How much are you worth? If you had to sell everything you own and added the proceeds to your savings, then subtracted the amount you owed, what number would you be left with?
The answer will tell you what your net worth is.
And does it really matter what your net worth is? What purpose, if any, does it serve? Well a statement of net worth is simply your financial balance sheet. It shows, at a point in time, where you stand financially. It provides a summary of your assets and their value, minus your liabilities.
I recently began to think about what people’s net worth is and should be because it is something I am often asked by clients, when they want to check what it is compared to others.
When the Central Statistics Office (CSO) last week released its Household Finance and Consumption Survey 2013, a study which was undertaken between March and September 2013, it produced some interesting figures.
The one that stood out for me was that the average net wealth for households in Ireland stands at €224,000.
How does your net worth stack up against this figure?
Are you better or worse than the national average amount? I am going to show you how to draw up a rough balance sheet for your household shortly which will show you what your number is.
But before I do I think the CSO figure is a very hard one to compare yourself against because how do you take into account age differences, lifetime earnings, lifestyle differences and so on when comparing your net worth against someone else?
A 40-year-old with a mortgage, for example, is going to have – you would think – a lower net worth than a 65-year-old who might have their mortgage paid off, inherited money, had longer time to save etc.
So, what measuring stick can you use that will allow you to arrive at a figure that you can compare yourself against others of a similar age/earning profile?
There is a great book that I have referred to in this column many times in the past called The Millionaire Next Door, written by Thomas Stanley and William Danko. In this book, the authors provided a formula for working out what your net worth should be and it is as follows:
Multiply your age by your gross annual income and divide by 10 – this is what your net worth should be.
So, for example if you are 40 years old, earning €40,000, then your net worth should be €160,000 (40 x €40,000 / 10).
The formula has been recognised in the financial community as one that has been tried and proven and whilst it doesn’t factor in things like inflation, personal taxes and interest rates, it is a useful and credible formula that will give you a figure you can compare yourself against.
Now you know what your number should be, how do you calculate what it actually is?
Get out a piece of paper or turn on the laptop (email me if you want a ready-made net worth template) and on the left hand side of a sheet, write down two columns, one describing what your asset is and the other stating what it is worth.
Do exactly the same on the right hand side of the sheet, which is going to describe your liabilities.
In the asset column you can include cash in all savings and investment accounts, pension funds, property, car, shares, valuables etc. anything that can be converted into cash.
Your liability column on the other hand, is your debts and you can use amounts due from your most recent statements to insert here.
Don’t list every single item individually, put them together in categories like household possessions and include things like iPads/TVs/computers under an electronics category.
Once you have totalled your assets and liabilities, subtract one from the other and that is your net worth.
Once you know what it is, you can compare it against what it should be based on the Stanley/Danko formula.
One of the motivating factors in finding out what your net worth is and what it should be is that a number of things become very clear – the first being that debt is the enemy of wealth.
You could have €350,000 in assets but if you have €450,000 in debt then you have no wealth.
It will also show you assets that are non-cash assets that cost you money to own, operate, maintain and insure (vroom vroom).
If you end up having a negative net worth, you are by no means alone; many people I meet old and young have a negative net worth.
It’s only a number, nothing to do with your own personal worth, but knowing your financial net worth helps you understand what has to be done if you want to improve your financial situation.
I encourage my clients to carry out a statement of what their net worth is and it is something we re-visit every year to see how their financial situation is improving over time.
You can increase your net worth by reducing your debt or increasing your assets. And if you either decrease your debt or increase your assets by the same amount they will have the same effect, and it’s important you pay attention to both.
But reducing debt can only go so low i.e. zero, whereas increasing your assets has no limit, so that is the side of your balance sheet you need to focus on if you want to build wealth.