Net worth refers to the value of assets owned by an individual, company, corporation, or organization minus the liabilities. However, net worth computation differs depending on what is being measured. Therefore, there are many terms involved in the calculation such as liquid net worth. Do you know what is liquid net worth and why does it matter?
- Liquid net worth refers to the amount of money you have in cash or assets that can be easily converted into cash without significant loss in value.
- It includes assets such as savings accounts, checking accounts, stocks, and bonds.
- However, assets like real estate, retirement accounts, or other investments that cannot be easily converted into cash are not classified as liquid net worth.
What is liquid net worth?
You have probably heard about the importance of having a solid net worth. However, when it comes to financial planning, it is not just about how much you own. It is also about how much you can access at any given time. This is where liquid net worth comes in.
Liquid net worth refers to the portion of your assets that is easily accessible in cash or can be quickly converted into cash without significant loss in value. It includes assets such as savings accounts, checking accounts, stocks, and bonds.
However, liquid net worth excludes assets such as real estate, retirement accounts, or other investments that cannot be readily converted into cash.
How to calculate liquid net worth
Calculating your liquid net worth is relatively simple. Start by adding up all of your liquid assets, including cash, savings accounts, checking accounts, stocks, and bonds. Then, subtract any outstanding debts, such as credit card balances, personal loans, or car loans. The resulting number is your liquid net worth.
Liquid net worth = liquid assets – debts/liabilities
Remember that there are assets that cannot be included in this calculation. For instance, you cannot include retirement savings or your car because it cannot be easily converted into cash.
The bottom line is to ensure you only include assets that you know are accessible in cash form or there is an easy way to sell them for cash today. The assets considered to be liquid assets and liabilities in most cases are listed below.
- Certificate of deposit
- Jewelry/ collectibles
- Checking accounts
- Savings accounts
- Money market accounts
- And others
- Student loans
- Credit card dents
- Car loans
- Personal loans
- And others
An example of liquid net worth calculation
With the information above, it is easy to calculate liquid net worth. Take the following example.
Joy has $100,000 worth of stocks in a brokerage account. She also has $20,000 her home bank. She also owns a golden ring worth $10,000. However, she has an outstanding student loan of $30,000 and a mortgage of $45,000. Calculate her liquid net worth.
The formula for calculating liquid net worth = liquid assets – debts/liabilities.
Liquid assets = stocks + cash in hand + ring = $100,000 + $20,000 + $10,000 = $130,000
Total debts/liabilities = student loan + mortgage = $30,000 + $45,000 = $75,000
Liquid net worth = $130,000 – $75,000 = $55,000
Therefore, Joy’s liquid net worth is $55,000
Why liquid net worth matters
Now you know what is liquid net worth, why does it matter? First, it matters because it provides a more accurate picture of your financial health than your overall net worth.
You may think that it is good to have a high net worth, but the majority of your assets could be tied up in illiquid investments. As a result, you may not be able to access the funds you need in an emergency. To avoid falling into such “false” convictions of your net worth, you need to know what is your liquid net worth.
Secondly, liquid net worth is an important factor in determining your financial stability. In the event of a job loss or other unforeseen circumstances, having a healthy amount of liquid assets can provide a cushion to help you weather the storm.
While liquid net worth is an important metric, it should not be your only focus. Instead, ensure you build wealth through long-term investments, such as retirement accounts or real estate. It is also important to strike a balance between these investments and maintaining a healthy liquid net worth.
Which is the ideal liquid net worth?
How much liquid net worth should you have to be considered financially stable? Well, the answer to this question varies depending on circumstances. You could have a low liquid net worth and still be financially stable if you do not have debts.
However, financial experts generally recommend having enough liquid assets to cover at least three to six months’ worth of living expenses. This provides a buffer in case of unexpected expenses or a loss of income.
For instance, if you live in New York, your monthly expenses are estimated to be $4299. That means that your 3 months’ expenses will be $12897. If you are in such a situation, ensure you have cash or assets that can be converted into cash easily and are equivalent to $12,897 at the minimum.
How to build a healthy liquid net worth
Of course, building up a healthy liquid net worth takes time and effort. Here are a few tips to help you get started.
1. Prioritize saving
Make saving a priority by setting up automatic transfers from your checking account to a savings account each month. Then, set a saving target and work hard to achieve it.
2. Pay down debt
High levels of debt can eat away at your liquid net worth. Therefore, make it a goal to pay down any outstanding balances as quickly as possible. Start with the high-interest debts first and pay the low-interest debts last.
3. Diversify your investments
While it is important to maintain a healthy liquid net worth, never neglect long-term investments. Therefore, you should diversify your investments if you want to build lasting wealth over time.
4. Keep an emergency fund
In addition to your liquid net worth, it is important to have a separate emergency fund to cover unexpected expenses. Aim to have at least three to six months’ worth of living expenses saved up in this fund.
5. Slow spending
You need to scale down your spending. You can do that by creating a budget plan. The plan should include your daily, weekly, and monthly spending targets. Ensure you stick to your plan to avoid impulse buying.
Financial experts also recommend paying with cash as a way of reducing spending. When you pay with cash, you avoid the temptation of buying items on credit. Ultimately, you reduce your debt obligations.
The bottom line
Net worth is an important metric in financial planning, but it is not the only one that matters. However, liquid net worth provides a more accurate picture of your financial health and stability. Therefore, it should be a key part of your financial plan.
You should prioritize saving, paying down debt, diversifying your investments, and keeping an emergency fund if you want to build a healthy liquid net worth that provides a solid foundation for your financial future.