Warren Buffett, Jeff Bezos, Rihanna. When you hear the term “net worth”, you might automatically envision some Internet billionaire or media tycoon because those are the only people who have and need to know their net worth, right? Wrong! This could not be further from the truth. Net worth is an important metric for everyone to monitor assets, track liabilities, and learn how to become financially independent. When it comes to your money, your net worth is one of the best ways to see where you stand financially.

Is Knowing Your Financial Net Worth Important?

People often base their financial health primarily on one of the following: a sizeable income, minimum debt, sizeable asset holdings, or the amount of cash in their bank accounts. While these are inherently some good measures of financial health, net worth is a metric that can provide a better picture of your overall financial health at any point in time. Therefore, understanding and tracking your net worth over time is a helpful indicator of your overall financial position and health. Your net worth can help determine if your finances are trending in the right direction and can also help track your progress toward reaching financial goals. So, is it important? Yes, it is. In the same way you routinely visit the doctor to determine if you are in good physical health, you should, in like manner, routinely assess and calculate your net worth and take deliberate steps to build it. This will help determine if you are heading in the right direction toward your goals and, if not, what steps you need to take to reach them.

How To Calculate Net Worth

Figuring out your net worth is not rocket science — it is a simple formula. Your net worth is the difference between the total value of what you own (assets) and what you owe (liabilities). Remember, assets are anything that you own that is 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 certain types of financial assets, such as treasury bills, CDs, and listed stocks. Illiquid assets, on the other hand, cannot be converted to cash as quickly. They include the equity in a house or car, a piece of land, precious jewellery, or the value of your privately owned business. Liabilities, meanwhile, represent money you owe. This can include loans, mortgages, credit card and student loan debt, outstanding medical bills, etc. Your net worth can be positive or negative depending on the amount of assets you have relative to your liabilities. In essence, if you increase the value of your assets while maintaining or reducing your liabilities, your net worth will increase. However, if you are taking on additional debt, such that your liabilities exceed your assets, then your net worth will ultimately decrease.

What Your Figures Mean

Firstly, everyone should aim for a positive net worth and to increase it over time. A growing net worth is an indication that you are on track to achieving your goals of attaining financial independence. Having a positive net worth is pivotal to building wealth. When you own more than you owe, you are better positioned to take calculated risks in investments, potentially increasing your assets further and positively contributing to your overall net worth. If your net worth is negative, it simply means you owe more than you own. There is no shame in this; however, having a negative net worth usually implies a high debt-to-income ratio, and as such, managing debt payments becomes difficult, leading to a cycle of borrowing more to meet existing obligations. This cycle can be hard to break without a strategic debt repayment plan. Further, long-term financial goals, such as buying a house, starting a business, or retiring comfortably, become a distant dream when burdened with a negative net worth. Accumulating wealth and achieving these goals becomes exceptionally challenging without a positive financial base.

How To Build Net Worth

One of the best ways to build your net worth is to acquire income-generating assets that earn higher returns than it costs to service your debts. In order to build net worth, it is important that you use debt wisely. Use debt to purchase assets that will appreciate over time. Consider purchasing assets such as real estate or other real assets. Invest in the right type of real estate property and it will increase in value over time, increasing your net worth. Importantly, as inflation increases the value of the asset you have purchased, it is also reducing the value of your fixed monthly payments you make to service the debt you use to purchase it. If you purchased a house 10 years ago, think about how onerous the mortgage payments were then compared to now. Further, the amount of the debt is also declining as you make payments over time. Therefore, buy assets that will increase in value, generate income, and allow you to pay off your liabilities. When the debt is paid off, the asset will be yours free and clear. Compare that to using debt to purchase a car, which depreciates in value.

This takes us to another strategy for building net worth – paying off debt and investing in financial assets. You can either decide to pay high-interest debt first as it carries higher interest rates, or you can pay off smaller debts first and then work your way up to the larger one or consolidate debt. Whichever method you choose, be disciplined about it, and avoid adding new debt to fund consumption. Finally, investing is another common yet bold way to build your net worth, and the most common investment options include stocks, bonds, mutual funds, and private equities. While most investments will fluctuate in value in the short term, the aim is to select investments that will increase in value over the long run.

Your net worth tells a holistic story about how many aspects of your finances are working together, and while there is no “right” net worth to aim for, you generally want to work to make it positive and aggressively increase it over time. Having a positive net worth means that a person’s assets are greater than their liabilities, giving them a financial cushion and the ability to make wise investment choices and plan for the future. Knowing your net worth is important, but you cannot stop there. The steps you take to build your net worth are even more important. Building your net worth will be a gradual process that requires patience, discipline, and a long-term perspective. However, by acquiring income generating assets, paying off debt, and investing, you can remain committed to your financial goals and steadily increase your net worth, achieving financial security and independence.