Wednesday, 29 December 2010
How to calculate your NET WORTH
Happy New Year!! The time when we celebrate the passing of another year and make a resolution that we're going to take control of our finances. What does that mean exactly?
The answer to that question differs from person to person. Some people may have significant debts and need to drastically reduce their credit card debts, some people may have multiple investments that they need to reassess and some people feel like they're pretty much in control of their finances but would like to save a little extra.
A good way to start the process of taking control of your finances is to undertake a process of calculating your "net worth". This process requires you to list all your assets (cash, super, shares, property, investments etc.) and you liabilities (credit card debt, mortgage, investment loan etc.). Effectively, this is your own personal Balance Sheet comparing what you own (your assets) and what you owe (your liabilities) and this is what you are worth, your NET WORTH.
When calculating your net worth, do it like the accountants do it, debits (your assets) on the left and credits (your liabilities) on the right. For example, the right hand side of the ledger will include the value of your home, any cash savings account, the market value of shares etc. and let's say it totals $1,000,000. Then the left hand side has your mortgage, credit card debts and a car loan and let's say it totals $600,000. Your net worth is $400,000 (assets - liabilities).
Once you've complete the net worth process, it's time fo you to review the data…. assess your asset base and ensure you're in control of your liabilities.
Ok, on the left hand side, list all of your assets, everything you own.
Your home is your home and unless you’re thinking of selling it in the next 6 - 12 months, then make an assessment of the current market value and include at the top of the list.
Cash - pretty simple really, just list the cash savings you have. If you have a home loan make sure your cash is held in an offset account which will reduce the interest payable on your home. If you have term deposits or savings account, then list the balances and the interest you're earning and the interest rate. Just like loan, shopping around for interest on savings is good practice and can lead to additional returns!
Have a look at your other assets and assess whether they are performing as best as possible. Is your investment property still performing or is it time to sell and look for an alternative property or investment? Share portfolio need a revision, too aggressive or too conservative etc. Car with a car loan attached to it?
With your super, although it's not available until retirement age, it's still an asset. What you can do is asses how your super fund is performing. Should you look at adjusting the allocation of the assets in the super portfolio? Do you have multiple super accounts that could be consolidated? Fees or commission…can it make a difference?
Now, on the right, list all liabilities, everything you owe.
When listing you liabilities, it's good practice to list the interest rate, the regular amount payable and whether it's tax deductible or not. Listing the balance, interest rate and regular payment due really helps you to identify exactly how much you're required to finance each month.
For example, home loan of $300,000 at 8% with a monthly repayment of $600, not tax deductible. It's good to distinguish between tax deductible and non tax deductible as these are two very different types of liabilities.
With your home loan consider whether you're getting the best possible deal on interest rates, offset account, early repayments etc. Banks are very competitive and it's easier for them to retain a customer by matching a more competitive offer from an alternative lender compared to acquiring a new customer.
When you take out an investment loan (be it for an investment property or to finance any other investment) you should structure the loan so that it is "interest only". That way, you're using your free cash flow to pay for the costs which are tax deductible only meaning you can save the excess to help pay down non tax deductible loans.
Credit cards - list all cards, credit limits available, current balance and interest rate. I do try to avoid paying the minimum balance instead try to pay the balance at the end of the month. This is a good habit as then you don't pay any interest! If you can’t repay the whole amount, pay as much as possible and work on reducing that debt every month as the interest is a killer!
Other loans - car loan, student loan, boat loan or any other personal loan. Again, current balance, interest rate and minimum monthly repayment.
Ok, now you've got you assets listed on the left and liabilities on the right, it's time to calculate your net worth. Like any balance sheet, simply deduct your liabilities from your assets and that's your net worth.
You are now ready to start assessing you own personal balance sheet and determining what and how you’ll manage your balance sheet over the next 12 months. This, coupled with a good savings plan and regular budget, will help you control your finances.
In the next post we'll start looking at budgeting. If you want to take control of your finances, the first step is to understand exactly where all your money is going.
Note: if you've completed your personal balance sheet and your liabilities are more than you assets, double check the information to ensure all your assets are properly listed and it’s properly calculated. If are double or triple checking the data, then you may require some professional financial advice. I recommend you contact your accountant to work through this in more detail to ensure you're doing it right and/or determining what are the next steps.
Good luck and happy budgeting!
Labels: Personal Finance