and before you make any New Year's resolutions about handling your finances differently next year - take stock of how much you own and how much you owe. In other words, calculate your net worth.
Articles about the wealthy often note their astronomical net worth. But the rich are not the only people who find it helpful to weigh assets - what they own - against liabilities - what they owe."The whole concept of working toward financial independence is dependent on building a net worth that will generate income," said Peter Blackwell, a partner in the financial planning firm of Blackwell, Bloch, Meier, Nestor Financial Group in Maitland, Fla.
Building net worth is the cornerstone of financial planning, because your investments probably will provide much of your retirement income. Workers generally pay more attention to their pay raises, even though such salary boosts are important to future financial independence only because they supply more money for investment.
Also, lending institutions often ask for statements of net worth before approving large loans such as mortgages. Brokerages often require net worth to be at or above a certain level before allowing customers to make large or risky investments.
Your net worth is the value of your assets minus the total of your liabilities. What you own can be divided into personal assets, which generally are belongings, and investment assets, which generally are money and investments. Liabilities include current obligations that must be paid off within one year and long-term obligations that do not have to be met within the next 12 months.
You also may have investment liabilities, or money you borrowed to make investments, such as a mortgage on rental property.
Calculating your net worth can reveal patterns in your spending and borrowing habits that may not be obvious otherwise. But remember this: Because the figures are always changing as you make new investments and pay down debt, your net worth is a snapshot of your finances at only one point in time.
"When you are first starting out and are first buying a home, a substantial portion of your assets will go toward buying a home," said Ron Tamayo, vice president of Integrated Planning Services Inc., a financial planning company in Maitland. "As you get later in life and start to accumulate substantial assets, then they may be weighted more toward investments."
The first category in the assets portion of your net worth statement is personal assets. Those include your home, vacation home, car, jewelry, furs, furniture, and most everything else inside your house. Such assets usually do not provide the owner with any financial return.
The second category, investment assets, includes any cash, checking and savings accounts, investment property, equity in a small business, stocks, bonds, precious metals, mutual-fund shares, certificates of deposit, individual retirement accounts and the vested portion of other retirement savings accounts. Investment assets also include any debts owed to you and the cash value of whole- or universal-life insurance policies.
"As far as the assets go, you want a balance depending on the age of the client," Tamayo said. An older couple nearing retirement, for example, probably should have most of their investment assets in bonds, bond mutual-fund shares, IRAs and other retirement savings accounts. Such debt-based assets, which represent money owed to the investor, usually preserve principal and pay interest income.
The investment assets of younger people, however, probably should be composed of equity-based assets such as stocks, stock mutual-fund shares, real estate investments and precious metals. Those assets do not pay interest but will grow in value; they are riskier than debt-based assets and so are more suitable for the young.
Also, evaluate your personal belongings as a portion of the total value of all your assets. Unless you are right out of school and are just beginning to buy the things you need, your personal assets probably not exceed 25 percent of the total.
A higher amount "probably indicates a tendency toward overconsumption," Blackwell said.
At the other end of your net-worth statement are liabilities, or all the debts you owe. They may include mortgages and auto loans; money borrowed against a line of credit; home-equity loans; any installment debt, including credit-card balances; mortgages on rental property; money borrowed to buy securities on margin; and loans against the cash value of whole- or universal-life policies. Also, your estimated taxes for the year are a liability.
Liabilities are usually divided into two categories: short term and long term. The former, to be paid within one year, include credit-card balances and any other debts to be paid off in that time. Other liabilities are considered long term. If you have too many short-term debts, you may have trouble meeting the payments out of your income.
Subtract total liabilities from total assets to arrive at your net worth. Calculating net worth "gives you a starting point," Blackwell said. "My concept of building wealth is to have the net worth increase faster than the rate of inflation."