Out with the old, in with the new: Calculate your net worth

In December and January, The Simple Dollar is posting a daily series focusing on specific activities you can do right now to set the stage for a great 2011. Out with the old, in with the new.

I’ve always seen the five weeks between Thanksgiving and the new year as a time for reflection and for setting the stage for a successful year to come. It’s usually full of time spent with family and time spent preparing for those family events, too.

This year, I thought I would fill the month of December with a collection of the kinds of activities and preparations that I undergo during this period, both to put some closure on the year that passed as well as set the stage for an even better year to come.

Some of these will work for you. Some won’t. Nevertheless, give as many of them as you can a try. You might find that it’ll put you in a better place than you ever expected.

1. Calculate your net worth.

In my experience, there is no better snapshot of your financial health than your net worth. With one single number, you can get a glimpse of your financial state, good or bad. More importantly, by calculating your net worth on a consistent basis and comparing the numbers, you can get a sense of whether you’re making positive financial progress or whether you’re regressing.

There’s no better time than right now to get started. Here’s what you need to do.

Make a list of all of your assets and their values. How much do you have in all of your savings accounts? Your checking accounts? Your investment accounts? College savings? Retirement savings?

Some people also choose to include assets such as their automobiles and their homes. I generally think automobiles are a poor idea to include because they’re difficult to value properly and they’re not easily liquidated for most people, as they need some form of transportation. It’s up to you whether or not to list your primary residence’s value – I don’t list it on my own calculations.

The important thing is that you use a standard, so that when you calculate your net worth again, you’ll be able to make a fair comparison.

Make a list of all of your debts and their balances. How much credit card debt do you have? What’s your mortgage balance? What about auto loans? Personal debts?

Again, make a list of all of these things with their current balances. As with the asset list, this may take some time as you locate all of these balances. Net worth calculations are a task that’s greatly aided by personal finance software like Quicken.

Add up the assets and the debts separately. You’ll want a total value of all of your assets as well as a total value of all of your debts. Time to break out the spreadsheet or the calculator!

Take the total of your assets and subtract the total of your debts from it. The resulting number is your net worth, and it’s a great snapshot of your financial health.

Ack! My net worth is negative? Many people, particularly young professionals with a big pile of student loans, will find themselves with a negative net worth, something that seems really ominous.

I wouldn’t worry too much about it, particularly if you’re gainfully employed. Instead, I would focus on the month-to-month or quarter-to-quarter change in your net worth. If your net worth is going up on a consistent basis (meaning that negative number is getting smaller and smaller as it heads toward zero), then you know you’re headed in the right direction.

How do I use this information? In my experience, the best use for one’s net worth is to provide a yardstick and a motivator for better personal finance behavior.

First, you can raise your asset level – and thus your overall net worth – by living more frugally and by finding new ways to earn income. If you resist spending, then the money stays in your account. If you earn more money, that money goes into your account. The better you are at either side of the coin, the higher your asset total will be and thus the higher your net worth will be.

Second, you can reduce your debt level – and thus increase your overall net worth – by living within your means and sticking to a debt repayment plan. These methods will reduce your debt load, thus increasing your net worth.

In other words, your net worth is directly related to your financial moves. If you make good moves, your net worth goes up. If you make bad moves, it goes down or stays stagnant.

This is particularly true when you start keeping track of your net worth over time, calculating it (say) on the first of each month and comparing it to earlier net worths. It’s almost like keeping a financial “score” for yourself, one that, if you’re competitive, will make you want to beat your earlier scores through good financial behavior.

I have calculated my net worth each month since 2006. For a while, I calculated it weekly and, for another period, I calculated it every two weeks. All of this data tells me a few things: frugality really does pay huge dividends, getting rid of debts accelerates your net worth growth (because you’re not dumping money into interest), and my financial progress has been a very good thing. I keep the numbers in a spreadsheet – you can use whatever documentation system works best for you.

Get started on your own net worth track record today.

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