We have often come across the term ‘net worth’. Generally, common people have the notion that this term is only to be used by the industry behemoths, TATAs and Ambanis, for determining their financial worth. But, anyone can and must calculate their net worth as it presents the big picture to an individual about the overall financial health. It is a snapshot that shows where an individual is on their financial journey.
What is net worth?
Net worth is the difference between investments and liabilities. The total investment made by an individual can include investment in stocks, mutual funds, gold, real estate, equities, insurance policies, fixed deposits, etc. Liabilities, here, are the total amount of loan that we owe to the bank or any family friend or relatives for example, car loan, education loan, credit card, house loan, etc. Therefore, the difference between the two is an important metric of financial health as it helps an individual keep a check on the amount of debt affecting the future wealth. It also serves as an effective indicator to help an investor understand which liabilities to pay off before retiring.
Net worth is mathematically denoted as –
Net Worth = Investment – Liabilities
A high value of net worth indicates good financial strength and gets a good credit rating. Low or negative net worth shows a weaker financial strength and lower credit rating, thus affecting an individual’s ability to raise funds from the market.
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Net worth is the difference between investments and liabilities. It serves as an effective indicator to help an investor understand which liabilities to pay off before retiring.
Why is calculating net worth necessary?
Let us understand this with a small example –
Suppose an individual has deposited Rs 10,000 in a bank under cumulative fixed deposit that offers interest of 5 percent whose maturity value at the end of 4 years will become Rs 12,000. Meanwhile, against the savings, it has taken a loan worth Rs 20,000.
But say, fate has other plans that caused an unfortunate death of that sole bread earner right after investing in for 3 years, just one year from its maturity. Now, the family, under emergency circumstances, wants to withdraw the fixed deposit amount, which will be slightly less than the maturity amount as banks will levy penalty charges of 0.5 -1 percent due to premature withdrawal. Therefore, with a reduced interest rate of 4%, the amount at 3 years will become Rs 11600.
The family now owes Rs 8,400 (20000 – 11600) to its lenders or bank.
The example presented here is for smaller loans or liability, now imagine the same for a bigger amount of loans.
Sometimes, unforeseeable circumstances can affect a family’s financial stability making it difficult to sustain. Therefore, tracking net worth will help one understand how much money lies in the liabilities and how many investments or alternate savings one has in case of any such emergencies.
How investors can ensure to have a positive net worth?
If investors are disappointed with their current net worth, they simply need to increase the investments or assets and decrease the liabilities. Here is how they can do it –
Transfer loans to new banks: First, make a list of all loans against their interest rates and notice which liabilities have higher interest rates. The ones having higher interest rates, try to shift them in banks where they charge lower interest rates for the same loans. Always compare the interest rates charged by your current banks with others. In this way, we can bring down our liabilities.
Minimise expenses: We are not advising you to become a miser, but try to cut down on unnecessary costs which might be irrelevant now, but it can add up to savings to be used for spending on assets. To prevent unnecessary spending, we can monitor expenses daily for about a week, or even a month, and then take stock of how many expenses were relevant. Once an investor is aware of its spending patterns, one can analyse spots that can be afforded to make adjustments. This is especially when we are shopping too much on a credit card.
Invest more: Ankur Warikoo, CEO, Nearbuy.com has a simple mantra to increase more investments or assets – ‘by investing more’. He suggests investing more in direct mutual funds and not in commission or growth mutual funds since it will attract a high expense ratio. Young investors should invest in stocks, not in real estate or bonds as it usually has a low growth rate as compared to stocks and mutual funds. Also, adding the inflation rate the growth rate further slows down. One must always invest in assets where the inflation rate has minimum impact on an investment’s growth rate.
