If you want to measure and monitor your financial progress then net worth is a really good way for you to visualise this. But what is net worth and how is it calculated?
- What is net worth
- Why should you monitor your net worth
- How to calculate your net worth
- Net worth distribution
What is net worth
Net worth is defined on Investopedia as the value of the assets a person or corporation owns, minus the liabilities they owe. For the purposes of this article we will focus on the person side of things. It is an important metric that allows us to see not only our financial health but also our progress.
Net worth can be described as either a positive or negative value and will be expressed as a Dollar or Pound amount. If your net worth is a negative value, then the value of your liabilities exceeds the value of your assets. Alternatively, if positive then the opposite is the case.
Before you start to think about net worth you first need to understand the difference between assets and liabilities. Put simply, an asset is something that puts money into your pocket; whereas a liability is something that takes money from your pocket. Examples of assets include cash, stocks, and a business. Liabilities could include your mortgage or any credit card debts.
Why you should monitor your net worth
To start with, your personal net worth is personal and will reflect your individual circumstances. While you can look at other peoples’ net worth, it is important that you try not to compare yourself to other in too much detail. Remember that everyone’s financial position is different.
That said, it can be useful to look at national statistics that can give you average net worth by age band as a loose guide for goal setting. When looking at statistics, however, I would use a median average figure rather than the mean average as this will be highly skewed by high net worth individuals.
Data from the Office for National Statistics (ONS) showed that between April 2016 and March 2018 the total net worth of private households in Great Britain was £14.6 trillion. During the same period the median household net worth was £286,600. It is worth stressing this is a median figure of household net worth for the whole of Great Britain.
The above graph show the average savings by age group in the UK. Take the age group 25-34, the average (median) net worth for this age range is £85,000 to £200,000. But when you dive deeper into this graph you can see the percentage of low and high net worth within any given age range. E.g. 18% of those aged 25-34 have a net worth below £20,000 while 6% have a net worth over £1 million.
When you are reflecting on your own personal net worth it can be useful to use data such as above to aid in your goal setting. That said, try not to compare yourself to others too much – personal finance is personal to you.
Net worth should be one of many tools you use to measure progress towards achieving set goals. Remember that net worth is divided into assets and liabilities so your goals could be set relating to progress towards those individual items. Over time you will be able to see your progress which could motivate you to work harder, net worth will show you an overall picture.
How to calculate your net worth
As with all things personal finance, the first step to calculating your net worth is to look at your budget. If you haven’t got one, make one. Your budget should contain to key things – a summary of current cash flow and list of assets and liabilities.
The cash flow element to a budget is not necessarily required for the calculation of your net worth, but your assets and liabilities are. As stated above an asset is something that puts money into your pocket; whereas a liability is something that takes money from your pocket.
Common questions relating to the calculation of net worth usually hover around if you include depreciating items such as cars, and how do you include your house if you own one. With regards to cars, I see them as assets. While the do not directly put money in your pocket they do give you the means to earn money. So I would put the current value of your car in the assets column. You current house value, not the purchase price, should also be placed in your assets column; however any mortgage owed must be shown in the liabilities column. Below I is a worked example of a net worth calculation:
- House – £120,000
- Retirement accounts – £15,000
- Cash at the bank – £5,000
- Car – £15,000
- Stocks – £10,000
- Mortgage – £85,000
- Car finance – £7,000
- Credit card – £2,000
Net worth: £165,000 (assets) – £94,000 (liabilities) = £71,000 (net worth)
Net worth distribution
It is interesting to see how the distribution of net worth varies across percentiles of the population. The Resolution Foundation did a study on UK net worth published in December 2020. The most interesting part is their finding on the composition of net worth in the 10th decile (most wealthy 10%) compared to the 2nd decile (least wealthy 10% with a positive net worth).
In the graph above the Resolution Foundation found that the majority of net worth in the 10th decile was found in assets such as pension, property, financial and business. On the other hand the 2nd decile gets the majority of net worth (60%) from physical assets.
Property and physical assets have opposite trends when you go through the deciles. As net worth increases so too do the proportion that property takes, while physical assets reduce as a proportion. Therefore, the trend is that less wealth households place more importance on physical things than appreciating assets. Additionally, it is interesting how business wealth makes up a larger portion of the 10th decile than any other.
It is interesting to see as shown above that the poorest 10% have a massive proportion (71%) of their assets in zero-return assets, this proportion doesn’t go below 50% until you get to the 4th decile. Therefore, the takeaway from this is that we should invest in more income producing or positive-return assets as opposed to zero-return (depreciating) assets.
None of the content in this article should be considered financial advice, I am not a financial adviser and you should always do your own research prior to investing. These are my opinions only.