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You’ve just looked at your net worth, and you’ve had a nasty surprise. If you had to liquidate all you own today to pay off all your debts, you’d still owe money. You have a negative net worth.
You may feel like hanging your head in shame, like one in five of all U.S. households. That’s how many people have negative net worth, according to the Billionaire Bonanza Report, compiled by the Institute for Policy Studies using the Federal Reserve’s 2016 Survey of Consumer Finances.
Startling, isn’t it? Especially when you consider that the report also concludes that the wealth of just three men combined – Bill Gates (Microsoft), Warren Buffett (Berkshire Hathaway), and Jeff Bezos (Amazon) – equals the wealth of the bottom half of the population in the United States; approximately 160 million people.
But is a negative net worth as bad as it sounds?
Why Is Net Worth Important?
Your net worth is a snapshot of your financial position. It shows you where you are now and, most importantly, it can give you clues on how to get to where you want to be.
In one single number, your net worth summarizes what your financial life has amounted to. It’s like adding up all your earnings and your savings and investments, and deducting all your rent or mortgage and bill payments, and all your other spending. Then producing a final number, which is your net worth.
If your net worth is negative, it should spur you into action. You may need to consider how to reduce your liabilities or cut your expenses. You may need to find easy ways to earn more, or learn how to make money from your hobbies.
By monitoring your net worth at regular intervals, you will more easily decide how to spend and save more effectively. And when your net worth begins to improve, you’ll be motivated to continue your own improvement in how you manage your money.
In summary, measuring your net worth provides an overview of your financial health. You can then drill down to decide how to improve that financial health, and accelerate toward financial freedom.
How Do You Calculate Net Worth?
Now you understand that knowing your net worth is important, you’ll want to know how to calculate it. Though it summarizes how far your money management has taken you to date, you’ll be pleased to know that you won’t have to dig out all of your earnings since you started work and every receipt you ever collected. It’s far easier than that.
In simple term, your net worth is:
The value of all your assets – the value of all your liabilities
Examples of your assets include:
- The value of any real estate you own
- Bank account balances
- Savings account balances
- The value of your investment portfolio
- The value of personal property (e.g. cars, jewelry, antiques, etc.)
Examples of liabilities include:
- The amount outstanding on your mortgage
- Amounts outstanding on loans
- Your student loan balance
- Credit card balances
- Overdraft amount
Here’s a couple of examples:
From these two examples, it is likely that the first is of a person who is older. They have repaid their student loans and have made some good financial choices along their journey. The second example is more likely to be a newly qualified graduate, just starting out on their life journey.
One of the challenges when calculating your net worth is the amount of work involved. Collecting all your financial data together takes time, even in the world of online banking. This may be a reason why many people never calculate their net worth (they’ll go through life never knowing where they will end up, and usually must work many more years because of a lack of planning). Others calculate their net worth in an annual review with their financial advisor (these are better at planning, but could still do better).
With today’s personal financial online tools and apps, you can always know your net worth in real time. This knowledge will empower you to make the very best financial decisions every time.
Apps that can help you track and build your net worth link all your financial accounts, take in data (usually in real time) and show you a net worth figure. They can show you how you are spending your money, and help you stick to a budget. Two of our favorites are:
Acorns, which asks questions about your financial goals, helps you assess your risk tolerance, and then recommends a portfolio based upon your answers. It’s a great tool if you are just starting out as an investor, and has some neat tools to help you save. One is the ‘round-up’ feature, which rounds up purchases you make on your credit cards and streams the extra into your investment account.
Personal Capital, which tracks your spending and investments. This is better for those who have been investing for a while. It’s great to keep you aware of how you are spending your money, and links all your financial accounts – including retirement investments – into one easy-to-see value.
When you are using Personal Capital, the app literally tells you how you are doing. There is no effort needed to calculate your net worth. It also makes budgeting a breeze. Your spending is categorized, making it easy to spot where you are overspending.
Is Negative Net Worth Bad?
A negative net worth does not mean you are financially irresponsible. For many people, negative net worth is temporary. Your net worth also fluctuates. For example, the day you get paid you’ll have your paycheck in your account. As the month progresses, you spend your paycheck, and your net worth diminishes.
Temporary negative net worth may be caused by a variety of factors. For example, it may be caused by falling home prices – sending you into negative equity. However, providing you can afford the mortgage repayments, does this matter (if you don’t plan to move)?
In the United States, student loans are a major contributor to negative net worth – accounting for 40% of total debt on average in those households with a negative net worth between $12,500 and $46,300 (The Motley Fool – reporting on the findings of the Economic Policy Institute).
However, your college degree should allow you to earn higher salaries and pay off your student debt faster. Once you have, you should then be able to accumulate wealth faster. (We should point out that is also possible to find success after dropping out of college.)
If temporary, a negative net worth does not have to be bad. However, if this financial position lasts longer, it could impact your ability to borrow at favorable rates. So, it is better to try to avoid debt or minimize where possible. For example:
- You might decide to attend a public, in-state school instead of a private one. This could save $24,000 on your tuition costs.
- Living at home and commuting to college instead of dorming could save $10,000 each year.
Throughout your life, the decisions you make have an impact on your financial standing and your net worth. Thus, we recommend calculating the opportunity cost of your decisions and understanding how your net worth is impacted by what you do, what (and how) you spend, and what (and how) you save.
Can You Get a Mortgage with a Negative Net Worth?
While it may surprise you, negative net worth does not usually affect your ability to get a mortgage. This is because lenders assess your ability to repay your mortgage via your income.
Let’s say that you have a credit card debt of $5,000 and are paying $500 each month. You also have $25,000 in savings. You plan to use these savings as a down payment on a home. Effectively, you have a negative net worth of $5,000. A mortgage lender will assess your ability to pay the mortgage payments based upon your income – it is not concerned that you have a negative net worth of $5,000.
(I have to say, in this example, it would probably be better for you to pay off your credit card and make a smaller down payment on your mortgage – you’ll benefit from a lower rate of interest and lower monthly payments.)
Getting out of Negative Net Worth
While temporary negative net worth is not necessarily a bad thing, you don’t want to stay there. Your financial goals will be set to create positive net worth, and plenty of it, as you move toward financial freedom.
To get out of negative net worth, you must increase your savings and investments and decrease your debt. Effective strategies to do this include:
- Making a budget that you can stick to. This will help you to reduce unnecessary spending, keeping more of your money to save and invest.
- Finding ways to get free money, and using your extra earnings to pay off your debt more quickly.
- Slashing your expenses, and using the money you save to pay off your debt faster.
- Saving for your retirement using retirement planning accounts like a 401(k) or IRA.
- Investing in assets that benefit from compounding returns (which helps grow your wealth faster).
Negative Net Worth – Your Springboard to Financial Freedom
In summary, negative net worth is common – but it is also dangerous if you don’t combat it. Taking the right action will help you reduce debt and build long-term wealth that will provide financial freedom. Using an app like Personal Capital or Acorns will help you monitor and track your net worth – and this knowledge should help you to manage your money more effectively and work toward your financial goals successfully.
If you have discovered you have negative net worth, don’t be disheartened. Instead, use it as a springboard to create strategies that reduce debt and create wealth.