Why It Pays to Know Your Net Worth

What was your financial position a year ago? Maybe it seems like an odd question, but it's one you should think about. Few people track their net worth from year to year, even though it can be an extremely powerful motivator to achieve goals.

Your net worth is a point-in-time snapshot of your assets and your liabilities. When you compare your net worth number from year to year, you can tell whether you improved or not. Hopefully, your net worth increases over time.

[See: 10 Ways to Maximize Your Retirement Investments.]

How to calculate net worth. Simply subtract your liabilities (debts) from your assets. For example, if you have $10,000 in a savings account and $70,000 in investments, you would have $80,000 in assets. If you had credit card debt of $2,000 and student loan debt of $8,000, you would have $10,000 in liabilities. Subtract liabilities from assets and you have a net worth of $70,000.

How to track net worth over time. You can use anything from a pen and notebook to Excel, or an app or online platform like Mint or YNAB (You Need a Budget). Whatever method you decide to use -- just getting started is the most important step.

Also consider what you want to include in your net worth statement. Technically, this is a summary of all your assets and liabilities. However, you may not wish to include the value of a depreciating asset like your car since that will drop over time -- and if you don't update that value regularly, it could artificially inflate your net worth statement and give you a false sense of progress.

Then set a schedule for checking in on your net worth. Monthly makes a lot of sense for many people because it corresponds with receipt of earned income, and isn't too frequent.

How to improve your net worth over time. The two ways to improve net worth are to increase your assets or decrease your liabilities -- hopefully both. A few strategies on both fronts:

Save

Sounds easy -- but many investors view savings as a "whatever is left at the end of the month" strategy. If you wait for that, your savings will never be as efficient as they could be.

[See: 9 Places to Invest $500 or Less.]

View savings as a bill. It is not negotiable -- it is just something you do every month without fail. The question of where to save to depends on your financial goals.

-- You could increase your retirement savings by increasing deferrals to an employer sponsored plan like a 401(k) account.

-- You could increase your savings for college goals by starting or increasing your auto monthly savings to a state-sponsored 529 plan.

-- Increase after-tax savings by setting up an automatic monthly fund transfer.

-- Try a "round-up" program where each purchase is rounded up to the nearest dollar and the change is transferred to your savings account.

-- Segregate different accounts according to their goal or purpose and tag them as "off limits" for other expenses.

Invest

Cash has historically delivered low returns (and low risk, of course), so it doesn't help your bottom line of your net worth much on a long-term basis. Taking advantage of the power of equity and bond markets can be an incredibly impactful way to increase your net worth over time. By investing, you also take advantage of the incredible power of compound interest -- which is essentially interest on interest.

If you are just getting started, you could consider a low-cost brokerage firm to open an account and begin to invest, or a robo advisor solution. Once you have investable assets accumulated, you can seek out an advisor to assist you. Be careful when selecting your advisor -- selecting a fee-only advisor who is a fiduciary ensures that you avoid corrosive commissions, and makes sure that the recommendations your advisor makes are in your best interests.

Reduce Debt

There are a number of ways to tackle debt (the debt snowball method, the debt avalanche method, paying the highest interest rate first) and a number of philosophies as to which is best. Remember though, that high-interest debt is extremely harmful to your net worth. The longer you have high-interest debt, the more it grows.

Try to avoid taking on variable debt wherever possible, and take advantage of "healthy debt" like a fixed-rate mortgage where prudent.

Tracking your net worth can be motivating, and once you get going, the numbers can be significant and impactful. Many people find this more motivating than, for example, the negligible difference that cutting out an extra cup of coffee each day makes. Of course shaving incremental costs is important, but from a motivation standpoint -- net worth tracking can be more impactful and promotes focus on the bigger long-term picture.

In this vein of thought, one final step related to your net worth can be rewards. Just make sure the rewards aren't so financial luxurious that they make a dent in your net worth, or detract from another financial goal.

[See: 8 Things to Remember When Reviewing Your 401(k).]

If you have set a goal, tracking and updating your net worth regularly can be key in helping to keep your financial life more simple and organized for yourself and others. This has benefits even beyond meeting -- and exceeding -- your net worth goals.