April is Financial Literacy Month, and our goal is to help you raise your money IQ. In this series, we'll tackle key economic concepts -- ones that affect your everyday finances and investments -- to help you make smarter choices with every dollar decision you face.
Today's term: net worth.
In a nutshell, net worth is what you get when you subtract liabilities from assets -- what you owe from what you own. Like many economic and financial terms, net worth can apply in a variety of situations.
If you're evaluating a company for your portfolio,you might glance at its balance sheet to get a handle on its net worth. Balance sheets break out assets (such as cash, inventory, and receivables) and liabilities (such as debt and accounts payable). Subtracting the latter from the former gives you net worth, which is also referred to in this context as shareholders' equity or book value.
Here's an example: As of the end of 2012, IBM's (IBM) assets totaled $119 billion, and its liabilities totaled $100 billion. Thus, its net worth, or shareholders' equity, was $19 billion.
Net Worth in Our Lives
Each of us has an individual net worth, too, and it's arrived at in similar fashion.
First, grab a sheet of paper and list all your assets. These would include the contents of your bank accounts, your investments, the equity you have in your home, your retirement accounts, the current value of your car(s), the value of your jewelry, the contents of your wallet or purse, and so on. Be thorough -- your sizable board game collection might be worth several thousand dollars, for example.
Next, list all your liabilities, or debts. These would include what you owe on your mortgage or car loan, your credit card debt, any school loans outstanding, and any other debt, such as a home equity loan.
Finally, subtract the liabilities from the assets. What's left is your net worth.
Ideally, your net worth is positive and will grow over time. If your net worth is in negative territory, that's not great, but by saving aggressively, paying down your debts, and being careful in your spending you can reverse the situation over time.
How Does Your Net Worth Compare?
For the record, a typical net worth for an American family these days is between $100,000 and $200,000.
The aggregate net worth of Americans has risen recently and is finally back to pre-recession levels. But much of those gains have gone to wealthy Americans and can be traced to the stock market's recovery.
Middle-class Americans have about two-thirds of their net worth represented by their home equity, and home values have not recovered as much as the stock market at this point. The Dow Jones Industrial Average has more than doubled since its bottom about four years ago, while the national average home price is still some 30 percent below its peak.
Other Reasons You Should Know Your Net Worth
Knowing your net worth has practical value beyond just highlighting what you own and what you owe.
It can also give you an idea of how well you're doing at saving for retirement. (Don't let seemingly large sums fool you -- even a million dollars at retirement may not be enough for some people's needs.)
Net worth also matters when we engage in estate planning, as our estate is essentially our net worth. Deciding how to organize and manage your assets to minimize taxes and make things easy for your loved ones depends to some degree on the size of your estate, or net worth.
So go ahead and calculate your net worth and see where you stand.
Motley Fool contributor Selena Maranjian has no position in any stocks mentioned. The Motley Fool owns shares of International Business Machines. Try any of our newsletter services free for 30 days.
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