Net Worth = Assets - Liabilities
Pretty straight forward stuff here.
Add up the present value of the following categories to find the present value of your assets:
Then Subtract the above "asset" amount by what you owe, or your liabilities:
Net Worth (at time of calculation) = Assets (present value) - Outstanding Liabilities
Net Worth Is Timestamped
In other words, it is snapshot. It is unique to when you calculate it.
Consider a 10% increase in equities, or a hit on local real estate by 15% this year. That will dramatically effect your inputs into the net worth equation.
Just because you got to a point where your net worth crosses a certain threshold does not mean you will stay there forever.
The present value of your net worth is very transient. It is based on both individual behavior and market behavior.
Finally saved enough to cross into six-figure net worth, then went out and purchased a speed boat... guess what... you can likely say goodbye to that six-figure net worth. Why? Because you purchased a depreciating asset (unless you can find another dummy to pay as much or more than you originally paid for it).
The purchase of depreciating asset is nearly as bad as any other liabilities. There present value will most likely be much higher than their future value. When you purchase that speed boat for $100k and sell it down the road for $40k (if you're lucky), you have lost $60k of net worth in the process of owning that boat. What's worse, if you would have instead invested that $100k in a low cost index fund for the 10 years, instead of owning the boat, you could have $215,892 in 10 years assuming an 8% annual return (take a little more off for taxes on long-term gains of course). In reality, that makes the purchase of a boat, otherwise held for 10 years, a total cost of $175,892 - the loss of $60k in value of the boat over 10 years plus the loss of investment income of $100k invested over 10 years assuming 8% return.
So What "Should" I Be Worth?
My favorite simple equation for determining how much you "should" be worth is based on annual income and your age. It comes directly from the book The Millionaire Next Door by Thomas Stanley.
Expected Net Worth = (Age x Pre-tax Annual Household Income)/10
I really like how this equation actually provides an excellent reflection of your spending vs. accumulating behavior to date.
Essentially, if you make $600,000 a year and you are 50 years old, with a present net worth of $450,000, you are actually a fairly poor accumulator of wealth. Per Stanley's equation, you should be worth $3 million!
Tell us what you think in the comments below. Are you worth what you should be? Are you now motivated to save and invest even more than you already have?!
Dr. Jon is a physical therapist by day, and a dedicated frugalist by night, deeply enthralled in the thrill of "pinching pennies" and investing the margin.