Understanding Net Worth: What It Is and How to Calculate It
Experts debate whether to include your home in your net worth calculation
Knowing your net worth is essential for understanding your overall financial health and progress towards your financial goals. It is the sum of your assets minus your debts and provides a snapshot of your financial worth. However, there is ongoing debate among financial experts about what should be included in the calculation. One key point of contention is whether or not to include your home as an asset. In this article, we will explore the concept of net worth, the different perspectives on including your home, and how to calculate your net worth effectively.
What is Net Worth and What Does It Include?
Net worth is the total value of everything you own (assets) minus everything you owe (liabilities). However, there is no consensus on which assets should be included in the calculation. Generally, assets can be divided into three categories: liquid assets, investment assets, and personal use assets.
– Liquid assets include cash in checking and savings accounts.
– Investment assets encompass retirement or brokerage accounts and other investments.
– Personal use assets are physical items of value, such as your home, cars, or jewelry.
How to Calculate Your Net Worth
To calculate your net worth, you need to determine the value of your assets in each category and subtract your total debts and liabilities. While it’s easy to determine the value of cash and investments, caution is advised when estimating the value of personal use items. Overestimating their worth can lead to an inflated net worth figure.
Why You Should – or Shouldn’t – Include Your Home In Your Net Worth
The inclusion of your home in your net worth calculation is a matter of debate among financial advisors. Including your home provides a comprehensive view of your assets and liabilities, as it represents a significant asset and any associated mortgage or loans are considered liabilities. This approach, known as total net worth, offers a holistic picture of your financial health.
On the other hand, some argue for a narrower focus on liquid net worth, which excludes your home. Liquid net worth includes cash, cash equivalents, and investments, minus other liabilities. This approach emphasizes the assets that are easily accessible and can be readily used to fund short-term goals.
The Importance of Home Equity
One compelling reason to include your home in your net worth calculation is the potential to tap into home equity through loans or lines of credit. Home equity loans and home equity lines of credit (HELOCs) offer relatively easy access to cash, making your home an important asset in terms of financial flexibility.
Considering Your Financial Goals
The decision to include or exclude your home in your net worth calculation may depend on your financial goals. If you are planning to use your home as collateral for a loan or considering a future home purchase, including it in your net worth is crucial. However, if you are primarily focused on short-term liquidity and easily accessible assets, excluding your home may provide a more accurate representation of your financial situation.
Conclusion:
Calculating your net worth is a valuable tool for assessing your overall financial health and progress towards your goals. The inclusion of your home in the calculation is a contentious topic, with varying perspectives among financial experts. While including your home provides a comprehensive view of your assets and liabilities, it may not accurately reflect your short-term liquidity. Ultimately, the decision to include or exclude your home depends on your financial goals and the specific context of your situation.