Grab a pen and a piece of
paper and jot down off the top of your head your household net
worth. Net worth, in case you are not exactly sure, is the total
value of your assets minus your total liabilities.
The first thing to know
about your net worth estimate is that it probably is wrong -- not
just by a few dollars, but by a lot of dollars. Numerous studies
have found that families either donít have any idea what they are
worth, or their idea is wrong. For example, a study last year by Jay
Zagorsky, a research scientist at the Center for Human Resource
Research at Ohio State University and Boston University School of
Management, estimated that 70 percent of households underestimate
their net worth, and 25 percent overestimate their wealth.
Furthermore, those who
underestimate their wealth do so by nearly 40 percent. For every
dollar they are really worth, they think they are worth only 62
cents, and for each dollar their wealth rises, they think they are
gaining only 27 cents.
Why should you care
about your net worth? Net worth is the best measurement of the state
of your financial health. Most of our major spending, investing and
other financial decisions are made, or should be, based on our net
worth, and obviously the more accurate that estimate, the better.
For example, if you overestimate your net worth, you may not save as
much as you should for your retirement, or you may overspend based
on your perceived wealth. Underestimate your net worth, and you may
either save more than necessary for your retirement, take on extra
investment risk in the belief you need to make up for what you
perceive as insufficient wealth, or buy insufficient insurance
recent focus on the 'wealth effect' illustrates how net worth
affects household financial behavior. During the late 1990s and
early part of 2000, American consumers spent heavily because they
had seen their stock investments rise in value and that made them
feel wealthier -- however accurate that feeling was for any
particular household. However, with the decline in the stock market
in 2000, the total net worth of American households fell in 2000 for
the first time since the federal government began collecting figures
at the end of World War II. Many economists attribute the nationís
current economic slump to declining consumer confidence in response
to their declining net worth.
Calculating an accurate
picture of your net worth is relatively easy. Computer programs or
worksheets are readily available that run you through the process.
Generally, start with how much money you have in checking and
savings accounts, U.S. savings bonds (current value), and
certificates of deposit and money markets. Add in the current market
value of your stocks, bonds, home, real estate investments,
retirement plan accounts, individual retirement accounts and
business interests. Include the surrender value of your annuities
and the cash (surrender) value of your life insurance. And add up
the value of your personal belongings: jewelry, automobiles,
clothing, furnishings, appliances, collectibles, computers, and so
on. Their value should be their current market value -- what you
could get in cash for the items.
On the liability side,
include the mortgage on your home, car loans, student loans,
credit-card debt, unpaid taxes, insurance premiums, charitable
pledges and outstanding bills. Subtract your liabilities from your
assets. Thatís your net worth.
Take this measurement
every year. It provides a benchmark about how well you are doing. Is
your net worth positive or negative, and perhaps more important, is
it improving or getting worse? Take a freshly-minted college
graduate saddled with student loans. Their net worth is probably
negative. They land a job that pays well. They buy a new car, loads
of consumer items, maybe even a new home or condo. Current income is
enough to pay the bills, but thatís about it. Yet what about their
net worth? Unless theyíve made a concerted effort to pay extra
toward the student loans, they still have a negative net worth. In
fact, the car and house have added to that negative picture. If they
arenít salting away much money in savings and investing, their
overall financial health isnít as sound as their regular income
would make it appear.
This column is produced
by the Financial Planning Association, the membership organization
for the financial planning community.