Do you know your net worth? If you have no idea, don't worry, this article will help you understand how to calculate the value of all your assets and liabilities. There is a significant difference between your net worth and your net worth, and you may wonder how that affects your financial position.
Your net worth is the value of all your assets, minus your liabilities. Your net worth is the current value of your assets after deducting expenses related to your settlement in a cash position.
Let's unpack everything you need to know about calculating your net worth.
Before you begin, it is essential to understand why knowing your net worth is vital to your financial livelihood. Knowing your net worth is essential if you have to pack everything suddenly and move to another country. The number also gives you a clear indication of your wealth, and that is important for assuming credit facilities.
Before you start estimating your net worth, you must calculate your total net worth. To reach your general net worth number, use the following formula;
Assets – Liabilities = Net worth
Sounds pretty easy, right? All you need to do is open a spreadsheet and list all your assets. After that, list all your current obligations.
Assets are things you own, such as your home, vehicles, furniture, savings and investments. Liabilities are the debts you owe or ongoing expenses, such as the outstanding balance of your mortgage or your cars. You can also include items such as personal loans in your liability column.
After adding the two columns, subtract your liabilities from their affirmation value and you will get the total net worth figure. It is possible to finish this exercise in less than an hour, and it gives you a holistic view of your finances.
However, it is not a completely accurate view of its "liquid" position. For example, you can own your home directly without a mortgage. The market value of real estate is $ 500,000, but if you sold your home tomorrow, would you end up with $ 500,000 in your bank account after the sale ends?
The short answer is no. You must make payments to agents and lawyers with the sale, in addition to many other hidden costs. If you are selling in a weak market, the buyer is likely to offer you between 10% and 20% less than the requested price.
All of these factors play a role in determining the final payment that goes into your bank account, and could be significantly lower than the $ 500,000 you expected.
Understanding your net worth is crucial if you plan to start a business and need to ask for a loan. Banks calculate your liquid position and take it into account when assessing the risk involved in lending you money.
Personal Capital is a great free application to keep track of your finances and net worth, read our full review for more information.
How to calculate your net worth?
Calculating your net worth implies eliminating all transaction costs and expenses related to the liquidation of all your assets. It also takes into account depreciation and market conditions that may affect the final settlement figure.
Using our methodology in the previous section, if you round up the value of all your assets, you could reach a figure of, say, $ 1 million.
Congratulations, you are a millionaire! Or is it you?
- If your liabilities reach $ 400,000 for all your outstanding debts, then you have a total net worth of $ 600,000. However, this is not your liquid position. Suppose you have to liquidate all your assets to finance a medical procedure. What would be the value of all your assets in a fire sale?
- If your car has a value of $ 30,000 at the current market value, and you have a note for $ 10,000 pending, then the value of the vehicle is now $ 20,000.
- However, if you had to sell it quickly, you may only find a buyer who is willing to give you $ 25,000. Therefore, the sale value of $ 25,000, minus the $ 10,000 note, leaves you with a figure of $ 15,000, that is, half of the estimated value of the asset.
- If you have an IRA and your current value is $ 100,000, then this is not your liquid position. Even if you are 60 years old and are withdrawing money for retirement, you will have to pay money in closing costs and transaction fees, which will generate a little less than the total of $ 100,000.
- That also means you get a tax-free payment with a Roth IRA. If you have a traditional IRA, you will have to liquidate the tax collector with your payment, which may vary according to your tax category. For the sake of the discussion, suppose you end up paying the IRS $ 30,000 in taxes on your account.
You also end up paying $ 2,000 in closing fees. As a result, you end up with a final payment of $ 68,000, which is 32% lower than the $ 100,000 you expected.
Factors that affect your net worth
Some other factors also affect your net equity position. For example, you can have all your assets immobilized in real estate investment, with a total value of $ 1 million. Another person could have $ 600,000 in assets in a savings account, using dollars after taxes.
In this case, although real estate is technically worth more than the savings account, you must pay taxes and fees for the sale of your properties. After accounting for taxes and capital gains charges, you can withdraw your real estate portfolio for a total of $ 500,000.
However, the person with the $ 600,000 in cash would not pay taxes, since he financed the account with dollars after taxes and received no growth in his money. In this case, the person will end up with a liquid value very close to the $ 600,000 mark.
Therefore, the person with the lowest total net worth actually has a higher net worth than you, the real estate investor.
What are liquid assets?
In our previous example, you can see that there is a significant difference between assets and liquid assets. So what exactly are liquid assets? Here is a list of liquid assets that you may already have in your portfolio.
These include cash and cash equivalents.
- Cash in savings accounts or available physical cash
- Precious metals such as gold and silver.
- Accumulated earnings
- Promissory notes
- Government stocks and bonds
- Accounts Receivable
- Deposit certificates
- Taxes devolution
When you withdraw these assets, there are almost no commissions, which means that the cash value of liquidating these assets is closer to the market value.
However, it is also important to keep in mind that you may have to pay the capital gains tax on the investments, as well as the fees, which makes the amount you receive less than the market value.
The reason why they are classified as liquid assets is that you can collect them on short notice, sometimes in just 24 hours.
Read: Best Investment Ideas for Millennials: Complete Guide
Understand the liquid value of accounts and retirement plans
Many people make the mistake of assigning the value of their IRA and 401 (k) plans in their calculation of net worth.
These assets are not true liquid assets, although you could withdraw them in a few days and have the money in your bank account, ready to spend.
However, you must keep these investments until the due date, to qualify for the total value of your payment. When you reach 59.5 years of age and can access the cash, you must pay taxes on payments 401 (k) and IRA.
The amount of tax you pay depends on your income tax category when you retire. Most people rise between the tax levels during their career, as they begin to earn more money. Therefore, when you withdraw cash at 59.5 years, you could end up paying the tax collector up to 30 percent, or more, of the total value of the investment.
If you decide to retire earlier, you will also have to pay a 10% fine, significantly reducing your payment when we also include the tax obligation.
It is important to keep in mind that taxes only apply to traditional IRA accounts and 40-1 (k) plans. If you have a roth
IRA, so your contributions are tax exempt since you make payments with dollars after taxes. However, if you decide to make an early withdrawal, then your payment is exposed to taxes and you will have to pay the penalty for early withdrawal.
If you are under the retirement age and calculate the liquid value of your Roth IRA, remember to deduct taxes, fines and fees when determining the liquid value of your asset.
Calculation of the liquid value of your real estate assets
Real estate is probably the most difficult asset to liquidate. When you decide to sell your home, you can stay in the market for months before finding a buyer. The longer your home stays in the market, the more you will have to discount the property to attract buyers.
It is even a strong real estate market, it could take weeks to sell your home. The sale value depends on how desperate you are to sell your home. If you need cash urgently, you may have to offer a 10% discount on the price requested to attract buyers, reducing the liquid value you receive after the sale.
Read: Fundraising review: collective real estate financing platform with large returns
Transaction fees for real estate sales
When calculating the liquid value of your home, you should also take into account the transaction fees involved in the sale of the property. Your real estate agent may charge you between 3% and 6% of the transaction value.
Closing costs are also a concern and can add between 1% and 2% of the final value of the transaction. Closing costs include taxes on transactions, which vary by state, as well as attorney fees to facilitate legal work related to the change of titles of your name to new owners, as well as custody costs.
As a result, you could end up paying around 10% of the total value of the sale in rates, something that you should consider when calculating the liquid value of your real estate. Investors selling a rental property are exposed to pay taxes on capital gains on the profits they obtain from the sale.
For example, if you buy a house for $ 300,000 as rental property, and the value increases to $ 350,000 for 5 years, then you will have to pay taxes on the $ 50,000 gain you earned on the value of real estate.
The liquid value of your business
If you thought finding out the liquid number in your home was a challenge, wait until you have to value your business. Placing a number in your company is a challenge for several reasons.
As a starting point, you must discover how easy it is to sell your business. For example, undoing a new business is much more complicated than selling a cash business like a car wash. Start-ups are much harder to sell than cash companies, and are difficult to value using GAAP accounting methods.
In most cases, you should hire a business consultant to help you with the valuation process. These costs are deducted from the final number you receive in the cash value of the value, and you must also consider the tax on the final amount.
Therefore, in most cases, it is better if you exclude the value of your business from your total net worth, unless a commercial consultant verifies a precise figure.
Read: How to make your small business more successful: Complete guide
Calculation of the liquid value of your possessions
Many people make the mistake of calculating the liquid value of their possessions at current market prices. However, it may surprise you to know that the liquid figure is much lower than you expect. As a general rule, you must add the retail cost of all your belongings, such as furniture, electronics and clothing, and then allocate 5 to 10% of the number to your net worth.
For example, you may pay $ 500 for a new TV, but when you sell it a few years later, you will probably only get $ 50 to $ 100 in the second-hand market.
There are exceptions to this rule, such as jewelry. However, even these assets are only worth about half of what you paid for them in liquidation. Jewelry retailers often charge margins of between 100% and 200% on the "fusion" value of the piece.
An example of calculating your net worth
At this point, you must understand how to calculate your net worth. Let's look at an example to help you get a visual idea of how to complete this calculation yourself.
- For this example, suppose you have a total net worth of $ 1 million and your obligations are $ 400,000.
- In that example, it has a net worth of $ 1 million – $ 400,000 = $ 600,000.
Now that we have your net figure, let's review each of the asset classes individually to calculate your net worth.
Your home has a market value of $ 400,000, with a pending mortgage of $ 200,000. If you want to sell your house quickly in a down market, you may have to settle for a sale price of $ 380,000.
After subtracting an additional 10% for the transaction costs related to the sale of your real estate property, you get a liquid figure of $ 162,000.
Both you and your partner have a car, and both bought the same model for $ 40,000 each. The total market value of the vehicles is $ 80,000. However, their cars are two years old and you can count on a 40% discount of the original retail value in the depreciation of the vehicles.
As a result, the final sale value of their vehicles is $ 48,000. Subtract the $ 20,000 you owe on your car notes, and it will have a final liquid value of $ 28,000.
Their traditional IRA and 401 (k) plans total $ 100,000 in assets under management. Given that you are likely to be under the retirement age, you must pay the 10% fine, which leaves you $ 90,000.
Next, closing costs and transaction fees related to the collection of your accounts will represent another 2%, leaving you with $ 88,000. The tax collector requires a 30% reduction in taxes, leaving him with $ 61,600 as the liquid value of his retirement assets.
Furniture and household goods
Total the retail value of all your items other than jewelry. For this example, we will say that all your possessions are worth $ 50,000 at market value. Therefore, the liquid value is $ 5,000. If you have jewelry worth $ 20,000, you can count $ 8,000 of that value for your net worth.
In conclusion: do the math in your net worth
Now we enter all these liquid values in your spreadsheet to determine your final net worth, doing the calculation as follows;
- Main residence: $ 162,000
- Cars: $ 28,000
- Retirement Savings: $ 61,600
- Furniture and Trinkets: $ 13,000
- Total net equity = $ 264,600
Editorial Disclaimer: The opinions expressed here are only those of the author, not those of any bank or credit card issuer and have not been reviewed, approved or endorsed by any of these entities.
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