When you see headlines like “Zuckerberg’s Net Worth Surpasses Buffett’s” or “Warren Buffett has a net worth of US$84.7 billion”, you may end up scratching your head.
“What is net worth?”
“What is my personal net worth?”
“Why does knowing my net worth matter?”
If you desire to be wealthy, you must know about this important financial health indicator known as net worth.
To help you along your financial journey, this article will attempt to answer the following five questions on net worth.
• What is net worth?
• How do you calculate your net worth?
• What does your net worth really mean?
• Why is it important to know your net worth?
• How do you increase your net worth?
Once you know the basics of net worth, you can find and interpret your own personal net worth statement.
Q1: What is net worth?
Your net worth is your total assets less your liabilities. The concept of net worth is applicable to both individuals and businesses as a key measure of how much an entity is worth. A consistent increase in net worth indicates good financial health.
Net Worth = Assets – Liabilities
For a simpler explanation, your net worth is the difference between what you own and what you owe. A person’s net worth can even be negative when liabilities are more than assets.
Your net worth won’t be able to show you an in-depth examination of your personal finances. But it is a reliable method for a quick evaluation of your general financial well-being.
A simple example:
• The only asset you own is a property worth RM500,000.
• You took a loan from the bank and owe RM300,000.
• Your net worth is RM500,000 (asset) – RM300,000 (liability) = RM200,000.
Q2: How to calculate your net worth
You now know that your net worth is your total assets and liabilities. Assets and liabilities typically consist of a mixture of various assets and liabilities.
To calculate your net worth, you will need to know the value of ALL your assets and liabilities which entails having on hand:
• Property ownership documents
• Investment statements
• Current value of vehicles owned
• Bank account statements
• All mortgage statements
• Credit card statements
• Student, car, bank loans, credit line, personal loan statements
• Personal Insurance statements
Type of assets
Cash and cash equivalents:
• Money in your bank accounts (savings, current accounts, fixed deposits) and in your wallet.
• Cash equivalents refer to short-term (less than three months) accounts and investments that can be easily converted to cash. For example, short term government bonds, commercial papers, and money market funds.
• Unit trusts
• Jewellery, art, antiques, coins, or other collections with value
• Life insurance
• Employee Provident Fund (EPF)
• Company Pension Schemes
Types of Liabilities
• Property Loan: Can be a good liability with the corresponding asset (house) value increasing over time.
• Education Loan: A short-medium financial burden but may be a worthwhile investment in yourself and potentially higher future earnings.
• Credit Card Debt: Often a significant obstacle to building net worth. Outstanding credit card debt is charged at high interest rates compounded monthly.
• Car loans/Hire purchase
• Outstanding tax owed
• Personal loan
• Other loans or owing
Apply the net worth formula: Total assets – Total liabilities = Net worth
Q3: What does your net worth really mean?
Your net worth statement shows what you own and what you owe. But it won’t tell you the complete analysis of your financial well-being.
The number by itself is much less important. It’s the change from year to year that you pay attention to. Your net worth will fluctuate from year to year but it is the overall trend that is important.
As you get older, if you manage your finances well, your net worth ought to increase in tandem. Your assets will grow while paying down your debts.
A negative net worth is not indicative of a disastrous financial life. It just means your debts are more than your assets.
However, if the trend continues, then this is something you should be concerned about. The objective is to strive to have a higher positive net worth over the long term.
A good benchmark is to compare your current net worth with the amount you should have accumulated based on your income level and number of years working.
Q4: Why is it important to know your net worth?
Knowing your net worth is a great start to organising your finances, creating a budget, and prioritising paying off your debt. Your net worth helps you to:
• Know your current financial condition.
• Have a reference point for mapping the journey to your financial goals.
When you see the pattern of your finances in writing on your net worth reports, you will be compelled to face the truth of where you are financially.
Examining your net worth statements over time can aid you in determining the following:
• Where you are currently.
• How to get to where you want to be.
Q5: How to increase your net worth
Simple! Since net worth is all about assets less liabilities, you either increase your assets, reduce your liabilities or both.
Review your net worth statement and identify which assets and liabilities you can prioritise to take action on.
Increase your assets
You need to save and invest. For example, start out by trying to save RM100 a month if you have been struggling to save. And then work towards savings RM1,000 or more monthly.
You can also start an aggressive personal campaign to cut unnecessary expenditure.
This is a detailed thought out plan that may need time to get used to. You may be surprised that every single expense can be reduced from a minimal 1% to 20% or more.
Reduce your liabilities (and expenses)
Spend on needs, not wants: Your net worth statement can show you which expenses are on the high side. These are your priority areas where reductions are a must to get back on track.
The best way is to separate the needs and the wants – evaluate whether the wants can be totally taken out or drastically reduced. Consider replacing costs that are needs with better value alternatives.
Reduce your debt: Develop a plan for paying down debt before even investing. It does not make sense to put extra money into an investment earning, say 6% per annum, when your credit card is charging you 12-15% per annum. Instead, use available funds to pay off the credit card debt.
This article first appeared in https://mypf.my