Last week, we worked through some spring cleaning for your financial house so now let’s take a look at where you are in your financial life. What do you have and what do you owe? Those are the questions and the bottom line answer to your net worth. More about net worth in a bit. First, what do you have and in what form?
Assets are usually separated by how quickly they can be converted into cash. Let’s look at the following categories:
Checking and savings accounts – these are in cash or almost cash. A money market fund is a “cash equivalent” as it is accessible to you same day.
Investment accounts – these are the next level as the investments can be sold and converted to cash, usually within a few days. Some investments are more restricted or “illiquid,” but that is rare.
Real estate – your house, property, rental house, etc. make up this next level. They can be converted to cash but generally this takes months to accomplish.
Illiquid investments – antiques, collectibles, jewelry and the like could be converted to cash, but that may be a more difficult task as these items have a more limited market so finding the right buyer who will pay the right price is more challenging.
Use assets – cars, furniture, etc. are assets, yes, but their values are dropping with each day and each use. In a pinch, they can be sold, though, so include the big stuff, like cars, especially if they have a loan attached to them.
Retirement assets – 401k’s, IRA, Roths, pensions, and the like could be converted to cash but if you are younger than 59 ½, there could be significant penalties and probably will be a tax liability. This is your long-term financial security.
Liabilities are debts – I owe, I owe, it’s off to work I go! When you take a look at liabilities, track several things: balance owed, interest rate, due date (usually monthly), minimum payment.
Short-term liabilities – credit cards and other debts that will be due within a one-year timeframe.
Long-term liabilities – those like car loans, student loans, and mortgages that stretch to longer than a year.
So, grab your pencil or your mouse and record every debt that you have. I would not include things like utilities where you will owe a balance monthly but it is paid off. Similarly, if you always pay your credit cards in full, that is more of a recurring expense rather than a liability for purpose of tracking the balance.
Net worth is simply the difference between your assets and your liabilities. It is a measure of financial security. Put in terms like this: net worth divided by annual income tells you how many year’s income you have saved. It also tells you how long you could exist if you did not work again. For example, if your net worth is $100,000 and you make $50,000/year, you could, theoretically, sell everything that you own, pay off all of your debts, and live for 2 years without working. There is a lot more to it, of course, but that gives you a high level perspective on where you are financially.
Next week, we’ll take a look at how you might dig a little deeper into this balance sheet (also called a net worth statement). In the meantime, let it sit with you and think about how you feel about where you are and be thinking about what changes you would like to see.
To your financial success!