On the surface, liquid net worth means your cash and other easily convertible assets like stocks and bonds and leaves out the value of your home, retirement account, and vehicle.
If you’re like me, you have probably come across the term – net worth in personal finance a lot. You also have a good understanding of what it means and have probably made references to it.
In simple terms, net worth is the total value of an individual’s assets, cash inclusive, minus the total liability. The net worth of the person then is the value by which their assets exceed their total liabilities.
But a more important tool in evaluating our financial health is our liquid net worth. Although much less talked about, it is key to determining our financial security and achieving financial freedom.
For many years I have been keeping track of our net worth but not our liquid net worth, never. Maybe in my mind but not on a spreadsheet or using a financial App. I started tracking ours about three years ago and was totally impressed by how detail and creative I can make out of it.
What is Liquid Net Worth and How Does it Affect Your Finances?
In the next 5 minutes, you’ll know all there’s to know about it, and most importantly, how to use it to achieve your financial goals.
As I previously stated, calculating your net worth is easy. You just add up your assets, subtract your debts if any, and you have your net worth.
You may ask at this point, what exactly constitutes an asset?
In simplest terms, your assets include anything you own with value. These usually consist of:
- Investments – stocks, bonds, Certificate of Deposits, etc.
- Retirement accounts
- And valuable jewelry, artworks, antiques, etc.
While liabilities are your debts. Which could be:
- Outstanding mortgage balance
- Student loans
- Credit card balances
- Any other loans such as payday loans.
Your Assets – Your Liabilities = Your Net Worth
However, don’t get too excited. While this figure is a neat guide, it won’t be of much help in an actual emergency.
If an urgent need for cash arises, your 7-bedroom mansion and brand new Mercedes won’t be of much help. Therefore, liquid net worth was introduced – to offer a more practical overview of your financial standing which the regular net worth calculation somehow overlooks.
Liquid net worth is the value of money you have that is readily accessible. Can you see the difference now?
Why Does it Matter to Me and My Family?
I started paying attention to our liquid net worth a few years ago when my daughter started college and the cost of her college tuition and other expenses associated with education has a lot to do with it. We were ready for the tuition but not on other expenses such as apartment, furniture and security deposits. It was a wake-up call for us to plan for and be prepared for such events.
You also would want to be sure your liquid assets will cover you when faced with a sudden illness, accident, or loss of your home to fire or natural disaster.
It gives you an idea of the amount of cash you can lay a hand on instantly.
Having significant liquid net worth will make it possible for you to quit your job if you want to. You can afford to take a sabbatical for some years, travel the world, or try your hands at a new venture.
How I Calculated Our Liquid Net Worth
Getting a fair idea of our liquid net worth requires careful consideration of what it takes to turn our assets to cash.
While homes, cars and retirement accounts are not considered to be liquid assets, I use them in the calculation, but I will apply reasonable discounts to take into consideration the cost and time it takes to convert our assets into cash. To give a clear illustration, I considered some common assets:
To calculate the liquid asset value of our home, I have to consider the following:
- The cost of sales. A typical home sales usually involve fees paid to realtors. You can set the value at 5 – 6% of the selling price.
- There’s no guarantee the buyer will pay the full asking price and completing the sale of real estate can take up to a couple of months to conclude.
- Home equity and mortgage balance
Therefore, it’s advisable you apply a 15 – 30% on the value of your home when calculating your liquid net worth to account for the costs involved and length of the sale. In our case, I went for 30%.
Our Roth IRA’s
A Roth IRA is not really a liquid asset. While you may be able to withdraw your contributions free of tax, withdrawing your investment gains before the age of 59.5 would attract an early withdrawal penalty of 10% on accrued gains and taxes on the profit at your marginal tax rate.
For instance, if I have $30,000 in my Roth IRA and I decided an early withdrawal of $10,000, a 10% penalty fee on that is $1,000 and factoring in my marginal tax rate, it may be considerably higher than that. Thus, to calculate the liquid net worth, I have applied an 11% percent discount on the account balance.
Just like the Roth IRA, withdrawing your 401k or any other retirement savings plan before you are 59 and a half years old incurs a 10% penalty. You also owe taxes at your marginal tax rate.
Based on these calculations, I decided to apply a conservative discount of 30% on the balance when calculating our liquid net worth.
Our Investments in Stocks
Stock and bonds can be considered to be liquid assets. This is because you could dispose of the stock and bonds in your brokerage accounts and get paid within three days.
However, the gains are subject to taxes depending on how long you’ve held the stocks.
For your brokerage accounts, the discounts you’ll apply will depend on the value of the gains in your portfolio. A conservative 5 – 20% discount is advisable based on the type of stock investments but in our case, I used a 20% discount for my calculations.
A reasonable discount of 20% discount on the value of our cars (based on expert valuation) should suffice.
To arrive at a final liquid net worth figure, I applied the appropriate discount to each balance sheet item and add up the results. Subtracted the debts, and there you have it – a close approximation of the cash I can lay hands on in an instant.
Tracking Our Liquid Net Worth
To build the financially-free future of your dreams, calculating your net worth is not enough. You have to actively monitor and track it. While apps like Personal Capital are handy for tracking your net worth, you can also do it manually. I use an Excel spreadsheet on mine.
Open a spreadsheet to track your liquid net worth. Put down all your liquid assets in one column. Assets such as checking and savings account balances, marketable stocks and bonds, and non-IRA mutual fund values. In the next column list all that you owe – loans and credit card balances. Add them all up and subtract the debts from the liquid assets.
Periodically update the data in the spreadsheet as the need arises.
Do not despair if the final figure is not what you expect it to be. Strategize on how to pay down your loans starting from credit cards to student loan debt and others. If you end up with a positive net worth, set a goal for yourself and work towards achieving that. It could be $100,000 or $1,000,000 – anything is possible.
Increasing Our (Your) Liquid Net Worth
So, after drawing up the figures and calculating your total liquid net worth, you discover it wasn’t exactly what you hoped for. Or, you end up in the red. Now, this is common, especially for those who just started in their career. Significant student debts are also a common cause of negative liquid net worth.
The object of tracking any parameter is to make adjustments as required. Here is what you can do to improve your liquid net worth and swing into financial health.
1. Earn more money
This is the best thing to do to turn your finances around. And it’s not as difficult as it sounds. You can increase your income by working an extra job, taking up a side hustle, negotiating for higher pay, or switching to a better-paying job.
Increasing your income not only helps you pay down debt faster it also makes it possible for you to save more and invest more. You will also be able to budget easily with increased income. All these essentially lead to a dramatic increase in liquid net worth.
2. Pay down loans
Make efforts to pay off your loans, especially the short-term, higher-interest loans. These include Credit Cards, Personal Loans, Car Loans, and other short-term liabilities.
You will rapidly increase your liquid net worth when you reduce your liabilities. And, you get to pay less interest overall. Try to pay more than the minimum repayment amounts due on your loans to reduce the principal and hasten up your loan repayment.
3. Negotiate lower interest rates
Refinance your high-interest loans and credit card to a lower rate to speed up debt reduction. Lower interests mean more money goes into the principal, which helps you knock off the loan faster. You can find credit card companies that can refinance your credit cards using a 0% balance transfer.
You could also consolidate high-interest debts with a home equity loan. Although you risk losing your home, it offers you a lower interest rate and a way of simplifying your repayments.
4. Reduce expenses.
Monitor your expenses and eliminate or reduce the unnecessary ones. This will free up more cash to use towards loan repayments or increase investments. You also get to retain more of your paycheck as cash which directly increases your liquid net worth.
There are many tools and budgeting apps – free and paid, that you can use to track and eliminate unwanted expenses.
5. Increase investment contributions.
When you earn more and cut expenses, the next logical step is to channel the extra money into your investment contributions. The more you contribute to your stocks and bonds investment portfolio, the more effective compound interest will work in your favor and increase your liquid net worth over time.
Calculating and tracking your liquid net worth may make you appear poorer, but it’s a necessary and interesting exercise. If you are planning on complete financial freedom, work on building your assets – especially the liquid ones, so you’ll have enough to support your lifestyle even if you never work again. That is why you need to calculate and track your liquid net worth- to put you on the fast lane to ditching the concerns of the working life forever.