Your friend who earns 120,000 CHF per year is rich right? What about your friend who earns just 65,000 CHF per year? They are poorer than the friend earning 120,000 CHF per year, right?
Well, to make this judgement based on income you can’t say. Simply speaking, income is not a good measure of wealth.
The first person may have a lifestyle beyond their pay grade. Or maybe they have huge debts, meaning their total net worth could be just 30,000 CHF. The second person on the other hand might be a frugal minimalist who saves over 30% of their income. This person could have a net worth of 60,000 CHF.
Therefore, the friend earning 65,000 CHF a year is wealthier than the friend earning 120,000 CHF.
To make this assessment however you need to go beyond income. You need to know the net worth.
1. What does it mean?
Networth is very simply the sum of your total assets, minus the sum of your total liabilities.
Networth = assets – minus liabilities
If the balance of this calculation is negative, then you have more liabilities than assets and your net worth is negative. If your assets are more than your liabilities then it is positive.
The higher it is, the higher your wealth.
The calculation of your net worth denotes your financial situation at that point in time.
It is an indicator of your overall financial health.
Therefore, according to your financial situation, it increases or decreases. However, the goal should for it to be positive and generally increasing.
2. Why knowing your net worth is important
As the above example of the two friends shows, income is not a good measure of financial wellbeing. Income just shows one side of the picture and it doesn’t even include all assets, such as your house.
Net worth, on the other hand, shows a more complete picture of your financial situation, including all important assets and debts. This allows you to more accurately evaluate your current financial position.
If it is negative, that could be a key sign of poor financial health. This is an indicator that you should pay attention to and use it to review your financial position.
Moreover, once you know your network you can use this information to track your progress. It may be negative due to high debts. If this is the case, you can calculate how much the debt is. Furthermore, you can calculate how much you need to pay off from your debts to reach a positive balance.
A quick example here to illustrate the difference between paying off your liabilities and having a positive net worth: if I repay the minimum amount each month, it will take me seven years to pay off my student loan completely. However, my net worth should be positive by July of this year as my assets and savings are relatively high and thus outweigh the liabilities.
Therefore, your net worth not only tells you your current financial situation but it is also a useful indicator to track your progress and estimate your future financial situation.
3. How to calculate your net worth
Remember, your net worth is just your total assets minus your total liabilities. Therefore to calculate it you just need to know these two components.
First, calculate your total assets. To simplify this, just take your major financial assets, such as your bank accounts, retirement accounts, investments, your house, and any other key assets. There is no need to make an inventory of everything you own and your whole closet (unless you have a Birkin, maybe include that).
Second, calculate your total liabilities. These are the debts you owe. Here, do make sure you include all debts that you owe, from personal credit card debt to your mortgage. This is your total liabilities.
Now you can calculate your total net worth by subtracting your liabilities from your assets.
However, to be truly effective, this should not be a one-off calculation! Set up a net worth tracker next to your monthly budget and regularly update it. This way you can see how it develops over time and hopefully see how your wealth increases.
You download my budget and net worth tracker that I use here. Fill in your assets and liabilities on the second sheet and let it calculate your wealth. You can find a graph of your wealth over time on the third sheet.
Have fun calculating and watching that number grow!