By now statements from banks and investment companies from the end of last year have arrived, making now a great time for the most useful personal finance project of the year, the calculation of household net worth.
This may seem like a vanity exercise for the very wealthy, but regular people should keep track of household wealth, too. To state the obvious, getting net worth to grow over the course of a lifetime is a fine idea. At the end, having more wealth leads to a comfortable retirement and along the way it’s a cushion for job loss, a health crisis and other misfortune.
And to skip measuring progress is a little like adopting a healthy diet and fitness lifestyle and then never stepping on a scale.
It’s important to say what net worth isn’t — some sort of measure of income. More income beats less, but people with great-paying jobs can still end up broke. It’s not even a very good measure of how many nice things a family has. Sadly, the value of a lot of those nice things — like a fancy new TV — quickly sinks like a stone. So another reason to keep track of wealth is it helps to build better spending and borrowing habits.
Personal finance software seems to update net worth pretty much automatically, but calculating it by hand is both a useful thing to do and doesn’t take very long. All that’s really needed is a spreadsheet program like Excel or even a piece of paper and a calculator, plus credit card statements, bank statements and the like.
The numbers get put into two columns; start on the left-hand side with the assets. Here a person writes down the liquid assets like checking account balances, along with investments like a 401(k) or mutual fund shares. Don’t forget cash value of any life insurance plans. The values for these assets are easy to find.
To get to a reasonable estimate of what a house is worth, try using a pricing service like Zillow.
It’s more challenging to figure out what a small business might be worth. Back when I owned half interest in a small consulting firm, we knew a global firm like Accenture wouldn’t be buying our little business at 30 times earnings. To calculate its value, I added up the checking balance and what clients owed us and then subtracted what we owed suppliers, the American Express card balance and 12 months of office rent. Sometimes the net value approached zero.
Finding the value of a car is easy: just use the Kelley Blue Book site or one like it.
Because this is a planning exercise and not preparing a for-sale ad, don’t fib about the car’s actual condition.
What’s left is putting a value on things like clothes, home furnishings and personal electronics. As a rule of thumb that stuff isn’t worth nearly what anybody paid for it. Don’t believe me? Try walking through an estate sale, and watch how boxes of books, CDs, knickknacks and electronics get carried out the door at prices that might be as little as a few dollars.
Take a stab at estimating the value of your household’s personal property. Then cut it in half and write that number down.
When all the assets are listed, it’s time to start on the liability column, and that’s what’s owed to other people. Here’s where the mortgages, student loans, credit and store charge-card balances and other loans get listed. The liability column needs to include anything borrowed from a family member, too, like for a down payment on a house. Maybe grandma forgives the loan someday, maybe not, but for now it’s real money that’s owed.
If all the debts total up to a distressingly big number that calls for a change in behavior, well, good, now one reason for doing this exercise becomes a little clearer.
Add up the left-hand column and subtract the total of the right-hand column, and that’s net worth. Study this piece of paper for a bit, think through financial habits that need to change if it looks out of whack and then write all those down. Then put the net worth sheet in a drawer for a year.
And for younger people in particular, calm down if net worth doesn’t even reach zero. My household started out deep in the hole with college loans and stayed there for years. But it’s possible to make the long climb out, and there’s no real magic to it.
A computer hard drive crash and a few missing paper files mean that I’ve got an incomplete record for our household, but I have net worth statements as far back as August 1998. For people in their 30s with very young children, we were then doing fine; we had good jobs and both joined 401(k) retirement savings plans the year we graduated college. But we were certainly not well off.
We were paying many thousands of dollars for child care, had only just retired the last student loans and had both a mortgage and a second mortgage. And what really sticks out now, almost in a what-were-we-thinking way, is how we owed $17,200 on a 1997 Volvo 850.
Now, after more than 18 years, our net worth is several times what it was in the summer of 1998, without benefit of a windfall and without scrimping on vacations, healthy fresh food or other good things for our family. What happened, mostly, was spending less than we made and just the passage of time.
Our incomes did increase, and we saved a bigger percentage of income, but we also adopted the hardly innovative financial strategy of retiring the house mortgage one monthly payment at a time. As for the value of savings, investment return compounding over the course of years really does work.
The only disappointment out of the net worth update is that the car I’m driving now, according to Kelley Blue Book, has slipped in value to a depressingly small number. The good news, of course, is that nobody is still owed $17,000 for it.