People always look for ways to compare how rich they are with one another. Or if you are a child in elementary school, you might look for ways to tell classmates how much richer your parents are than theirs. One of the best ways to compare wealth is by looking at your liquid net worth.
Table of Contents
- What is Liquid Net Worth?
- Difference Between Net Worth and Liquid Net Worth
- Liquid vs. Non-Liquid Assets
- How to Calculate Liquid Net Worth
- Why is Liquid Net Worth Important?
- What if Your Liquid Net Worth is Negative?
- Helpful Resources
What is Liquid Net Worth?
One of the most commonly-used metrics for such comparisons is someone’s total net worth. This looks at someone’s overall balance sheet and then subtracts liabilities from the total assets.
This very simple formula can sometimes be misleading in order of determining “how rich or wealthy” someone is. This is because not all assets that people have can be easily sold and turned into cash to pay off their liabilities.
That is the whole point of finding out what you are worth, it breaks down into things you own and things that you owe to others.
Net Worth = Assets – Liabilities
Difference Between Net Worth and Liquid Net Worth
Liquid net worth is different form regular net worth in that it only counts liquid assets rather than every asset you own.
Liquid Net Worth = Liquid Assets – Liabilities
Liquid vs. Non-Liquid Assets
What are Liquid Assets?
The term liquid in finance means how easily an item can be sold or converted into cash. Cash, specifically the US dollar, is the most liquid asset in the world because it is money that is accepted pretty much anywhere and by anyone in exchange for other goods or services.
Anything someone owns that they could quickly and easily sell and receive a fair value of cash in return would be considered a liquid asset. Some assets that would be considered liquid include; cash, checking and saving account balances, money market funds, certificates of deposit, bonds, and stocks.
Assets on a balance sheet are typically listed in descending order from most to least liquid. This can be useful when looking at assets owned by a corporation.
What are Non-Liquid Assets?
Assets that you could not sell right away and easily convert into their fair market value for cash would not be considered liquid for the purpose of calculating liquid net worth.
Some assets, such as a house or a car could be sold for a fair value but would take an extended amount of time. Other assets, such as jewelry or a 401k plan could be sold right away but would not be paid their fair value because the jewelry would be pawned, and the 401k plan would incur a tax penalty.
Given these problems, non-liquid assets include; a house, a car, jewelry, and retirement plans. These non-liquid assets will not be included in your calculation. Although there is no exact way to decide which assets to include and how to include them in the calculation, at Financial Chiefs, we decided to keep it simple and only include liquid assets. Some other sites may have different methods for this calculation by discounting some of the less liquid assets at a certain percentage of their fair value, this is also a fine method that just takes some more time and judgement.
The next part of the equation (again, a simple equation with only 2 components) is liabilities. Liabilities are things that someone owes to someone else and are all counted, no matter how liquid they are or how short or long term they are expected to be paid off over.
Common liabilities that many people have affecting their net worth include; credit card balance, student loans, home mortgage, and car loans.
How to Calculate Liquid Net Worth
Liquid net worth can be calculated by looking writing down your current list of assets and liabilities and their corresponding values. Doing this will let you add up each list and then subtract the liabilities from the liquid assets to get your total.
Calculating Liquid Net Worth
|Total Liquid Assets||$65,000||Yes|
|Credit Card Bill||$5,000|
Total Liquid Net Worth = Total Liquid Assets – Total Liabilities:
Now let’s look at this total value if someone were to calculate overall net worth and not just the liquid portion:
|Credit Card Bill||$5,000|
Total Net Worth = Total Assets – Total Liabilities:
$515,000 = Net Worth
This is significantly higher than that same person’s liquid value and it is because they are including these valuable other assets that they could not liquidate quickly for a fair value.
Why is Liquid Net Worth Important?
It is very important for people to know regarding their personal finances. To know your overall net worth is good but is not necessarily as useful as knowing the more liquid version.
People can be put into tough financial situations at any moment in life based on the uncertainty that comes along the way. This article was written during the time of the COVID-19 pandemic which saw the shutdown of businesses and markets from a local to global scale. Although some people may have had strong emergency or rainy day funds saved up for an event like this pandemic and others received help from their governments, there were many that did not have the liquidity to weather this stretched out economic shutdown.
Prepare for the Unexpected
It is often recommended to have an emergency or rainy day fund of enough cash to cover between three and six months of your cost of living. This will include things like; groceries, gas, rent, utilities, and debt payments.
The first step to being prepared financially for an unexpected problem or event is to be aware of your current financial situation. People can decide if they would be able to financially handle a future unexpected shock like a global pandemic.
Check if You Are Financially Fit
Another way to see if you are prepared for a financial shock in your life is to be financially fit. You can take our Financial Fitness Quiz to see how financially fit you are. You can also read our article on the 5 Key Components to Financial Fitness
The next step to being prepared financially for an unexpected financial shock is to work to make sure you have enough liquid assets. A positive value will enable you to right away have enough cash to pay off your outstanding debts if needed. Knowing that you have the ability to pay off all your creditors while still having some cash (and other non-liquid) assets left over is a good peace of mind to have.
What if Your Liquid Net Worth is Negative?
If you just calculated your liquid net worth and the value came out to have a negative value, you are not alone. Many people have negative values, however, not all of them have the foresight to do something about it.
Simply knowing that you have read this far into the article means that you have the desire to learn and therefore probably also have the will power and financial knowledge to get yourself into the positive realm!
Lots of younger people will find themselves with negative values right out of college as a result of student loan debt. While lots of older people will find themselves with negative values because they moved into an expensive new home. Either way, the situation is not ideal and there are ways you can work your way out of it.
Here are some helpful resources:
Personal Capital – This is a great, easy to use, financial management platform where you can visualize all your accounts in one place. Personal Capital also has a great net worth visualizer to help you see liquid vs. non-liquid net worth.
Improving your liquidity will be a process that can take time and commitment. Simple things you can do to start improving will be to build a budget, cut back on spending, earn some extra side income, purchase more liquid assets, pay off debts. Besides these, you can also check out our 5 Key Components to Financial Fitness post to see if you fit into the financially fit category which will put you on track to improving your liquid net worth.
The stocks and bonds that your IRA are invested into are considered liquid assets themselves, however, it gets a little more complicated when viewing them within the individual retirement account. Assets within a Roth IRA (after-tax dollars) would be considered liquid assets (only total contributed amount if you have had the Roth IRA for more than five years) and would be counted towards your liquid net worth. Assets within a traditional IRA (pre-tax dollars) would not be considered liquid assets because you would incur a significant 10% tax penalty in addition to the income tax that would need to be paid. Here at Financial Chiefs, we consider a Roth IRA to be included as a liquid asset in your calculation, but do not consider a traditional IRA to be a liquid asset and not included in your calculation.
The best time to calculate your liquid net worth is right away if you have not already done so! It is a useful metric to have a good idea of how well you would be able to handle a negative financial shock in your life. The greater the value, the more easily you can quickly shoulder a financial blow.