It is that time of year again. January, when millions of people make New Years Resolutions they aren’t going to keep.
Whether that be signing up for the gym, starting a new diet or spending less. Chances are for a lot of people, they would have failed before the month is over.
To be honest, I am not one to judge. I have made my fair share of New Years Resolutions, many of which haven’t lasted as long as I would have hoped.
This year one of my New Years Resolutions is to write on this blog at least once a week. Yet here we are on the 3rd week of the New Year and I am only just getting round to writing the first blog post of 2020.
However, the one New Years Resolution that I won’t be giving up on is to become financially independent. If one of your life goals is to become financially independent too then one of the things on your checklist should be to calculate your Net Worth.
Your Net Worth is an indicator of how much wealth you have accumulated. It is simply the value of your assets minus your liabilities.
If you are reading this blog chances are you already know a thing or two about personal finance, or are at least on the path to. In which case, after calculating your net worth you will hopefully be left with a positive figure.
If you are quite early on in your FI journey then you may well have a negative net worth figure. In which case you have taken the first step in identifying the areas you need to improve on.
As mentioned your Net Worth follows the following equation:
Net Worth = Assets - Liabilities
So let’s have a look at what makes up our assets and liabilities.
Your assets are the value of the things you own. Typically you would include the following as Assets:
I wouldn’t go crazy on the last point here. Generally, if you happen to own something else that is worth as much as your car then it might be worth listing. Anything else can be probably be left. If you own a £100,000 grand piano for example that might be worth listing.
If you are going to list your car or any other vehicles you own as an asset, it is important to get a realistic value for it. Unless you own a vintage classic, chances are your car is losing value every day. It is what we call a depreciating asset.
You can use sites like AutoTrader to see if anyone else is selling a car similar to yours in terms age and mileage to get a rough idea what you might get for it.
The total value of these makes up your total assets.
Your liabilities are the value of everything you owe. As you can probably guess we want to keep these to a minimum.
Car loans are a common cause of negative net worth. This is because the value of a new car will drop by 10% within a month of being driven off the lot.
It would have lost as much as 20% by the end of the first year. Therefore the car loan you took out to pay for it may total more than the car. If you sold the car you wouldn’t have enough money to pay the loan.
This can also happen if you got a mortgage with a high Loan To Value (LTV) ratio. If you bought your house at the wrong time and it drops in value then this could be another cause for negative net worth.
Now that you have all your totals, your net worth is simply your Assets minus your Liabilities.
Lets take a typical example:
Total Assets = £392,000
Total Liabilities: £180,000
Net Worth = £392,000 - £180,000 = £212,000
Your net worth is a useful indicator of your overall financial health. However, it can’t be used for early retirement planning.
Typically your net worth will contain assets such as your pension that can’t be released until your 55 and your house which you probably weren’t planning on selling and becoming homeless for your retirement.
It is useful though, I calculate my net worth each month after I have been paid and I have cleared any outstanding credit card balances. It is good to see the progress you have made each month and it is nice to look back and see how far you have come.
Alex started Pursuit of FIRE in 2019 to try and help people reach financial independence. He has spent nearly a decade working as a software developer in the finance industry and now is looking towards early retirement so he can spend more time with his young family.