If you’re just starting to get a handle on your personal finances, one of the first steps you need to take is calculating your net worth. At its simplest, your net worth is your assets minus your liabilities. In human terms, that means things you have that hold value (cash, investments, house, car, etc.) minus your debt. In 2017, a US federal reserve study found that 16.6 million households in the US have a negative net worth.
It’s now 2021 and the world has changed, yet no new studies exist. I would hazard a bet that the number of Americans with a negative net worth is growing. So what does a negative net worth indicate? Is it inherently a bad thing?
Understanding net worth
Net worth is simply an indicator of how much you own vs. how much you owe. Millennials and Gen Zers are kind of f*cked in this department. When you graduate with suffocating levels of student loans and the housing marketing is smoking hot, it’s pretty hard to get ahead.
Personally, I didn’t go into the black on net worth until I was 35, and that’s only because I got really lucky with my house. Right now the average net worth of Millennials is $18,000. That’s up about $8,000 over the past two years.
What’s a “good” net worth?
According to Investopedia the best way to calculate ideal net worth is the following calculation
Ideal net worth = (your age – 25) * (gross annual income/3)
With that calculation, my ideal net worth would be $574,200. WTF?? Who has over half a million dollars in their 30s? Essentially an $18,000 net worth would only be ideal for a 26-year-old earning $54,000/year. I suspect many of us are in the same boat, falling far short of what’s considered the ideal. Or even in the negative.
How to calculate your net worth
If I have your attention now, you may be seeking to calculate your own net worth. You can find a ton of worksheets for this purpose, but I think the easiest way to do so is to use this handy dandy tool from bankrate.com.
If you have many accounts or don’t regularly check in on your retirement account it may take some time. But it’s worth it to know if you’re on the right track.
You’ll need to start by looking at everything you have. This calculation includes cars, investment accounts, retirement savings – anything of value. If you’re a homeowner, use the estimated total value of your house.
Then list your liabilities, money you owe. This could be for your car, credit card debt, or student loans. If you are a homeowner, this is where you can list your outstanding balance on your mortgage.
Be sure not to worry too much if you’re not in the ideal state. The value of knowing your net worth is more important as an indicator over time than it is as a single data point. You want your worth to be going up rather than down.
My net worth is negative, now what?
If you crunched those numbers and there’s a big ugly negative sign in front of your net worth, then you need to know a couple of things:
1. This does not define you as financially irresponsible. The deck is stacked in favor of debt when you live in the US.
2.If you have student debt or a mortgage, then you have what’s called “good debt”. That means, in theory, that this money owed is for things that can help build wealth or increase income over time.
Now, it’s time to take action. There are really only two ways to increase your net worth – save more or pay down debt. That’s a really simple answer to a very tricky question. The answer will be dependent on the kind of debt you have, your income, and your comfort with debt.
How much should I save or put towards debt?
While conventional wisdom suggests that you should save 20% of your take-home pay and those debt payments should fall within a 50% limit of your needs (read more here on the 50/30/20 rule) , sometimes reality has other plans for us.
One way to dive deeper into what’s going on with your money is to build a cash flow statement. The purpose of a cash flow statement is to
1. See if you’re living within your means
2. If you are, calculate how much extra you can set aside for debt or savings
3. Evaluate timing of payments due vs. incoming cash to see if there’s a mismatch that’s holding you back (for example, you overdraw on your checking to pay car insurance at the end of the month).
How to create a personal cash flow statement
Start by listing out all of your income streams and their value and dates you receive them. These might include:
Salary
Overtime
Bonuses/commissions
Interest/dividends received
Gifts, tax refunds, rental income
Then list your fixed expenses. These are expenses that are generally the same every month. List out the amount you owe, and the dates they are due. These might include:
Savings contributions (also investments and retirement)
Housing expenses (rent, mortgage)
Automobile payments (loan or lease)
Insurance payments
Installment loan payments
Taxes
Utilities (on an equal payment plan)
Cable TV
Cell phone payments
Finally, list your variable expenses, the things you spend money on that vary from month to month. You can calculate these using an app (try Mint, or see if your bank does the calculations for you) or you can go old school and add up expenditures over the last 3 months to get an average. Variable expenses might include:
Food costs (groceries and restaurant expenditures)
Utilities (not on an equal payment plan)
Transportation (gas, auto maintenance, licenses, registration, public transit)
Medical expenses
Clothing
Education
Household furnishings
Personal care
Entertainment/recreation/vacation
Charitable contributions
Credit card payments
Miscellaneous
Why did I just do all this work?
Now comes the fun part… look over your cash flow statement and ask yourself:
- Is there extra room to save or pay off debt?
- Are there places you’re surprised by how much you’re spending?
- Can you cut back on any of your expenses?
- Are there times when more money is leaving your account than coming in?
If you’re spending more than you make, then that’s going to keep you living with a negative net worth for the long run. Unfortunately, there are only two ways to shift this balance:
- Spend less
- Make more
Again those are big topics, if you want to learn more about them subscribe below to my newsletter to stay up to date on olive the tips!
Finally, remember that a negative net worth does not define you as financially irresponsible. It’s just a data point to get you started.
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