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Some people use income as a gauge for financial success. But is income the most accurate indicator of wealth? What does your net worth reveal about your financial health? And what's the difference between your income and net worth?
Income shows the amount of money you earn from your job and other sources, while net worth measures your total assets minus your total debt—a more accurate picture of where you stand financially. Let's take a closer look.
What Is Net Worth?
Net worth is a figure that represents the amount you own (assets) minus what you owe (liabilities). While many use income as a measure of wealth, net worth is a more effective marker.
Your income—and your after-tax net income—is a key component of your finances, but income alone doesn't guarantee you'll create more wealth than someone who earns less. Even the best savers don't save every penny they earn.
By contrast, your net worth considers both sides of your financial balance sheet: the value of your assets and your debt liabilities. It reflects how you use your money to buy, borrow and invest.
How to Determine Your Net Worth
Calculating your net worth is as straightforward as subtracting the total of all your debt liabilities from the total value of your assets. Here's an example illustrating how to figure out your net worth:
|Net Worth Calculation|
|Home (current value): $450,000||Remaining mortgage balance: $350,000|
|Auto (current value): $10,000||Remaining auto loan balance: $5,000|
|Emergency fund: $5,000||Credit card debt: $10,000|
|Brokerage account: $10,000||Student loan debt $40,000|
|Retirement savings: $35,000|
|Assets total: $510,000||Liabilities total: $405,000|
|$510,000 - $405,000 = $105,000 net worth|
In the above example, the total net worth is $105,000. Keep in mind that it's possible to have a negative net worth if the total of your liabilities exceeds that of your assets. Knowing your net worth is important for evaluating your current financial health and planning for the future.
How Is Income Different From Net Worth?
Your income is money you regularly receive through your job, business, investments or other sources. For example, you may have several sources of income, such as:
- Employment paychecks
- Profits from a business you own
- Investment dividends or interest growth
- Passive income, such as rent from a rental property
- Government benefits including Social Security
And similar to how your net worth is your assets minus your liabilities, your net income is your income minus taxes and other deductions—also known as your take-home pay. The total compensation you receive before taxes and other deductions is called your gross income.
Income represents one aspect of an individual's finances, and you can't assess much about the soundness of someone's financial lifestyle just by knowing their income. Net worth, on the other hand, measures your actual level of wealth because it also factors in your debt.
In other words, income is different from net worth because it shows how you're making money, even though you may or may not be creating wealth with it. On the other hand, your net worth depicts your true financial position, accounting for everything you own minus your total debt.
That's why, if your goal is to increase your income, it's also wise to devote some time and attention to growing your net worth in turn. You may not see much benefit from an increase in income if phenomena such as lifestyle creep or inflation increase the cost of your liabilities.
Why Is It Important to Know Your Net Worth?
Your net worth provides an important snapshot of your financial standing that you can use to determine what you need to do to reach your goals. For example, if you have a negative net worth, you might focus on paying off debt to help create positive net worth. Conversely, if your net worth is positive but lower than you'd like, you might consider buying a home, investing in stocks or bonds or taking other actions to create assets and grow your net worth.
Calculate your net worth every month, quarter or year, depending on how often you want to review your progress. Knowing your net worth can motivate you toward achieving your financial objectives.
How to Improve Your Net Worth
Generally, improving your net worth is a long game, where success is the result of simple and consistent actions over time. Here are some easy and effective strategies for increasing your net worth:
- Reduce your expenses: Review your regular expenditures to identify expenses you can cut and apply the money you save towards savings, investments or debt accounts. Consider cutting banking fees, restaurant takeout and food delivery fees, fees for unwanted subscriptions or gym memberships and discretionary purchases that exceed your budget.
- Pay yourself first: Financial experts often recommend paying yourself first as a way to prioritize your long-term financial well-being. When you get your paycheck, direct a specific amount to a savings or investment account to make sure you meet your savings goals before you do any other spending.
- Pay down debt: Apply the extra money you're saving towards any high-interest credit accounts, the principal on your mortgage loan or other debt. For example, making bi-weekly mortgage payments instead of monthly payments will result in you paying one extra mortgage payment each year. Doing so could shave several years off the time it takes to pay off your mortgage.
- Boost your income: Consider requesting a raise from your employer, picking up a side hustle or taking on a part-time job. Then, put the extra money toward your savings or debt balances to improve your net worth.
- Build an emergency fund: An emergency fund could help cover your bills and prevent you from relying on credit cards or loans if you end up facing a temporary financial hardship. Experts recommend building an emergency fund equal to three to six months of living expenses.
The Bottom Line
Your income is significant because you can use it to generate wealth. You can measure that wealth by calculating your net worth, including your assets and liabilities. Think of your net worth as a financial measuring stick, providing you with an instant summary of your financial position, so you can take steps to improve it.
While lenders may consider your income or debt-to-income ratio to determine your eligibility for credit, neither are factors in your FICO® Score☉ . However, you'll likely need good credit to qualify for credit cards and loans—like a debt consolidation loan to pay off debt and improve your net worth. Get free access to your Experian credit report and credit score to see where your credit currently stands and how specific scoring factors may be impacting your credit score.