Principle 20. Know your net worth


NET WORTH

Net worth is simply, your assets (less) liabilities.

Assets – you own them. You can sell them anytime and take cash.

Liabilities – you owe them. Money flows out until these are settled.

ASSETS.

Look around. You have lot of assets with you. Some of them are very large assets like land and others are personal ones like a gold coin or a ring.

The assets you have can be classified into moveable assets and immovable assets. Immovable assets are those which cannot be ‘moved’ from where it is exists – for example the villa or the apartment you own.

Moveable assets are those assets which your can move- those assets which you can take along with you where ever you go. All the assets apart from the villa or flat you own would fall in this category. For example – gold, shares, mutual funds, insurance, fixed deposits, refundable deposits like rent deposit, cash, vehicles, furniture, electronics, art works, antiques, musical instruments, coin & stamp collections, jewellery, books etc..amounts you’ve lend to your friends /relatives .. All these are your assets.

Some of you (for example – poets or authors) might also posses certain assets which exist only in value – for example copy rights and patents. These are also assets. These assets are called ‘intangible’ assets- ie, assets which cannot be seen or touched, at the same time it has a value which can be realised if sold.

LIABILITIES

The liabilities you owe include home loans, vehicle loans, business loans, personal loans, credit card dues, unpaid taxes, any other amount borrowed from your friends / relatives,  plus, students who have just got a job may have student loans pending.

MEASURING ASSETS & LIABILITIES.

Having known what your assets and liabilities are, the next question is how to express these assets and liabilities in monetary terms. Here are some pointers:

  • Assets like land and building can be valued at the fair market value. Fair market value is the price that a willing, rational, and knowledgeable buyer would pay. Fair market value is recommended for immovable assets because, people tend to attach a lot of sentimental value to such assets and hence put a price tag which might be on the higher side. Fair value concept keeps this mistake in check.fair value of immovable assets can be measured by availing the services of a registered property valuer.
  • For shares, silver, gold etc..you can use the current market value.
  • For mutual funds, use the current NAV.
  • For other items such as furnishings and electronics, an itemized price tag need not be made. It’s enough if you can put a consolidated value for all.
  • For fixed deposits and bonds, use the current value and not the value at maturity.
  • Similarly, add up only the surrender value of insurance (and not the maturity value).
  • Add amounts receivable from friends and relatives only on actual receipt.
  • The value of Items like artworks, coin collections, musical instruments and antiques can be highly subjective. To include the value of such assets, you will have to value them by professionals or have a good idea about how much someone would pay for them in today’s market.- add up everything and you will  get the value of what you own.
  • The value of intangible assets like patents and copyrights   are also highly subjective . The value of intangibles  should be decided by professionals.

As far as liabilities are concerned, it’s fairly simple to calculate the amount. Most of the amount you owe would be in the form of credit card dues or loans and hence, the right idea is to take out the loan statements and then check the actual outstanding liabilities. Remember to add a margin of two or three percent to it because, most of the loans when closed pre-maturely would attract pre-closure fee. For other liabilities like amount borrowed from friends and relatives, consider the actual amount outstanding. (Unlike banks, your friends are not going to punish you for being prompt) That’s the liabilities part.

HOW TO CALCULATE

Make a list of assets first. On the left side,  list the names or categories of assets and on the  right side,  write down the value of each asset determined by you. After listing all the assets, add up the figures – that’s the total of assets for you. Mark the total as ‘A’. Deal with liabilities in the same manner. Mark the total of liabilities as ‘B’. A (minus) B is your net worth.

NET WORTH – REVIEW EVERY YEAR.

Your net worth will keep changing even if you don’t do anything to change it. That’s because, the value of assets and liabilities keep changing. For example- one year from now, the value of land, building, gold etc in all probability, would have increased. The value of shares and mutual funds can go either way, the realizable value of assets like vehicles, furniture, electronics etc…will come down due to usage , wear & tear and technological changes. If you have paid your EMIs regularly, your liabilities will also reduce in a year. So, It’s important to check your net worth and track the changes periodically.

IDEAL NET WORTH

There is no ideal net worth figure that fits all. There is no need to investigate into such a topic because the message is quite simple-

  • If you are having a negative net worth, you financial condition is not healthy. You need to think of ways to better your position.
  • Having a positive net worth is always preferable than a negative net worth.  It’s a healthy sign.
  • Higher the net worth, the better it is.

FORMULA FROM THE ‘MILLIONAIRE NEXT DOOR’.

If you are still interested in some benchmarks, Thomas Stanley and William Danko, in their book ‘the millionaire next door’, suggests a general formula:

  • Net worth = Age x  Pre-tax Income /10

So according to this formula, if you are 30 years old and if your annual  income is Rs 2,50,000, your ideal net worth will be:

  • 30 x 2,50,000/10= Rs 7,50,000

As you grow older, your required net worth will also go up.  It’s Simple and very effective. It keeps giving you higher targets as you grow older. In other words, it’s ok to have some loans or liabilities when you’re young, since, you have the advantage of age on your side.

SUGGESTIONS

  • Don’t panic if you discover that your net worth is negative.
  • If your net worth negative, It means that – right now, if you sell all your assets, it will not be enough to settle all your liabilities.
  • That’s not a case to worry because, as long as you keep paying your EMIs on time, you are making your liabilities smaller. If your assets list has cash / gold/ land/flat etc.. the value of those will keep increasing. The net effect would be a faster growth towards positive net worth.
  • You can improve your net worth by closing your loans as soon as possible,  reducing your cost of living ad by investing the surplus.
  • Calculating net worth is a very useful task since you  get an instant list of what you own and what you owe. Periodic check would motivate you to work hard and reduce your debts. Improvement in your net worth would give you more confidence in life.

So that’s net worth for you. It gives a snapshot of your financial health.  This is the first figure you require to plan your financial goals.

You may like these posts:

  1. Principle 18. Safeguard your documents.
  2. Principle 12. Lending money to friends and relatives.
  3. Principle 1.Finding money !

8 Responses to “Principle 20. Know your net worth”

Vikas Medhekar

June 6, 2012 at 2:06 pm

Dear Victor,

Thank you for the great article! I’m a big fan of you and reading your articles on a regular basis. Would you please write on the topic “Straddle” investment strategy?

Thank you! Keep up the good work..

- Vikas Medhekar

J Victor

June 6, 2012 at 4:05 pm

Yes . coming up soon in Option basics.

thanks for writing , Vikas !:)

Vikas Medhekar

June 7, 2012 at 6:50 am

Thank you Victor! Have a great day.

manoj

June 7, 2012 at 10:04 pm

worthy article !

Arun

March 13, 2013 at 7:02 pm

I know nothing about investments . This page is good for guys like me. The topics are very good and easy to read .

Thanks and continue writing.

Deva

June 2, 2013 at 10:26 pm

Very good and valuable article.

suhel

August 13, 2013 at 1:25 pm

nice…!!!!

Manish Gupta

October 11, 2013 at 5:03 pm

Very Very Informative article. I have learn many basic financial things which i was not aware
Thanks

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