In order to reach any financial goal, you must first know your starting point. For example, for many people the goal is to become a millionaire. But what does “millionaire” really mean?
It doesn’t mean they have a million dollars sitting in a savings account at their bank. What it means is that their net worth is greater than one million dollars. Unless you know your net worth today, you cannot know how much you need to increase it before you can reach certain financial goals such as becoming a millionaire.
Your net worth is calculated by subtracting your liabilities (what you owe) from your assets (what you own).
Net worth = Personal assets – Personal liabilities
Your net worth represents your total wealth at a point in time. Similar to a company’s balance sheet, your net worth as calculated using the formula above is your personal balance sheet, and it shows a snapshot of your assets and liabilities at a point in time. The difference between the two is your net worth. The goal is to increase your net worth over time by accumulating assets while simultaneously reducing your liabilities. Note: This isn’t to say that all liabilities are bad. Similar to how companies use leverage to grow faster, you too can use liabilities (i.e., personal debt) to grow your net worth as well. The key here is that is has to be the right kind of debt, which will be covered in a later post.