Determining Your Financial Net Worth

This article will look at how to determine your net worth. In order to compute the net worth of your assets, you need to know the two main components in deriving your net worth:

* Assets; and
* Liabilities.

What are assets and liabilities? An asset in simple terms, is something you own whereas a liability is something that you owe.

Understanding Assets
Assets can be categorised as investment assets and non-investment assets. Investment assets are assets that generate cash flow, and can materialise in the form of dividend, capital gain, rental or income. Examples of investment assets would include savings, fixed deposits, stocks, unit trust investments, EPF, investment properties as well as your businesses.

Non-investment assets on the other hand are assets that do not generate any cash flow. Examples of non-investment assets are the houses you purchase to live in or stay during vacations, as well as your car. Even though owning these assets have become part of our “must-have” items for each family, they do not unfortunately enough, help generate income or bring in any cash flow.

Understanding Liabilities
As mentioned earlier, a liability is something that you owe. This would naturally include your outstanding credit card payments, car loans and housing loans. Liabilities can dry up most of your income. As such, in order to obtain financial freedom, you need to first establish yourself as a debt-free individual. Having liabilities mean, you would need to serve interest on those liabilities. Thus, you would have to clear your liabilities as soon as possible. The longer you hold on to your liabilities, the more they eat into your reserves if you are unable to generate returns higher than the interest costs that you are obliged to serve.

Understanding Net Worth
Your net worth is how many assets you have left over after paying off all your liabilities. To a banker, your net worth is simply the difference between your total assets and total liabilities. However, in order to achieve financial freedom, you need to own enough investment assets that can generate sufficient cash flows to cover your daily expenses as well as your lifestyle. Hence, your net worth in the context of financial freedom is the difference between your investment assets and total liabilities.

The following is an example of net worth for someone who has been working for 10 years in Malaysia.

Mr. Ali’s NET WORTH
INVESTMENT ASSETS	RM		LIABILITIES	RM
Bank Accounts	10,000.00		Credit Cards	2,000.00
Stocks	10,000.00		Car Loans	65,000.00
Unit Trusts	20,000.00		Housing Loans	100,000.00
Property for investment	-		Other Debts	-
EPF	60,000.00
Business Value (net)	-
Investment Assets Subtotal	100,000.00		Total Liabilities	167,000.00
NON-INVESTMENT ASSETS
Home	150,000.00
Car	75,000.00
Others	-
Non-Investment Assets Subtotal	225,000.00
Total Assets	325,000.00		Net Worth	158,000.00
(Investment Assets Subtotal + Non-Investment Assets Subtotal)			(Total Assets minus Total Liabilities)
Total Assets	100,000.00		Net Worth	(67,000.00)
(Investment Assets Subtotal only)			(Total Assets minus Total Liabilities)

Mr. Ali is currently working as a manager in a company. Last year, as a result of his promotion to a managerial position, he decided to reward himself by buying a new car worth RM83,000 with a bank loan of RM65,000 to finance the purchase. This year, as a result of one-year’s depreciation, his car is now worth RM75,000, a total depreciation of RM8,000.

He has an apartment that is worth RM150,000 with an outstanding housing loan of RM100,000. As a result of the two big down payments on the apartment as well as his new car, he does not have much cash left for his stocks and unit trust investments. In fact, he has just withdrawn a portion of his unit trust investments for the new car.

As a result, his total investment assets of stands at RM100,000 only. In fact, the main portion of his investment assets is his EPF, amounting to RM60,000, which he needs to save for his retirement. In excluding the EPF, he effectively only has RM40,000 investment assets after 10 years of working.

As far as a banker is concerned, there is no need to distinguish whether those assets are for investment or non-investment. A banker will consider his net worth of RM158,000, derived from his total assets which are worth RM325,000, with his total liability of RM167,000. However, for the purpose of assessing his net worth in the context of financial freedom - without considering the non-investment assets, he in fact has a deficit of RM67,000. He is still very far from securing financial freedom.

Hence, in order to attain financial freedom, the first objective of Mr. Ali would have to be clearing all his debts as soon as possible. By doing this, he would then be able to generate enough investment assets to cover his expenses.