When it comes to your finances, you need to understand a few key metrics to make intelligent decisions about your money. Net worth and liquid net worth are two essential concepts, The term “net worth” is well-known among the public, and most individuals have a reasonable grasp of it.
Net worth is quite simple in that it is the total value of all your assets minus the total of your liabilities. It leaves you with your “net worth,” which is what you own outright, free and clear.
But liquid net worth is not as commonly understood, even though it’s a critical metric for assessing your financial health. So, let’s understand what liquid net worth is and how you can calculate liquid net worth.
What is Liquid Net Worth?
Liquid net worth definition: Liquid net worth is the value of the assets you can quickly convert into cash. In other words, it’s the portion of your net worth that is “liquid” or easily accessible.
It is essential because it’s the money you have to cover unexpected expenses or take advantage of opportunities.
If you have an extensive, well-diversified portfolio of investments, your liquid net worth may be much higher than your regular net worth.
The basic formula for calculating liquid net worth is to deduct your liabilities from your assets, just like net worth, with one exception: liquid net worth only considers your liquid assets.
Even though this is a correct definition, you must consider several features when putting your liquid net worth together, which we will discuss later in this article.
Difference between Net Worth and Liquid Net Worth
The significant difference between Net worth and liquid net worth is that regular net worth includes all your assets, while liquid net worth only considers your liquid assets.
In simple words, items that can’t get converted into real cash quickly (assets you cannot sell fast) do not get included while calculating the net worth.
Non-liquid assets are things like real estate, art, and jewelry that can take time to sell or may not be able to be sold at all. While liquid assets are things like savings accounts, investments in mutual funds or ETFs, retirement accounts, and cash equivalents policies that you can quickly convert to actual cash.
In more simple words, your regular net worth is what you own outright, while your liquid net worth is the portion of that that is easily accessible. Further, it indicates your ability to withstand unanticipated events, and you should consider it throughout financial planning.
Now that we understand the difference between regular net worth and liquid net worth let’s see why your liquid net worth matters.
Why Does Liquid Net Worth Matter?
Liquid net worth is a crucial part of financial planning for several reasons.
First and foremost, your liquid net worth is a crucial metric for assessing your financial situation. It’s an excellent way to measure your ability to handle unexpected expenses or take advantage of opportunities.
For example, suppose you have a medical emergency and need to pay a large bill or lose your job and cover your living expenses for some time. In that case, it will be a critical factor in determining how well you can weather the storm.
Another reason liquid net worth is so important is that it’s a good indicator of your financial flexibility.
If you have a large amount of money in liquid assets, you’ll have more flexibility in your financial planning. For example, you may be able to take advantage of opportunities to invest in new businesses or real estate or make other large purchases without liquidating other assets first.
You may also be able to weather a period of unemployment or underemployment without as much financial stress.
What are Liquid Assets?
Now that we’ve discussed the importance of liquid net worth, let’s look at what assets are liquid.
As we mentioned earlier, liquid assets are those assets that you can quickly convert into real cash. The great examples of liquid assets are stocks and bonds, which one can sell relatively quickly and for a very close approximation of their actual value.
Other liquid assets include savings accounts, money market accounts, and short-term certificates of deposit. These accounts tend to have low-interest rates, but they offer the benefit of easy access to your money when you need it.
In simpler terms, anything that can be sold and turned into cash within a short period is a liquid asset. However, one should know how to calculate it.
Some people also consider investments in mutual funds and exchange-traded funds as liquid assets. However, it’s important to remember that it may take a few days for the sale of these investments to get settled and the cash to become available.
Another asset that people consider liquid is cash value life insurance. This type of policy has a cash value component that one can access through loans or withdrawals. However, taking money out of a life insurance policy will reduce the death benefit paid to your beneficiaries.
Determining an asset’s liquidity is often a simple matter of whether or not one can sell it quickly and for close to its total value.
However, some assets don’t fit neatly into the liquid net worth definition. For example, you can sell your fixed assets like real estate, but it often takes months (or even years) to find a buyer and finalize the sale.
And depending on the current market conditions, you may not be able to sell your property for its fair market value. So, for example, you might be able to raise the cash equivalents, but it won’t happen right away. In addition, you’ll leave with less money than your home is worth, owing to realtor fees, taxes, and other expenses.
Other examples of non-liquid assets include antique furniture, art, and collectibles. One can sell these assets anytime, but finding a buyer willing to pay the asking price may take some time.
Not to mention cars, retirement investments, and business interests, all of which can be sold but may not fetch their total value in a sale. These are the assets that are generally considered Non-liquid assets.
Now that we have understood the significant differences between net worth vs liquid net worth, it is essential to know the ways most people define it.
Different Ways to View Liquid Net Worth
So one can perceive it in a few different ways. For example, some people consider the liquid net worth the amount they can raise right away, mostly under 24 hours to even a week.
Others include cars, houses, and retirement funds because they know they can sell them if need be. Also, they’ll have a good idea of how much cash these assets may bring. So the important thing is to understand your finances and what works best for you.
If you plan to include your retirement savings or car, it is better to calculate a 10-30% deduction to account for the time it might take to sell these items and the fees associated with selling them.
Once you have a clear idea of the total value of your assets and how you want to view your liquid net worth, the next step is calculating it.
How to Calculate Your Liquid Net Worth
Calculating your liquid net worth is a relatively simple process. You need to take your total assets and subtract your total liabilities. It will give you your net worth.
You can deduct any non-liquid assets, such as real estate or retirement investments to get the final sum.
Here is the formula to Calculate Your Liquid Net Worth in the simplest way possible.
Liquid Net Worth = Liquid Assets – Liabilities.
As we have already mentioned, the liquid assets to include are
- Cash in hand.
- Your savings.
- Stocks, bonds, mutual funds, etc.
- Investments you can sell quickly.
- Jewelry, art, and other valuables.
- Retirement accounts such as 401(k)s and IRAs.
- Deferred compensation plans.
- Emergency fund.
- The value of your life insurance policy.
Liabilities that you should include are:
- Personal loan
- Car loans
- Credit card debt
- Outstanding house mortgage balance
Everyone should calculate liquid net worth to understand their financial situation in a better way. It would help if you were always aware of how much money you can access quickly in an emergency.
It is always advisable to increase it by investing in assets that can easily convert to cash. In addition, it will help you stay afloat during tough times and boost your financial health.
How to Increase Your Liquid Net Worth
Here are a few suggestions to increase it:
1. Invest in assets that you can convert into cash: Investing in stocks, mutual funds, and other investments that can get you quick cash.
2. Keep some cash in hand: It is always a good idea to have some money set aside for emergencies. This way, you will not have to rely on credit cards or loans if something unexpected comes up.
3. Pay off your debts: By paying off your debts, you will free up more cash that you can use in case of an emergency.
4. Invest in retirement accounts: Retirement accounts, such as 401(k)s and IRAs, can be a great way to increase your liquid worth.
5. Reduce your Liabilities: Reducing your liabilities will free up more cash that one can use in an emergency.
6. Create a budget: This is one of the most important things you can do to improve your financial health. By creating a budget, you will be able to track your spending and make sure that you are not overspending.
7. Start a passive income: A passive income is an income you earn without working for it. It can be from a youtube channel, a blog, investments, stocks or mutual funds, or other sources, such as rental properties.
Frequently Asked Questions
Here are some typical questions and responses relating to the topic.
Yes, net worth includes all of your assets, including money in the bank. It is because the money in the bank is an asset that one can use to pay off debts or other expenses.
Yes, net worth includes debt. Your net worth is the difference between your assets and your liabilities.
Yes, they do. You can sell your stock quickly for cash if need be. However, it is essential to remember that not all stocks are the same, and some may be more difficult to sell than others.
There is no one answer to this question because it depends on your financial situation. However, a good rule of thumb is to have funds equal to at least three months of your living expenses. It will help you stay afloat during tough times and boost your financial health.
It’s essential to know your net worth because it’s a key indicator of your financial health. If you have a negative net worth, you’re in debt, and you may have difficulty meeting your financial obligations.
On the other hand, if you have a positive net worth, you have a cushion of assets to fall back on in case of an emergency. Knowing your liquid net worth is valuable for managing your finances and ensuring your financial well-being.