Your Assets (What You Own)
Assets are things that you own, have acquired and possess at a particular moment in time. That is a very simple definition of a person’s assets. Examples of assets (although there are differing thoughts about what exactly defines an asset in accounting principles) are: cash, bank accounts, brokerage accounts, real estate/land (although some note that such an asset is not a ‘liquid’ asset i.e. cannot be quickly turned into a cash asset); collectibles; art; antiques; vehicles (although some do not determine a leased vehicle as an asset since you do not own the vehicle); and retirement funds (like IRA’s and annuities.) These are the broad categories of individual assets.
Note that copyrights and ‘good will’ may not constitute an individual’s assets, but royalties (for example from a book or song that you wrote) may (in some cases) be defined at an asset – they can provide income and are not a ‘debt’.
Your Liabilities (What You Owe)
Liabilities are such things as loans (including student loans); credit card debt; medical bills; mortgages; auto loans/leases. Include in liabilities any unpaid taxes and personal/family loans and all long term lease obligations. (Consider: you ‘own’ an expensive car…with a depreciated present value of $40,000… however, you still OWE a total of $42,000 in payments on the vehicle)
Example: If your total assets are $350,000 (at a particular moment in time) and your total liabilities (in the same period) are $280,000 – then your net worth would be $70,000 (at that period of time). Remember, the value will change over time. An example would be if you use $10,000 cash from your bank account to take an expensive holiday…the holiday is not an asset, so your net worth would decrease by $10,000 at that period of time. In other words, you have removed $10,000 from the asset column of your calculation.
************A Simple Formula for Determining What Your Net Worth Should Be
One of many formulas to determine what your net worth SHOULD BE (given your age)…
Target Net Worth = Your Age minus 25 multiplied by 1/5 of your gross annual income.
Let’s take an example: You are 45 years old. You have a gross annual income (before taxes) of $60,000.
Let’s apply the formula – Target Net Worth = 45 minus 25 times 1/5 of $60,000
Thus, (45 minus 25 equals 20) multiplied by $12,000 (1/5 of $60,000) equals $240,000
Your TARGET for your net worth (given your age of 45) would be $240,000.
In other words, your assets should exceed your liabilities by $240,000.
Let’s take another example of someone who is 72 and retired with an annual gross income of $36,000: (using the same formula)
72 minus 25 is 47…multiplied by $7,200 (1/5 times $36,000) equals $338,400
Their target net worth is $338,000.
In other words, at age 72…Their total assets should exceed their liabilities by $338,400.
I offer three other formulas for determining what your Net Worth Should Be…
Alternative Formula #1: Target Net Worth = Age X (Gross/PreTax Annual Income/ 10)
(The 10 in the formula makes the assumption that that a person’s net worth will grow 10% in a given year)
Alternative Formula #2 : Target Net Worth = Age – 27 X (Gross/PreTax Annual Income/10)
Alternative Formula #3: Target Net Worth = Age - 27 X (Annual/PreTax Income/5)
Each of the above formula will give a different target net worth.
Whichever formula you use….Use the same formula over time to access how your Target Net Worth is changing.
***************Why Bother to Track Your Net Worth?
Knowing your net worth:
* Gives you a reality check on your finances and a point of reference at a particular point in time. If you see that your net worth is significantly diminishing, perhaps it is time to take action.
* Allows you to confront spending habits
* Encourages you to pay down debt. Remember the formula – assets minus liabilities (debt)
* Helps to monitor your investments – certain “assets” can actually be a drain on net worth, for example, a heavily mortgaged second home with a diminishing valuation
* Helps you plan for the future in any economy – knowledge is power
* Gives you incentive to plan for the future – at each point of time and each age your net worth should be “on target”
* Helps to keep track of income and outgo and to encourage savings
* Creates good money habits – knowing the difference between something that you own versus something that is a charge on your credit card
Lastly, when determining your assets, avoid the pitfall of valuing your assets too highly.
1. The value of assets can change dramatically over time- for example the value of your home (probably a person’s biggest asset) in a ‘down’ economy; or the value of a ten year old boat that you cannot sell but still continue to pay mooring fees.
2. Realize that many ‘assets’ depreciate over time – like that expensive vehicle in a prior example.
3. Know the equity that you hold in all your properties, whether it is a home that you live in, a rental property or a ‘summer’ home.
Working To Preserve Your Wealth and Protect Your Future…in a Constantly Changing World
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