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Most people have heard of the term net worth, and many also have a good understanding of what it means.
Net worth is quite simple; the total amount of an individual’s assets, including any cash, minus the total amount of their liabilities or what they owe. So, net worth is the value by which a person’s assets exceed their total liabilities (or net worth can be a negative number if liabilities exceed assets).
But determining a person’s liquid net worth is perhaps a better tool to evaluate a person’s current financial health.
What is Liquid Net Worth?
Liquid net worth is what you would have left if you were selling your assets and paying all of your debts.
The basic formula to calculate liquid net worth is to subtract your liabilities from your assets (more detail on this later) just as net worth, except liquid net worth counts only your liquid assets. While this is an accurate definition, there are some essential factors you need to consider when calculating your liquid net worth.
Net Worth vs. Liquid Net Worth
The critical difference between overall net worth and liquid net worth is that liquid net worth ignores or discounts your assets that are not liquid (assets you cannot sell quickly). As a result, net worth may be a better gauge of your overall wealth, but liquid net worth indicates your ability to withstand unexpected events and should be considered during financial planning. In other words, liquid net worth is a more accurate gauge of your current financial stability.
Why Does Liquid Net Worth Matter?
Liquid net worth can be important because not all types of assets are equal or equally accessible. In an emergency or a situation where cash is needed quickly, liquid assets will be precious. If you want true financial freedom, you’ll need to be able to sustain something unexpected.
For example, if you or someone in your family has an unexpected medical crisis, and you get a hospital bill of $20,000, what’s more valuable: $20,000 in a savings account or a car that has a Kelley Blue Book value of $20,000?
Of course, the savings account is more valuable because you can immediately access that money and know exactly how much it’s worth. For example, you may not be able to sell the car for $20,000, even though it has a Blue Book value of $20,000.
Because liquid net worth only considers your liquid assets, your liquid net worth will be lower than your total net worth, which includes all assets.
There are several benefits to calculating and constantly keeping track of your liquid net worth.
Liquid net worth is a critical 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 of living expenses in your savings account, which is an asset and counts toward your liquid net worth. This is the main difference between net worth and liquid net worth. Net worth may be high but tied up in assets that are not liquid, which would make you vulnerable to unexpected emergencies.
For this reason, it’s imperative to know your liquid net worth so that you can liquidate any assets necessary to pay for that considerable emergency expense as soon as possible.
What are Liquid Assets?
Stocks and bonds are great examples of liquid financial assets since you can sell them and have money in your hands within three business days.
They are, however, still taxed. You’ll be responsible for capital gains taxes, which you should consider in your calculations of liquid net worth.
Other liquid assets are any cash you have on hand and cash equivalents like saving accounts, checking accounts, and money market accounts.
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 accounts such as a 401k or IRA. Liquidating (selling) something like your home could take several months, and you might not find a buyer. Although you might be able to get the money, it won’t happen immediately. Additionally, the amount of cash 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 and other income-producing assets would be considered while calculating your total net worth, but maybe not in your liquid net worth, unless you do a few essential things (more on this later).
While equity in your home is important, it’s not quite as helpful as cash. The typical net worth calculation values 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 transaction costs or sell below market value to liquidate it quickly.
When calculating liquid net worth, the goal is to figure out how much cash you could get for your assets. For example, if you had to quickly sell your house or investment property, how much cash would you walk away with? That $50,000 of equity might be more like $10,000 if the selling price is below market value to move quickly, and after the closing costs like realtor fees and taxes.
Similar to your home, retirement funds are not exactly liquid assets.
For example, if you have an emergency and choose to withdraw from your 401k before you reach 59.5 years old, you’ll incur a 10% penalty on investment earnings, as well as taxes if you have a traditional 401k. That’s a hefty price that can seriously eat away at the value of your assets. And don’t forget the fact that you’ll also have to pay ordinary income tax on the money you get out of a 401k or Traditional IRA.
But, of course, that doesn’t mean that retirement accounts have no value to you today. You can 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.
Different Ways to View Liquid Net Worth
Some people consider liquid net worth the amount you can get right away, within a set period like 24 hours or seven days. Others add in their home and retirement savings, depending on how long it would take 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, the cost of selling, or the fact that you might not get fair market value if you have to sell quickly.
There is no exact liquid net worth definition or rules for calculating. So it’s up to you to decide what you want to include and how much you’ll 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, we recommend that you place around a 10-30% deduction on each of those assets to make them fit in the liquid net worth definition.
The critical thing to realize is that even though these non-liquid assets do not increase your liquid net worth, they still hold value. Therefore, the way you calculate liquid net worth may be a bit different from someone else, or you may even choose to calculate two versions of your liquid net worth. For example, you could figure it, including your home and retirement savings, and calculate it without these assets or with ~20% fees.
It would be best if you also considered the reason why you’re calculating your liquid net worth. For example, if you’re trying to get a more accurate picture of your overall financial position, maybe the best approach is to include all of your assets in the calculation and reduce the value of non-liquid assets like a home, cars, etc. and retirement accounts. But if your primary reason for calculating liquid net worth is to see how prepared you are for a financial emergency, maybe the best approach is to not include the non-liquid assets at all since you wouldn’t be able to sell them quickly.
How to Calculate Your Liquid Net Worth
It’s pretty simple.
Liquid Net Worth = Liquid Assets – Liabilities
As we already discussed, assets include:
- Cash (including checking accounts)
- Stocks, bonds, mutual funds, etc.
- Retirement accounts (you can omit this or reduce the value to account for fees/penalties/taxes)
- House (you can omit this, as discussed before, or have the 10-30% deduction)
- Car (you can omit or include an undervalued amount)
- Jewelry, art, collectibles, etc. (these can appreciate, depreciate, or stay the same)
Liabilities include things like:
- Total outstanding mortgage balance
- Credit card debt
- Student loan debt
- Car loans
- Personal loans, payday loans, and other loans
- Any other types of debt
Calculating your liquid net worth may be an eye-opener and make you appear in worse shape than you thought you were. However, it’s a fascinating and essential exercise to achieve financial freedom and build assets.
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Calculating Liquid Net Worth: An Example
Let’s take a look at an example of how you would calculate your liquid net worth.
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.
Value After Discount
Next, add all of your liabilities and subtract them from the liquid value of your assets.
Update the data 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 the number is positive, set up a goal for your net worth and work on achieving that. It could be $100,000, $500,000, or more, or less. For some tips on how to increase your liquid net worth, scroll down and continue reading.
Related reading: How to Calculate Your Net Worth
How to Increase Your Liquid Net Worth
Ok, so we’ve looked at many angles of the topic so far, but you may be wondering what you can do to improve your finances. So here are a few suggestions.
Related reading: 7 Steps to Grow Your Net Worth
1. Review and Reduce Your Liabilities
One of the most basic ways to improve your financial situation is to reduce your liabilities or debts. Paying down your debts will reduce the amount you owe, so it’s not dragging down your net worth or liquid net worth.
Are there any liabilities that you can eliminate or reduce? For example, do you have outstanding credit card balances?
Consider making more payments towards your debt. For example, rather than paying monthly towards your debt, try to pay weekly. Frequent payments may help reduce the principal faster, and that will reduce the amount of interest you’ll have to pay.
Find ways to tackle your debt as efficiently and quickly as possible. If you’re looking for a strategy to pay off debt fast, see our comparison of the debt snowball vs. the debt avalanche.
2. Trim Your Expenses
Many people spend far more than they need to. Track all of your expenses and look for areas where you can cut back (I guarantee there will be many of them).
This includes the big things as well, not just day-to-day expenses such as gas, food, subscription services, 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.
Reducing your spending may seem like a big task, but it’s pretty easy to do when you take it one step at a time. Don’t try to go from spending $10,000 to $5,000 per month instantly because it will be too overwhelming. Instead, focus on making one incremental change at a time.
When you look at your monthly expenses, look for budget categories that could be reduced or eliminated. Then, just take them one at a time. Work on making one change, then move on to the next.
When you make one change at a time, it’s easy to have a significant impact.
3. Review Your Annual Costs
This is another overlooked aspect in many people’s financial lives. You probably have several bills and expenses that are paid quarterly, semi-annually, or annually. Look at things like insurance premiums, vacations, and other periodic costs.
Making changes in these areas may take some effort, but they can significantly impact the amount of money you spend over a year. So, again, focus on making one change at a time.
4. Start a Side Hustle
Things may get a bit more challenging and require more work as you are now trying to add to your income and not focused on reducing 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 primary source of income.
A good side hustle can earn anywhere from $100 to several thousand dollars a month. Freelance writing, selling crafts on Etsy, starting a blog, and transcription work are all great examples of side hustles that you can start with only an hour per day or whenever you have time available.
Consider the skills and experience you already have, and think about ways to make money outside of your full-time job. Of course, you can always learn something new, but in most cases, putting your existing skills to work is a better approach.
If you’re not sure how to get started, see our article on ways to make an extra $1,000 per month. You’ll get some practical ideas and action steps.
5. Start Investing
Of course, if you want to increase your net worth, you should be investing. You could invest in stocks and securities, mutual funds, ETFs, real estate, or alternative investments. What’s right for you will depend on your situation, age, current net worth, and goals.
We highly recommend investment apps like M1 Finance, Public.com, and Robinhood. They’re user-friendly, and they remove many of the barriers that typically prevent people from investing in the stock market. In addition, they have very low minimums, and you can get started even if you’re only able to add a small amount of money each month.
Tracking Your Liquid Net Worth
If you want an easier way to track your net worth and liquid net worth, Personal Capital is the best tool, and it’s free.
They offer several paid services, but the free app will allow you to quickly calculate and track your net worth, with no need to sign up for any of the paid services. Personal Capital will help you track your net worth and liquid net worth and help you think about and create a comprehensive financial plan using these free tools.
Frequently Asked Questions
Here are a few common questions, as well as answers related to the topic at hand.
Calculate or determine your liquid net worth by adding up your liquid assets and subtracting all of your liabilities. When you’re adding up the total of your liquid assets, you have the choice of counting only the assets that are entirely liquid (like cash and cash equivalents like savings and checking accounts). Alternatively, you can reduce the value of non-liquid assets according to how much money you could get right now for the asset. For example, the value of your home equity would be reduced by the realtor fees and other transaction costs that you would incur if you were to sell the house. You may also want to reduce the value of non-liquid assets to account for the fact that you may not get the total value if you need to sell quickly.
Cash, checking accounts, savings accounts, stocks, bonds, mutual funds, and ETFs will almost always be counted towards your liquid assets. The exact details will depend on how you define liquid net worth.
No, generally, it does not. Selling a house takes time, and even in a good market, you would have to wait at least a month until you’d get the cash for your home. Fees, transaction costs, and taxes will also cut into the amount of money you walk away with, especially if you have to make a quick sale. You can include the value of your home equity in your calculation if you want to, but you should reduce it to account for the costs of selling and the possibility of selling below market value.
No, retirement accounts like 401(k)s and IRAs are generally not considered liquid. If you’re under the age of 59.5, you’re likely to pay penalties if you withdraw money from your retirement accounts. At any age, you’ll owe income tax on the funds withdrawn (Roth IRAs are the exception). If you want to include the value of your retirement accounts in your liquid net worth calculation, be sure to reduce the value by 10%-30% to get a more accurate cash value.
It depends. Most CDs will involve a small fee or withdrawal penalty if you take the money before the date of maturity. However, some CDs are penalty-free. If you would face any penalties for taking money out of your CDs, be sure to reduce the value by that amount when you’re calculating liquid net worth.
Generally, cars are not considered liquid assets. Cars can be sold quickly in some cases, but it’s also possible that it could take a while to sell your car, and it’s also challenging to know how much you could get for it. You can include the value of your vehicle in your calculation if you’d like, but be sure to reduce the value by 10%-30% so you’re not overestimating how much cash you could get for it.
In general, yes, company stock and bonds are considered liquid assets because they can be sold at any time and converted to cash quickly. Therefore, as long as there is sufficient trading volume, so you will be able to sell the stocks or bonds at any time. They would be considered liquid. However, keep in mind that you’ll have to pay capital gains tax on the investment gains.
Individual retirement accounts (traditional IRAs and Roth IRAs) and not considered liquid assets. However, you may be able to withdraw your contributions, but not the investment gains. This can make calculation complicated, so in general, IRAs are left out of liquid net worth.
Negative net worth and negative liquid net worth are typical. This is especially true if you’re in the early stages of your career or if you have large amounts of student debt. Many people do not have enough cash or liquid assets to cover all of their liabilities completely. Follow the steps covered in this article to reduce your liabilities and increase your assets.
Liquid net worth may not get a lot of attention, but it’s a vital metric that you should be aware of. Take some time to calculate your liquid net worth and see if you’re surprised by the results. Then, if needed, follow the suggestions in the last section of this article to improve it.
READ NEXT: Living Off Dividends
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