsheet to really understand the different components of it. After that I suggest using an automated service such as mint.com or personal capital or other accounting software to make it easy to track. You can opt to continue to monitor it manually, but if that means you will lose interest in a few months, switch to an automatic platform.

Calculating your net worth one time is a start, however, to work towards your financial goals, you need to monitor it regularly. How else would you know if you are going in the right direction towards your goals? A business would fail quickly if it didn’t track its financials, why is your personal financial life any less important? You need to make a financial plan if you want to reach your goals.

So are you now ready to grow your net worth? Check out the other articles on this website for many tips and advice to get where you want to be.

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