Updated: February 6, 2021
Once you’re tracking your spending and saving money, it’s important to track your net worth. Your net worth is a measure of your financial health and indicates how close you are to financial independence.
What is Net Worth?
Net worth is simply all of your assets (things that have monetary value) minus your liabilities (money you owe to others). Basically, it’s a snapshot of your current financial worth and is commonly how people measure their financial independence (or lack of).
Assets are things like cash (including checking/savings accounts), investment accounts such as a 401k or IRA, and home value. Liabilities are credit card debt, car loans, student loans, and mortgages.
Your net worth likely changes daily, since your assets and liabilities likely change in value daily. For example, you may have a 401k invested in stocks, and that changes daily depending on the market. Similarly, you probably have cash in the bank or loan balances that change regularly.
Why You Need to Know Your Net Worth
First, your net worth shows you how diversified your assets are. You can clearly see if the entirety of your net worth is tied up in your primary house (which is not extremely beneficial for retirement purposes since you will not receive that money unless you sell your house—and you’ll still need somewhere to live). Or it could help you realize if all of your money is invested in the stock market, and maybe that prompts you to diversify with real estate.
Second, your net worth makes your debts apparent. You’ll be able to clearly see your debt balances and the impact they’re having on your net worth. It could help motivate you to pay off your debts more quickly, and which ones to focus on first.
Finally, your net worth tells you how close you are to financial independence. Once you hit a certain number, you can live off that wealth for the rest of your life without having to add more to it. I’ll go into more detail later in the article.
Determine Your Current Net Worth
You can use Personal Capital or Mint to track your net worth. Both of those sites will show your net worth over time (although I will say Personal Capital displays it much more obviously so that is my preferred account for net worth purposes).
Personal Capital will show your assets and liability totals, and your total net worth is your assets minus liabilities.
It also displays it in a nice graphical format:
If you decide to track your net worth manually, you simply have to add your assets and subtract your liabilities from that number. However, I recommend using Personal Capital or Mint since those will update automatically as often as you’d like to look at it. If you did this manually, you’d have to look up and update the current numbers in each account every time you want to evaluate your net worth.
How Much is Enough for Retirement?
A common question people ask is what net worth they need to retire, or to be considered financially independent.
First of all, you may be surprised and frustrated to learn that your net worth is negative. Know that most people have a negative net worth at some point in their lives, and you may have to spend some time “getting back to zero.” This is a normal step in the path to financial independence. If you have acknowledged the fact that you have a negative net worth and have committed to increasing it, you are ahead of most people already.
A general rule of thumb is that you reach financial independence once your desired retirement income is 4% of your net worth. This 4% number has been based on multiple studies which use historical stock market data. It assumes your net worth is invested in the stock market and that you would withdraw 4% from your portfolio every year. Basically, this rule says you could withdraw 4% a year without ever depleting your portfolio (since stock market gains are typically more than that each year).
More generally, you reach financial independence when your passive income exceeds your living expenses. This is a more general definition than the 4% rule, because it can account for other investments besides stocks.
For example, let’s consider someone who desires an income of $40,000. You could make this income from stock withdrawals once you hit ($40000/0.04) $1,000,000 in your stock market portfolio. OR you could make $20,000 a year in a side hustle you plan to continue, and then you’d only need $500,000 in the stock market to cover the other $20,000. OR you may have 5 rental properties which produce $30,000 a year plus $250,000 in the stock market. There are many ways to grow your passive income.
Start Thinking About Your Net Worth Goal
The most important thing is to consider how much income you’d like in “retirement” (remember, you don’t have to “retire” from working to be financially independent). This really depends on your cost of living. Some people may think $20,000 is enough while others may think $60,000 is enough. It depends on where you plan to live, if you have a family to support, how much you want for travel, etc.
Remember, the income you want for retirement isn’t necessarily the same as your current W2 income. You are (or will be) saving some amount of your current income, which you wouldn’t need to continue saving in retirement. And if your passive income is less in retirement than your current income, you will pay less in taxes. There are also additional costs of working, such as professional clothes, commuting, etc. that you wouldn’t necessarily need in retirement.
Your target net worth is a very personal number that varies from person to person. Don’t let anyone else tell you how much you need to be financially independent—do the math for yourself.
Keep in mind that your target net worth may change over time. You may find you’re able to significantly reduce your expenses such that you don’t need as much as you initially thought. Or, you may decide to have kids and need to adjust accordingly. For example, I know I can live off around $30,000 a year right now, but I also know I want a family someday so I need to be more conservative. I will have to keep reassessing as my expenses change, until I feel comfortable with my number.
Start thinking about what your target net worth might be, but don’t worry about having to decide right now!