Liquid Net Worth

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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 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 use to evaluate a person’s financial health.

→ Related reading: 9 Convincing Reasons Why You Should Be Tracking Your Net Worth

What is the Meaning of 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.

For example, if you or someone in your family has an unexpected medical crisis and you’re hit with an unexpected hospital bill of $20,000, what’s more useful: $20,000 in a savings account or a car that has a Blue Book value of $20,000? Of course, the savings account is more useful because you can access that money immediately and you know exactly how much it’s worth (you may not be able to sell the car for $20,000).

Because liquid net worth is only taking your liquid assets into consideration, your liquid net worth will be lower than your total net worth, which includes all assets.

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. This is the main difference between net worth and liquid net worth. Net worth may be high, but it could be tied up in assets that are not liquid, which would make you vulnerable to unexpected emergencies.

For this reason, it’s 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.

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Liquid Assets

Stocks and bonds are great examples of liquid assets since you can sell them and have money in your hands within 3 business days.

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 as well as cash equivalents like any cash in savings and checking accounts.

Non-Liquid Assets

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 and other income producing assets would definitely be considered while calculating your total net worth, but maybe not in your liquid net worth, unless you do a few important things (more on this later).

Real Estate

While equity in your home is important, it’s not quite as useful 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 selling a little below the value in order to liquidate it quickly.

When calculating liquid net worth, the goal is to figure out how much cash you could get for your assets. If you had to sell your house or an investment property quickly, how much cash would you walk away with? That $50,000 of equity might be more like $10,000 if you have to sell below market value in order to move it quickly, and after the transaction costs like realtor fees and taxes.

Retirement Investments

Similar to the home, retirement accounts 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 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 that 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.

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’re forced to sell quickly.

There is no exact liquid net worth definition, so it’s up to 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’s recommended that you place around a 10-30% deduction 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.

You should also consider the reason why you’re calculating your liquid net worth. If you’re simply 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, but reduce the value of the non-liquid assets like a home, cars, 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 quite simple.

Liquid Net Worth = Liquid Assets – Liabilities

As we already discussed, assets include:

  • Cash (including checking accounts)
  • Savings
  • Stocks, bonds, mutual funds, etc.
  • Retirement accounts (can omit this or reduce the value to account for fees/penalties/taxes)
  • House (can omit this, as discussed before, or have the 10-20% deduction)
  • Car (can omit or include an undervalued amount)
  • Jewelry, art, collectibles, etc. (these can appreciate, depreciate, or stay the same)

Liabilities include things like:

  • Total remaining balance 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. Personal Capital will 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.

Calculating your liquid net worth may really be an eye-opener and make you appear less-well-off than you thought you were. It is, however, a very interesting and very essential exercise to achieve financial freedom and build assets.

Calculating Liquid Net Worth: An Example