What is Liquid Net Worth and How Can You Calculate It?
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Maintaining finances involves dealing with various parameters and methods that help you gauge the true worth of a person. While it is difficult to tag things in black and white, there are a few parameters that give a fairly clear idea of how things currently are. One such parameter is the net worth of a person.
What is net worth?
Net worth refers to the amount you get after subtracting all the liabilities from the assets of a person. The assets can include cash, commodities, real estate, and other investments and savings. On the other hand, liabilities can include any debt, loan, or borrowed money. The number by which the assets exceed liabilities is called net worth. If the person is under heavy debt, net worth comes out to be negative. Yet, net worth is also not 100% reflective of the existing situation.
This is where a more detailed and evaluating parameter called Liquid net worth can help.
What is liquid net worth?
Liquid net worth refers to the amount you get by subtracting all liabilities from assets if all of your estates are liquidated. It is a better real-time tool to gauge the present financial health of a person or entity.
Note: Liquidation for this purpose would mean sold and converted to cash.
When you calculate your liquid net worth, you get a clear understanding of the actual worth of your assets and complete estate. For instance, if you have an investment portfolio of commodities, stocks, mutual funds, and real estate, it may become tough to make a fair calculation of where you stand or what your financial health is in terms of numbers.
When you use liquid net worth, you will be essentially converting all your assets and liabilities into numbers. Let us say you have the following estate:
- Mutual funds: $50,000
- Real estate: $2,000,000
- Commodities: $10,000
- Stocks: $10,000
- Loan: $70,000
- Debt: $80,000
Then your liquid net worth will be:
Liquid net worth = liquid assets – liquid liabilities
= (50,000+2,000,000+10,000+10,000) – (70,000+80,000)
This number will give you a fair understanding of what your current financial health is in terms of numbers. However, liquid net worth always comes out a little less than the actual net worth. This is so because while calculating liquid net worth conversion, transaction and liquidation costs are also taken into consideration.
Hence the formula actually would seem like:
Liquid net worth = (Liquid Assets – Liquid Liabilities) – Liquidation costs
Thus, the major difference between net worth and liquid net worth lies in the practicality and accessibility of the money in a needful situation.
How to calculate liquid net worth?
Calculating liquid net worth is quite simple. As mentioned above, the formula is the same as of net worth i.e. (Assets – Liabilities).
For the purpose of calculation, assets include:
- Cash and cash deposits
- Mutual funds
- Retirement accounts
- Real estate
- Jewelry and commodities
- Artefacts and Collectibles
Note: For the purpose of calculation, you must take the tax-adjusted and depreciated rates of all the assets wherever applicable. For example, in the case of real estate, vehicle, retirement funds, etc.
For the purpose of calculation, liabilities include:
- Car loans
- Home loans
- Student loans
- Personal loans
- Payday loans
- Mortgage balance
- Money borrowed from a lender
- Credit card bills
- Other debt types
Once you have the numeric worth of your estate, you can make the calculation.
Why is the liquid net worth important?
Liquid net worth finds its applicability highly in matters of financial assistance. Tracking your liquid net worth helps in financial planning as well.
Once you have a fair idea of your liquid net worth it can help you plan your investments and savings. In addition to this, it helps you in evaluating your financial security and making an estimation about the future financials.
One of the biggest advantages of calculating liquid net worth is to have a fair idea of your funding status in case of an emergency. If your liabilities outgrow your assets, you must channelize your money towards repayment of those liabilities and decrease your liabilities as soon as possible. Also, you must channelize some money towards creating an emergency fund that is easily accessible and gives at least the direct value of your investment in return. Ideally, an emergency fund must be equal to six months’ income of a family, plus the amount of the last emergency funding.
Liquid net worth and financial freedom
One of the main reasons people are interested in calculating their liquid net worth is to know where they stand financially. This is highly helpful in attaining financial freedom. Even if you have managed to build up an empire of assets, the more illiquid they are, the greater the difficulty will be in becoming financially free. The idea is to quickly convert your assets into liquid money as and when desired.
Financial freedom is highly related to early retirement as well. If you are looking forward to retiring early, you must have an idea of your asset’s worth. To retire early, it is crucial that you have a significant number as your liquid net worth, so that quitting your job will not be as harsh on you and your family. Also, liquidity in the case of FIRE (Financial Freedom Retire Early) does not mean having all the liquid money all at once. Rather, it means that you have assets that will ensure liquidity in your family’s financials. For example, dividend-paying investments, rental returns on real estate, etc.
To sum it up
Liquid net worth is the practical presentation of your estate in terms of cash such that it can be converted and used as and when desired. Although liquid net worth is easy to calculate, it can sometimes pose difficult calculations in front of you. Converting assets into liquid money involves tax and depreciation calculations that may sometimes be complex.
If you need more information on liquid net worth, you can reach out to financial advisors.