Liquid Net Worth: What it is, Why it Matters, and How to Calculate It
Most people have heard of the term net worth and many also have a good understanding of it and what it means.
Net worth is quite simple; the total amount of an individual’s assets, including any and all cash, minus the total amount of their liabilities. So, net worth is the value by which a person’s assets exceed their total liabilities.
But determining a person’s liquid net worth is perhaps a better tool to use to evaluate a person’s financial health.
→ Related reading: 9 Convincing Reasons Why You Should Be Tracking Your Net Worth
What is Liquid Net Worth and How Does it Affect Your Finances?
Liquid net worth is the value of your estate if it was all liquidated (immediately sold and converted to cash).
The basic formula to calculate this is to subtract your liabilities from your assets (more detail on this later) just as net worth, except the assets must be liquid in order to be counted. This is an accurate definition, but there are some important factors that you need to consider when calculating your liquid net worth.
Liquid net worth can be important because not all types assets are equal, or equally accessible. In the case of an emergency or a situation where cash is needed quickly, those liquid assets will be extremely valuable.
The gray area with this definition is whether or not assets that take more time to sell, and put cash in hand, can be considered liquid and therefore used in the calculations.
Some examples of non-liquid assets, if we use the standard definition, would be your home, car, and retirement investments such as a 401k or IRA. The reason for this is because liquidating (selling) something like your home could take several months (and it’s possible that you might not find a buyer), so although you might be able to get the money, it won’t happen immediately. Additionally, the amount of cash that you’ll walk away with will be less than the value of your home, due to realtor commissions, taxes, and fees (plus you’ll likely have other moving expenses).
These non-liquid assets would definitely be considered while calculating your net worth, but maybe not in your liquid net worth, unless you do a few important things (more on this later).
While equity in your home is important, it’s not quite as useful as cash. The typical net worth calculation counts all assets the same, so $50,000 in cash would be the same as $50,000 equity in your home. But liquid net worth will either ignore the equity in your home, or reduce the amount to allow for things like selling fees or selling a little below the value.
Similar to the home, these are, using strict definitions, not exactly liquid assets.
For example, if you have an emergency and choose to withdraw your 401k under the age of 59.5, you will incur a 10% penalty as well as taxes if you have a traditional 401k. A hefty price.
The Roth IRA has similar fees if you withdraw the money before the age of 59.5, with a 10% early withdrawal penalty and taxes on your gains.
You can, however, still manage to remove your contributions, not your gains on your contributions, without being taxed. So that’s another factor you may want to consider when calculating your liquid net worth.
Stocks and bonds are great examples of liquid assets since you can sell them and have money in your hands within 3 business days (though by some peoples’ definition, even this is not fast enough to be counted in your liquid net worth).
They are, however, still taxed. You’ll be responsible for capital gains taxes, which should be considered in your calculations of liquid net worth.
Other liquid assets are any cash you have on hand, any cash in savings, and any cash in your checking account(s).
So, some people consider liquid net worth the amount you can get right away, within a set period of time like 24 hours or 7 days. Others add in their home and retirement savings, depending on how long it would take for them to receive the cash. A common approach is to devalue assets like your house, car, and retirement account by 10-30% to account for fees or the fact that you might not get fair market value if you are forced to sell quickly. There is no exact definition, so it’s up to you how you what you want to include and how much you will deduct from assets like a home, car, or retirement account.
If you plan on including your retirement savings, your car, and your house in your liquid net worth, it is recommended that you place around a 10-30% fee on each of those assets to make them fit in the liquid net worth definition.
The important thing to realize is that even though these non-liquid assets may not be used while calculating your liquid net worth, they still hold value. Therefore, the way you calculate liquid net worth may be a bit different from someone else’s or you may even choose to calculate two versions of it, one including your home and retirement savings and the other without them or with ~20% fees on them.
Why Liquid Net Worth is Important
There are several benefits to calculating and constantly keeping track of your liquid net worth.
Liquid net worth is a very important measure as it allows you to evaluate your financial security (something many people avoid because they know it isn’t pleasant).
Another purpose that calculating your liquid net worth serves is to motivate you to create an emergency fund. You should already have a few months’ worth of living expenses in your savings account, which is an asset and is added into your liquid net worth, but suppose you encountered a major emergency/expense that your savings can’t pay for.
For this, it is very important to know your liquid net worth so that you can liquidate any assets necessary to pay for that large emergency as soon as possible.
How to Calculate Your Liquid Net Worth
It’s quite simple.
Liquid Net Worth = Liquid Assets – Liabilities
As we already discussed, assets include:
- Cash (including checking accounts)
- Stocks, bonds, mutual funds, etc.
- Retirement accounts (can omit or include fees that are associated with withdrawing too soon)
- House (can omit this, as discussed before, or have the 10-20% deduction)
- Car (can omit or include it, undervalued)
- Jewelry, art, collectibles, etc. (these can appreciate, depreciate, or stay the same)
Liabilities include things like:
- Total amount left on your mortgage
- Credit card debt
- Student loans
- Car loans
- Personal loans, payday loans, and other loans
- Any other types of debt
That’s all there is to it. If you want an easier way to track your net worth and liquid net worth (the ideal thing to do so you get the value of everything you own as well as how much cash you can get on hand in an instant), Personal Capital is the best tool.
They offer several paid services but the free app will allow you to easily calculate and track your net worth, with no need to sign up for any of the paid services. They’ll help you track your net worth and liquid net worth as well as help you to think about and create a comprehensive financial plan using these free tools.
Get a Free $20 Amazon Gift Card from Personal Capital
Personal Capital is a free app that syncs with your bank accounts, investment accounts, and credit cards to automatically calculate and track your net worth. It’s easy to set up and very powerful. Right now, Personal Capital is also offering a free $20 Amazon gift card just to try it. To get the gift card, sign up here, and after you’ve linked your first account, you will get an email with the code for the $20 gift card.
Calculating your liquid net worth may really be an eye-opener and make you appear poorer than you thought you were. It is, however, a very interesting and a very essential exercise to achieve financial freedom and build assets.
→ Related reading: How to Calculate Your Net Worth
Calculating Liquid Net Worth: An Example
If you aren’t looking for an app and other helpful features (although we highly recommend Personal Capital for other handy features and simplicity), this is a nice, simple example to follow.
All you do is create a spreadsheet and insert liquid assets and liabilities manually.
First, put down all of your liquid assets into one column and decide how much to discount non-liquid assets.
|Assets||Value||Discount||Value After Discount|
Next, add all of your liabilities and subtract them from the liquid value of your assets
Update the date in the spreadsheet as the need arises, as your home may appreciate, your car will probably depreciate, etc.
Don’t despair if the final figure is lower than you expected. Focus on paying off your debts (liabilities) if you ended up with a negative liquid net worth. If and when it is positive, set up a goal for your net worth and work on achieving that. It could be $100,000, $1,000,000, or more, or less. For some tips on how, scroll down and continue to read.
How to Increase Your Liquid Net Worth
→ Related reading: 7 Steps to Grow Your Net Worth
1. Review and Erase your Liabilities
This is an easy number to calculate and if you have now calculated your liquid net worth, which you should have, you know what your liabilities are and how much they add up to.
Are there any liabilities that you eliminate or reduce? Getting rid of debt is a huge factor in increasing your net worth.
Consider making more payments towards your debt. Rather than paying monthly towards your debt, try to pay weekly. This may help reduce the principal faster and that will reduce the amount of interest you will have to pay.
Find ways to tackle your debt efficiently and quickly as possible.
2. Trim your Expenses
Many people spend far more than they need to or even expect themselves to be spending. Track all of your expenses and look for areas where you can cut back and I guarantee there will be a lot of them.
This includes the big things as well, not just day-to-day expenses such as gas, food, magazine/streaming service subscriptions, etc.
Cutting your expenses by even just a couple of dollars here and there (although you can probably cut back much more) will add up very quickly.
3. Review your Annual Costs
This is another overlooked aspect in many peoples’ financial lives. Look at things like healthcare premiums and your insurance every year.
Compare interest rates and see whether or not any of your annual costs can be trimmed or eliminated completely.
Then, make sure to save or invest the remainder.
4. Get a Side Hustle
Now this is where things may get a bit harder and require more work as you are now trying to add to your income and not lessen your expenses.
Having multiple streams of income is very smart. Not only will it add to your primary source of income (9-5 job), but it will add safety in case you lose that source of income.
A good side hustle can pay anywhere from $500 to several thousand or even more a month. Freelance writing, selling crafts on Etsy, starting a blog, teaching English, etc. are all great examples of side hustles that you can start with only an hour or less a day (spend more time, earn more).
You can also use this time to work on whatever passion/hobby you love and try to find ways to make money off of that. You’ll be doing what you already do, but earning money for it.
For example, if you like poetry and creative writing, try to earn income on that by writing a book and selling it on Amazon, creating a writing course, etc.
5. Start Investing in Stocks
If you aren’t doing this already, you are missing out on a great opportunity. The US stock market has averaged an annual return of, since 1926, 10%.
Do you believe that businesses in America, or anywhere else in the world, will continue to thrive? If the answer is yes, then invest. That’s all it is.
It may be difficult and daunting to learn how to invest in the beginning, but you will get familiar with it soon.
Read a couple books if you want to invest by yourself. If you’re lazy or don’t have the time, a robo-advisor may be best for you. It manages all of your stocks and bonds based on the amount of risk you are comfortable with and takes quite a small fee as low as 0.25%, depending on the robo-advisor used.
READ NEXT: Living Off Dividends
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