Put simply, income is the amount you earn whereas net worth is the total value of your assets minus any debt. When it comes to measuring your financial health, income isn’t the metric that matters. Sure, you want to know whether your income will help you reach your goals, but looking at your net worth is a better measure of your overall wealth.
That being said, it’s important to understand how both play into your finances, so let’s take a look at net worth vs income and how they factor into your financial health.
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Income vs Net Worth: A Measurement of Wealth
Both income and net worth can help measure the chances of someone creating wealth. However, the difference is that income is the primary way someone generates wealth, whereas net worth measures your level of wealth. To put it another way, income is how you make money, but it doesn’t necessarily lead to creating wealth.
Instead, looking at your net worth allows you to see the value of all your assets and liabilities at a specific point in time. It gives you a sense of your financial health in terms of whether you own more assets — such as your home, investments and cash — than liabilities (any money you owe, like debts). Your net worth also allows you to see how much of your wealth is held in assets or cash, as well as offer a reference point to help you measure your progress toward your financial goals.
Is Net Worth More Important Than Income?
While income is a key aspect of your finances, net worth typically is more important. That’s because even if you have a large income, it doesn’t guarantee that you’ll generate more wealth than someone else who may have a slightly lower one. Sure, having a larger income can help you build wealth faster, but it’s all in how you handle your finances, such as the amount of money you save.
Let’s say your friend makes $100,000 per year but has a lot of debt, leading their net worth to be $15,000. On the other hand, you make $70,000 but have invested over 10 years, to the point where your net worth is $100,000. You have more wealth, and therefore are more likely to be financially stable than your friend.
Another instance where income doesn’t correlate with wealth is when someone is older and getting ready to retire. Their income may be lower because they’re working part-time, but their wealth could be in the millions because they’ve worked for many years.
All this to say, income is important but only as important as how you use it to reach your financial goals.
How to Calculate Income
Calculating your income doesn’t simply mean looking at the number on your paycheck. You’ll also want to factor in other sources of income, such as any government benefits, commissions, tips and dividends. Don’t forget to include irregular or occasional income sources, like cash gifts, inheritances and even tax refunds.
Make sure that when you add these up, it’s your net income and not gross income, as that will give you a more accurate picture of what you’re bringing in. Gross income is pre-tax money and before deductions are taken out. Net income, on the other hand, is income that has taxes and deductions taken out.
Example of Calculating Income
Let’s say you have a day job that offers bonuses and commissions. You also invest in securities that provide dividends.
Here’s how you would calculate your income:
- Annual net salary: $64,350
- Annual commissions: $3,500
- Annual bonus: $2,000
- Annual dividends: $3,234
- TOTAL INCOME: $73,084
You can then use this total to calculate monthly and weekly income — in this case, it’s $6,090.33 per month and $1,405.46 per week.
How to Calculate Net Worth
Calculating your net worth involves creating a net worth statement so you can see a snapshot of your assets and liabilities. Start by looking at your assets and determining the total amount of all accounts under this category. Assets are items that have some sort of monetary value. These include:
- Checking accounts
- Savings Accounts
- Your home
- Real estate
- Retirement fund
- Personal property (such as your vehicle)
- Pension equity
- Securities (like stocks and bonds)
- Life insurance policy
- Profit-sharing equity
Once you’ve calculated all of your assets, you’ll need to calculate the total amount of your liabilities. Liabilities are any debts or financial obligations you have, including:
- Credit card balance
- Personal loans
- Auto loans
- Student loans
- Unpaid medical and dental bills
- Home equity loans
- Money you owe to family and friends
- Unpaid taxes
After totaling up your assets and liabilities, subtract the former from the latter. This number will be your net worth. If your liabilities are greater than your assets, you’ll have a negative net worth. The more assets you have than liabilities, the higher your net worth will be.
Example of Calculating Net Worth
As an example, let’s say that Barbara decided to calculate her net worth. First, she’d list out her assets and liabilities:
- Checking accounts: $600
- Savings Accounts: $10,000
- Home: $365,000
- 401(k) balance $24,399
- Vehicle (current value): $32,590
- Brokerage account: $12,000
- TOTAL: $444,589
- Mortgage: $200,000
- Car loan: $29,251
- Credit card: $4,126
- Student loans: $36,700
- Personal loans: $13,857
- Unpaid medical bill: $300
- TOTAL: $284,234
Once she’d written that all out, she would be able to calculate her net worth using the following formula:
- Total assets – Total liabilities = Net worth
- $444,589 – $284,234 = $160,355
So, Barbara has a positive net worth of $160,355.
Ways to Improve Your Net Worth
Ideally, you’ll have a positive net worth and will keep growing over time. Here are several ways to improve your net worth.
1. Keep Track of Your Assets and Debt
Tracking your assets and debt will give you an accurate picture of where you stand. That way, you’ll be able to see your progress and what you need to improve or keep doing to grow your net worth. For instance, if you notice that your debt keeps growing, you can use this information to help you figure out why and take steps to rectify the situation.
2. Pay Off Debt
The fewer liabilities you have, the more your net worth will grow. To improve your net worth, you can focus on making sure you’re making on-time payments and avoid taking out new loans if possible. If your budget allows, consider making extra payments toward loans to pay off your debt faster. Some loans, like mortgages, may have prepayment penalties, so check with your lender before sending that extra check.
3. Increase Your Income
Getting a higher salary will help you build wealth by paying off debt or putting money toward investment accounts. Ideally, you want to increase your income and pay off your debts as soon as you can. To increase income, you can consider negotiating for more in your current job, looking for a new one or starting a side hustle to help you make more.
Sticking your cash in a savings or checking account can only get you so far. To accelerate your wealth-building journey, you’ll need to invest some of your money. Start investing by contributing to your employer-sponsored account (bonus if they offer a match), and then branch out to other products as you see fit.
Your net worth is a snapshot of your finances at a specific point in time and will fluctuate. It’s a good measure to see whether you’re on track with your financial goals. The more you track your assets and liabilities, increase your income and decrease your debt, the more your net worth will grow.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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