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Net worth measures the value of what a person or corporation owns after subtracting their liabilities. Net worth serves as a key indicator of a person or company’s financial health.
In the financial sector, net worth, sometimes referred to as net wealth, can help determine eligibility for specific investment strategies or financial products like hedge funds, structured products, and other complex or alternative investments. Additionally, net worth has captivated popular culture, leading to rankings of individuals and celebrities with the highest net worths.
Net worth can be calculated not only for individuals and companies, but also to sectors, and entire economies.
To calculate net worth, subtract all liabilities from assets. The formula is:
Assets – Liabilities = Net Worth
Assets include anything owned that has monetary value, while liabilities are obligations that drain resources, such as loan balances and accounts payable.
Net worth can be either positive or negative. A positive net worth means assets exceed liabilities, while a negative net worth means liabilities exceed assets. A positive and increasing net worth usually indicates good financial health, whereas a decreasing net worth is a warning sign, suggesting that liabilities are growing faster than assets.
To improve net worth, you can focus on reducing liabilities, increasing assets or both. You can pay down debt, and invest in assets you expect to grow.
When you’re trying to increase assets, net worth will sometimes go down initially, before it goes up. This is often seen with a new company that must pay some expenses, or even borrow some money before they generate new income and build their bank account. The bank account balance is an asset.
In business, net worth is also known as book value or shareholders’ equity. The balance sheet shows this value by subtracting total liabilities from total assets. It’s important to remember that the balance sheet reflects historical cost or book values, not current market values.
Lenders closely examine a business’s net worth to assess its financial health. If a company’s total liabilities exceed a certain percentage of total assets, creditors may doubt its ability to repay loans.
A consistently profitable company will see its net worth, or book value, increase as long as it does not distribute all its earnings to shareholders as dividends or owner distributions. For public companies, a rising book value often leads to an increase in stock price.
An individual’s net worth is the value remaining after subtracting liabilities from assets. Liabilities include debts such as mortgages, credit card balances, student loans and car loans.
Assets include balances in checking and savings accounts, the value of securities like stocks and bonds, real estate, and the market value of vehicles. After selling all assets and paying off personal debts, the remaining amount would be your net worth.
People with substantial net worth are called high net worth individuals (HNWI) and are often ideal clients for wealth managers and investment advisors. Investors with a net worth, excluding their primary residence, of at least $1 million—either alone or with a spouse—are considered “accredited investors” by the Securities and Exchange Commission (SEC) and can invest in unregistered securities offerings.
Consider a couple with the following assets:
Their liabilities include:
To calculate their net worth:
$300,000 + $150,000 + $25,000 + $35,000 – $120,000 – $15,000 = $375,000
Assume that five years later, their financial position changes to:
With these new figures, the net worth would be:
$320,000 + $180,000 + $50,000 + $25,000 − $90,000 – $10,000 = $475,000
This couple’s net worth increased by $115,000 despite the decrease in the value of their automobiles. This increase was due to growth in their home value, investment portfolio, and life insurance cash value, as well as a reduction in liabilities.
A negative net worth occurs when total debt exceeds total assets. For example, if an individual or family’s credit card balances, outstanding mortgage, auto loans, and student loans add up to more than the total value of their cash and investments, their net worth will be negative.
Family responsibilities or unexpected illnesses can lead to a negative net worth.
Negative net worth often means people should focus on reducing debt, but not always. It depends on the type of debt. Students graduating college often have a negative net worth because of their student loans, and this doesn’t necessarily mean they should pay this debt down right away.
Implementing a balanced budgeting/cash flow system and using debt reduction strategies like the debt snowball or debt avalanche can help people escape a negative net worth. Increasing your income and building assets faster, can also help to overcome a negative net worth.
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If you have a big debt problem and find it hard to cover basic living expenses and make progress paying down your debts, you may consider negotiating some debts with creditors to improve cash flow.
When all else fails, filing for bankruptcy protection might be necessary to eliminate excessive debt and prevent creditors from collecting on it.
However, some liabilities, such as child support, alimony, taxes, and often student loans, cannot be discharged in bankruptcy. Bankruptcy will remain on your credit report for many years, so this option is usually a last resort to overcome negative net worth.
What constitutes a “good” net worth can vary widely based on life circumstances, financial needs, and lifestyle. According to data from the Federal Reserve, the average net worth of an individual in the United States in 2019 was $121,700.
Net worth tends to be higher for middle-age people as they accumulate more savings and investments approaching retirement.
And it’s often important for net worth to be balanced across different asset types. For example, most people don’t want 100% of their net worth in stock investments, but they might be comfortable with 70% in stocks and 30% in life insurance or other savings.
How much you should have saved depends on your age, career, lifestyle, and life circumstances. Some advisors recommend having three times your annual salary saved in retirement accounts by the time you are 40.
Net worth is an effective way to measure the wealth of an individual, family or business. Focusing only on assets can be misleading since they are often offset by liabilities, such as debt. Focusing only on liabilities can also be misleading if plenty of assets are balancing these liabilities.
Figure your own net worth using our free calculator/worksheet. Understanding net worth helps you understand what options are best to grow and protect your wealth.
by John T. McFie
I am a licensed life insurance agent, and co-host of the Wealth Talks podcast.
At age 14 I started developing spreadsheet models and software systems to help my Dad share financial concepts with clients.
Skipped college at 17 recognizing the overinflated value and prices of most college degrees and built more financial software instead (see MoneyTools.net). Still a strong advocate of higher education without going to college. I enjoy making financial strategies clear and working through the numbers to prove results you can count upon.
Investing information provided on this page is for educational purposes only. McFie Insurance LLC does not offer advisory or brokerage services, and does not recommend or advise investors to buy or sell particular securities.
