There are lots of confusing words in the personal finance world. Assets and liabilities are two of them, but they’re also some of the more important terms you need to know when determining your net worth (aka the total amount of money that you are worth.)
What is an Asset?
Generally speaking, an asset is anything of value that you own, regardless of if it has a lien (a loan) against it. For example, you should include your vehicle as an asset even if you have an auto loan on it.
Assets come in two forms: liquid and illiquid. Liquid assets are those that you can access quickly if you need money, like any money in the bank, cash, possibly your retirement funds, and some investments. Illiquid assets include your vehicles and recreational vehicles, real estate, your home, and personal valuables like collectibles and furniture. Illiquid assets are still valued in your net worth, though it may take weeks, or even months, for you access the value of these items on a cash basis.
What is a Liability?
Liabilities are any debts you owe to some else, like your mortgage, home equity loan, auto loan, student loans, and credit card debt. It is always preferable to have fewer liabilities than assets, resulting in a positive net worth.
Why do Assets and Liabilities Matter?
Knowing how much value you have in assets and liabilities is important for determining your financial health. Equity and net worth are both ways of determining your financial health status, with net worth being the more popular method of determining your true financial value.
What is Net Worth?
Net worth is a measure of your worth that takes your total assets minus your total liabilities. Of course, this number isn’t always the best measure of your financial health. For those who’ve just recently graduated college or those of us still going to school like my husband, net worth is not going to be the best measure of financial health. It will probably show up as a negative number, especially if you have student loans. But don’t be alarmed; when you are just beginning to build net worth, this is pretty common.
If you are older and you still have a negative net worth, this is the time when you should be more concerned about your overall financial health and take drastic measures to get out of debt as quickly as possible. Create a budget and cut your spending where you can.
No matter if your net worth is positive or negative at the moment, you should recalculate it every few months to see if you are making progress in the correct direction.
As mentioned, determining your assets and liabilities to calculate your net worth isn’t the only important factor in personal finance, but it can be a great way to compare where you are to where you’re going and recognize the hard work necessary to get there. A positive net worth is something that nearly everyone aspires to and the higher the better.
What are you doing to improve your net worth?