Although the concept of liquid net worth stumps many people, most folks comprehend the definition of simple net worth. Add up the value of everything that belongs to you and subtract everything you owe, whether a big debt such as a mortgage or the $50 you borrowed from your sister. Hopefully, your resulting net worth is over zero.
The complexity of the calculation depends on the number and types of your possessions, formally known as your assets, as well as the number and types of your debts. The value of both assets and debts can fluctuate from day to day. Debts may accrue interest or earn penalties if they aren't paid on time. Stocks and bonds depend on the market, and material objects like properties or pieces of art are only worth what someone will pay for them.
The Challenges of Net Worth Calculations
When you calculate your net worth, you have to put a value on all your assets. Money in a canning jar or a bank checking or savings account makes valuation easy. You count your pennies, look online at your bank balances and use those numbers.
You probably will also use a straightforward amount for CD's, money market funds, stocks and bonds and retirement accounts even though values may change or penalties and taxes come into play. Whatever they are worth at the moment is what you write down.
Things get trickier when you put a price on autos, real estate, jewelry, antiques and other items that have some value. You can make a conservative estimate, seek a professional appraisal or use a price guide or online information. As long as you research carefully and keep the numbers realistic, you should be able to arrive at a reasonable figure for your total assets. Go ahead and subtract your debts from this total, and you arrive at your net worth.
Defining Liquid Net Worth
Not everyone agrees on the definition of liquid net worth. In general, it is the portion of your calculated net worth figure that you can quickly turn into cash. The conflict centers on the time used to convert non-cash assets into immediately accessible money. Some financial experts define liquid net worth as the portion of your net worth that you can use as cash in 24 hours or less.
In order to give you a good idea of where your cash-raising ability stands, you can prepare a spreadsheet for the assets that comprise your net worth. Put the assessed value of each asset in one column and the amount in another column that you could raise if you needed to withdraw the money immediately from an account or sell the asset today for whatever you could get.
The money in your wallet, checking account or savings account is worth exactly the balance that is there.
Stocks and bonds will bring in the current market price minus your brokerage fee. Your retirement IRA may have a healthy balance, but if you withdraw it before you turn age 59-1/2, you have to factor in taxes and early withdrawal penalties.
To calculate an immediate sale price of your auto, home or other property, you will typically need to discount the current value. Even if the real estate market in your area is a seller's market right now, and buyers are putting in offers above the asking price, you have no idea how long that situation will last.
To determine liquid net worth, assume you will have to price the property 20 to 25 percent less than market value to sell it immediately. The same may be true for your vehicles. If you need to turn a truck, motorcycle, or car into cash, you may have to take it to a used car lot and take whatever they give you.
Whether you are determining net worth or liquid net worth, the most challenging items include things such as antiques, collectibles, jewelry, and other articles that may have significant value but are not easy to sell. Appraisals and price guides may give you approximate figures, but in the end, an item is only worth what someone is willing and able to pay for it.
Although online sites such as eBay and craigslist offer possibilities for quick sales, most people end up selling to a resale shop at a deep discount when they need cash fast.
The point in all this is to figure out what you can raise for cash right now—not in a few days or next week. This simply gives you another perspective on your financial position.
Why Is Liquid Net Worth Important?
If evaluating your liquid net worth takes that much effort, why even bother? There are several good reasons for this financial exercise.
Liquid net worth provides a reality check.
If your financial situation looks good on paper, it may be easy to become overconfident and make buying decisions accordingly. You know you can't touch your retirement fund right now, but it's hard not to swagger a bit when you look at a substantial balance. If you own a classic car and see a similar model on a television auction go for $50,000, you may be tempted to think of that car as cash in the bank. By coming up with a realistic figure of your worth if you have to cash out today, you may think twice before taking on debt or jetting off on a tropical vacation.
Liquid net worth supplies valuable information for a financial emergency plan.
Whether you're a big picture person or you like to think about every detail, you need a financial emergency plan. Emergencies, by definition, cause unexpected disruptions in your normal routines. Panic often sets in, and clear thinking becomes difficult. If you plan when you aren't under stress, you can develop a strategy that is ready to implement if necessary.
Many financial emergencies involve some sort of personal crisis for you or a close family member. These events may include serious illness or accident, job loss, major appliance or auto repairs, or even a house fire or flood. Most of these calamities involve the need for immediate cash to address them, so the knowledge of your liquid financial worth will go a long way in helping you plan what to do first if disaster strikes.
Liquid net worth details may prove helpful if you want to finance a business, home or other investment.
Taking the time to prepare an itemized spreadsheet of your liquid net worth assets not only provides important information to help with planning but may also help prove your financial intelligence. This document often gives your financial advisor specific knowledge of your assets that you might not otherwise remember to share. It may also supplement any loan application or business plan you submit and typically makes a good impression by showing your fiscal responsibility.
Final Tips for Using Liquid Net Worth
As you work on improving your financial future and developing emergency plans, your liquid net worth may help you identify areas you need to address. Here are a few concluding thoughts to contemplate.
Consider the value of keeping some ready cash available.
This is a controversial thought for sure in a cashless society that thrives on plastic. However, we live in uncertain times, and although the possibility of a national financial crisis is remote, we went through two scary periods with 911 and the more recent Great Recession. In addition to your emergency bank account, which most financial experts recommend should cover at least three months of living expenses, you might want to think about a small cash reserve at home. While this money would not earn any income, not to mention the risk of fire or theft, it would be readily available in case a natural disaster or any other event barred access to your bank account for several days or more.
Develop advance strategies for liquidating items quickly.
A corollary to this suggestion would be to leave good information and plans for your family members or partner if you become incapacitated. Adding a few extra columns for each asset in your liquid net worth spreadsheet would keep emergency contact information right at hand for you or anyone else who might have to step in. For example, make sure your bank accounts list the name of the bank, account number, contact person and a phone number. Investments should detail your financial planner or broker, along with contact lists.
With non-liquid assets, from real estate to tractor collections, list any references that might prove helpful. Is there a real estate agent that you have worked with in the past and especially trust? How about an acquaintance who mentioned they would be interested in buying a particular item you own? Make notes about fellow collectors or experts you know who might be able to give advice about quickly selling an asset, whether it is a piece of art or a classic automobile. Be sure to include complete names and contact particulars. Gathering all the vital statistics in one place just makes good planning sense.
Finally, remain optimistic and enjoy your life.
This article has talked about reality checks and financial emergencies, but the purpose of knowing your liquid net worth should focus on responsible stewardship and peace of mind, not on depressing thoughts of catastrophes that are unlikely to occur. Even if you have discovered areas where you could improve your finances, be thankful for the opportunity to enhance your financial future. Once you have your plans in order, relax and take pleasure in the journey.