Friday, July 17, 2009

How to compute your net worth

By Dan Danford

A family statement of net worth (balance sheet) is a powerful financial tool. A statement is easy to compute, updated quickly, and offers a great way to evaluate decisions.

First, to build your family’s statement, start by listing the honest resale value of all things you own. List all houses, cars, boats, household goods (the national average for families is around $30,000), collectibles, and anything else of value. Next, add financial assets. Include bank, brokerage, or mutual fund accounts. Include IRA accounts or retirement plans from work. Include the cash surrender value of insurance policies. In short, this list should include everything you own with the current value.

The second half is -- hopefully -- a much shorter list. Here, list everything you owe with today’s payoff value. Start with the mortgage. Then, add any car, student, or consumer loans. List the balances on credit cards or money you owe family members. Don’t forget loans on insurance policies or money owed to a company retirement plan.

Simply, Family Net Worth (FNW) is the difference between what you own and what you owe. It’s the liquidation value of your financial life. If you sold and liquidated everything you own and paid off all debts, what would be left in your wallet?

Knowing this number helps you financially. It’s a running tally of financial progress. Update the numbers occasionally and see if your FNW is rising or falling. A rising number indicates progress; one that slips requires attention. Of course, there are life stages where FNW is expected to fall -- college years for children is one.)

It’s also a spectacular decision-making tool. Say you’re trying to decide whether to replace a car or start a mutual fund account. Consider what will happen to your FNW five years from now. Estimate the future worth of the car and the mutual fund in 2004. Does this help decide? Similar processes can help decide between two cars (which will have better resale value?) and houses (ditto).

Not every family decision is reached on the basis of finance. But, finance should be considered as part of any major decision. Understanding FNW helps all of us make better choices.

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