understanding gift tax

Creating a Personal Net Worth Statement

If you had a quick snapshot into your financial life, don’t you think you could make wiser decisions around your money?

Net worth is a measure of financial health. Your main financial goal should be to increase your net worth over your life. By creating a personal net worth statement you will give yourself a quick snapshot into your financial life, be able to understand what would happen in the worst case scenario and understand how your actions affect your finances.

What Your Net Worth Means

To arrive at your net worth, you add up everything you own and subtract everything you owe. Everything you own includes all your current, investment, and personal use assets. Everything you owe includes all current and long-term liabilities. You always want to maintain a positive net worth, having more assets than liabilities.

Over time, you want to increase your net worth by increasing assets, decreasing liabilities, or (preferably) doing both. A strong, positive net worth is a symbol of strong financial health.

Calculating Net Worth

You don’t need a lot of fancy tools for calculating your net worth. It is a simple process that can be accomplished using a spreadsheet or a sheet of paper. When you create your personal net worth statement, list all your assets on the left side of the page and all of the liabilities on the right side of the page.

The first thing you must do is list out all your assets. Your assets can be broken down into a few categories to make it easier to decipher. The first group is your current assets. This includes your very liquid cash assets, such as what is in your savings and checking accounts. You can include any liquid asset that you can use within the current year. Don’t include items such as income or bonuses. You want to only include what is in your accounts right now.

If you have a CD that expires in 2 years, don’t include this as a current asset. But, if your CD expires in 6 months, this is a current asset.

The next set of assets is your retirement and investment assets. We like to break this group down even further to understand exactly where the investable assets are located.

The groups we like to use are based on the tax treatment. By breaking it down to how the assets are taxed, we will be able to see if we are too heavy in a certain area, especially as we near retirement. If we do see that we are too heavy in one area, we can adjust throughout our life to balance out the future tax treatment. As you can see, a simple net worth statement is already taking the guesswork out of using a Traditional IRA or Roth IRA.

The three categories we like to use are sometimes taxable, always taxable, and never taxable accounts. Your sometimes taxable accounts are going to be your standard brokerage account. These accounts are sometimes taxable because you could be in a tax bracket that is low enough to qualify for 0% long-term capital gains. This may be more difficult to achieve if you are still earning income, but it will matter as you get closer into retirement. Currently, the lowest two tax brackets qualify for 0% long-term capital gains. A long-term capital gain is an investment that you old over 365 days. Short-term capital gains will always be taxed at your ordinary income rate.

The next group is the always taxable accounts. These will probably make up the largest portion of your investable assets because this is your standard retirement plan. If you have a Traditional IRA, 401k, or other work-sponsored retirement plan, it will most likely fall into this category. This group is always taxable because you have chosen to kick the tax can down the road. You opted not to pay taxes right now and instead pay taxes when you take the money out in retirement. Sooner or later, taxes will be paid on this amount, so it is always taxable.

The never taxable portion of your assets includes investments you have already paid taxes on. Mainly this is going to be your Roth IRA, Roth 401k, and an HSA.

The final group of assets that you need to worry about are your personal use assets. Personal use assets are typically harder to value and include assets that you currently use. Items such as your house, car, and household items would fall into this category.

When valuing these assets, you don’t need to be too specific. You also don’t want to overvalue your assets just to inflate your net worth. The idea is to take the value as if you had to sell the asset right now to cover your liability. For homes, we like to use the price that it was appraised at on your property taxes or by using Zillow.com to get a rough home value estimate. You can also use Kelley Bluebook to get a rough value for your cars. We like to leave off household items unless you have something of significant value in your home. Trying to value your furniture and pots and pans would be taxing and should be left off your net worth statement. Items such as fine jewelry, collectibles, or an art collection can be valued and placed on your net worth statement.

Once you have all your assets listed, sub-total all the individual groups and then do a grand total of all your assets at the bottom.

Now that you have all your assets listed, you need to list all your liabilities.

Liabilities are a bit easier to list because we are not going to break them up into so many categories and finding the value should be relatively easy (no guessing required).

The two categories we like to use are current liabilities and long-term liabilities. Current liabilities are any liabilities that will be paid off in the current year. If you have short-term debt or credit cards that you expect to pay off this year, they would go under current liabilities. If your car loan or house loan has less than a year left until it is paid off, those would also go under current liabilities.

The next group is long-term liabilities. This will make up all the rest of your debt. Credit cards, student loans, mortgages, and car notes would all fall into this group if you have more than a year left to pay them off. Try to use exact amounts when listing your liabilities so you can have a clearer picture of your financial situation.

Again, sub-total the two groups and then do a grand total at the bottom for your total liabilities.

Once you have your two grand totals, simply subtract the liabilities from the assets. This number is your current net worth. Net worth is always a snapshot of that current time. Anytime you want to update your current net worth, simply change the values of your assets and liabilities to reflect the current, most up-to-date, value.

What If Your Net Worth is Negative

What happens if you have a negative net worth? There is no harm in having a negative net worth if you are currently young or in the accumulation phase. At this point, you probably don’t have a lot of investable assets which can bring down your asset level. This is especially true if you have just put on a big loan for a car or a house. However, if you are racking up debt because of credit cards not being paid down, this will give you a good realization of that too.

How to Increase Your Net Worth

Your net worth only has two parts, assets and liabilities. You can increase your net worth by raising your assets, lower your liabilities, or doing both.

Look over your assets and see which assets are currently working for you. These are going to be your investable assets. Take the sub-total for your investable assets and divide that by your grand total assets. This will give you the percentage of your assets currently working for you. Ideally, you want this number to be at least 50%. A lot of times, people will discover that most of the net worth is tied up in their house. It is always good to have real estate, especially if it appreciates in value. Unfortunately, your home is not easy to sell, and you will still have to find a home to live in.

You can also take this time to notice if you have large cash reserves. You want to have a liquid emergency fund ready to go. But, are you holding too large of an emergency fund and is your emergency fund and the rest of your cash earning you a good interest rate? As interest rates rise, don’t settle for accounts that are giving you under 1%. Find accounts like the Goldman Sachs Marcus account or the Ally Online Savings Account that are paying over 2% on their savings accounts. This will keep your accounts liquid and in cash, but they won’t be a large drag on growing your assets.

When you are trying to grow your assets, the best way is to make sure your investments are properly taken care of. Inspect your various accounts to make sure you don’t have a lot sitting in cash. You also want to make sure your dividends and distributions are being reinvested as they are being paid out.

The next piece in the puzzle is to lower your liabilities. This will be a harder task but is equally as important. Having a mortgage or car note in your liabilities can be okay. Focus on shorter term liabilities such as short-term loans, credit card debt, and student loans. You may be required to really focus on your cash flow and find ways to save money so you can pay down your debts more quickly.

How Often Should You Look at Your Net Worth

Looking at your net worth every day might be excessive. Especially since there won’t be a lot of changes day-to-day. Looking at your net worth statement every month or once a quarter is much more useful. Spend this time to update your numbers and really understand what has changed since the last update. Without proper attention, money can leak out of your accounts. Find those leaks, plug them, and build your net worth up.

What should be your net worth goal amount? There is no “one size fits all” approach to coming up with a goal. The goal should be to increase your net worth year over year, not to achieve a certain number.

Conclusion

Your net worth statement will be your financial snapshot. There is no tool that will be greater use to you as you build your wealth. It doesn’t matter what phase of life you are in, get in the habit of build a net worth statement. It is a very easy process and becomes easier after you set up a master plan and know where to find the information.

Try updating your statement at end of every month to understand how your financial choices throughout the month has affected your overall financial health. Just because your net worth has dropped one month doesn’t mean it’s bad, if you understand why it happened. Keep a record of all your net worth snapshots so you can go back and review how far you’ve come and the changes you’ve made.

Want even more fun? Turn growing your net worth into a game by setting short-term targets for yourself.

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