Do you know what your net worth is?
Many people don’t consider the importance of their net worth until they start thinking about retirement.
But just as the consumer price index (CPI), the gross domestic product (GDP), and the unemployment numbers are key indicators of the health of the nation’s economy, your net worth is the key indicator of your overall personal financial health.
With that in mind, the simplest definition of net worth is your assets minus your liabilities. It’s the number that remains when you add up the properties and assets you own, and subtract any debt you have.
Calculating your net worth.
First, write down your assets. An asset is something owned by you that could be converted to cash (or which has cash value).
Common assets are:
- Cash (of course)
- Your checking and savings account balances
- Collectibles (jewelry and art and other rare items)
- Real estate and other property (homes, land, time shares and condos)
Next, make a list of all your debts. A debt is something that is owed. Common examples of debt, include:
- Student loans
- The amount you owe on your mortgage(s) or property
- The amount you owe on your vehicles
- Credit card balances or outstanding lines of credit
- Medical bills
- Personal loans
After you have your assets, subtract your debt, and the amount left over is your net worth.
5 key reasons your net worth is important.
1) Because financially, it’s who you are
You really don’t know your precise financial situation until you know your net worth.
I’ve met with dozens of couples who make $200,000 a year and would like to retire. Perhaps between their retirement accounts and investments and the equity in their home, they can even count $1.2 million in assets.
But some of these same folks also have $500,000 in debt (including their mortgage).
While at a glance, that $1.2 million looks appealing, my retired clients understand all too well that if your mortgage is, say, $5,000 a month, it’s a lot tougher to pay once you’re no longer earning that $200,000 salary.
So in that sense, your net worth has nothing to do with your salary. It’s what you’d have left over today if you had to cash everything out and pay all your obligations.
Simply, having $1.2 million in assets doesn’t mean your net worth is anywhere close to where it needs to be if you’re going to retire.
2) It measures your year-over-year progress
Your net worth should be increasing year-over-year, particularly if you’re a pre-retiree. But by how much should it be growing?
While there are many things to consider, it depends on your overall financial situation. My experience has been that people who work with an advisor and who know their net worth seem to have a better grasp of their financial situation than those people who don’t.
3) It refocuses your financial emphasis beyond income
This is a biggie, and each of these points reflects it. The day you retire (especially if, for health reasons, you can no longer work) is quite possibly the day your savings has to begin supporting you from that day forward, and for the rest of your life.
Your savings needs to earn income if it’s going to support you through a 25-plus year retirement.
4) It wakes you up to the downside of debt instead of just emphasizing assets
Money not going out is the same as money coming in. Hopefully, you’ve been working with an advisor for long enough to understand that even $1 million in assets isn’t likely going to be enough for a 25-year retirement if you have a big mortgage and other debt.
I urge you not to think of your retirement savings as a big pile of cash that automatically has to get smaller and smaller as you siphon from it to pay your monthly expenses. Rather, try and view your savings and investments as assets you use to generate retirement income.
5) If banks and lenders care, so should you
For some people, one of the ways they’ll improve cash flow once they retire is to refinance their mortgage out 20 or even 30 years. But once you stop working, you’d be surprised at how difficult it can be to refinance your mortgage if your debt is too high, even if you have ample equity in your home.
Remember, credit and loans are tougher to get when you no longer have a regular salary, so one of the biggest factors in retiree loan worthiness is net worth.
A final warning about net worth and assets: For a lot of people, the biggest asset they have is their home. This might be okay, but there’s a lot of risk in assuming that the $800,000 equity you have in your home is going to be there tomorrow (just think back to the housing crash of the last decade). Plus, your home is where you live, so it’s not an asset that can make a seamless conversion to cash.
Your net worth, along with savvy investment allocation that earns income, are important parts of retiring well.
If you have any questions, or if your net worth has (or may have) recently changed, contact us today.