Photo By: Miyukiutada

I have a very basic understanding of financial terms. When I read the business section of a newspaper, most of it makes no sense to me. It’s really difficult to be smart with money if you don’t even understand the terms of a simple contract with a bank. With that in mind, I’ve been asking my good friend Pete (of Growth In Value) to explain basic financial terms to me. Today, we’re starting at the beginning. We’re talking about net worth: what it it and why does it matter?

What is net worth?

Net worth is a very basic, but useful metric for keeping track of a person’s overall financial situation. Simply put, it’s calculated by adding up all of a person’s assets and subtracting their liabilities. Assets are things you own that could theoretically be sold in exchange for cash—things like houses, cars, stocks, cash and household items all generally qualify as assets. Liabilities are outstanding debts that you owe. They include things such as credit card debt, student loans, mortgages, car loans and lines of credit.

Net worth can be expressed as a positive or negative dollar figure. If the total value of your assets is more than the total value of what you owe, you have a positive net worth. If the total amount that you owe exceeds what you’d get if you sold every possession you own, you have a negative net worth.

Why does net worth matter?

Well, its useful at cutting through the BS. It’s a more accurate gauge of how good you’re actually doing. Someone could own a $1-million home and people would say they’re rich. But that guy could have a $900,000 mortgage on his monster home, owe $75,000 on his car in the driveway and rack up $100,000 furnishing the home, which gives him negative net worth. It means despite the fact that he’s a “millionaire,” he’s really not in good shape. Basically, it’s just a good way of telling the difference between assets and liabilities.

Net worth is only important in as much as it forces you to not ignore the bad stuff. It’s not about what you earn every year, or what you spend, or what your house is worth. Look at all those crazy celebrities. Michael Jackson has made like billions of dollars in his life, but the sad thing is, he spent more. So he’s not “rich.”
Also, net worth is very important when it comes to getting a better interest rate on a mortgage from a bank.
I mean, who would you rather loan money to? Someone who owns four condos but owes $2-million on them? Or someone who only has a $20,000 down payment?

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Thanks Pete. If you have any other questions about net worth, please ask them in the comments and I’m sure Pete would be happy to answer them. Have a financial term you’d like explained? Leave a comment or suggest it in an e-mail: and.chiu [at] gmail dot com.

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