- Liquid net worth is found when you subtract your liabilities from your liquid assets.
- Liquid assets include cash, savings, stocks, and cryptos. Non-liquid assets include homes, cars, and art.
- Having a higher liquid net worth benefits your financial health and there are several ways to build it.
What is Net Worth and What is it Used For?
Your net worth is the value of your assets after subtracting your total liabilities. Put another way, it’s the difference between what you have and what you owe that tells how much your financial holdings are worth. When people talk about wealth, they talk about it in terms of net worth when they say someone is worth a specific amount. For instance, as of this article’s writing, Jeff Bezos has a net worth of $168 billion while Elon Musk is worth $244 billion. People track their overall wealth and its progression by tracking their net worth over time. I also prefer to track my wealth this way and understand how much each asset class is a part of my total wealth.
First, let’s dive into the difference between assets and liabilities.
- Assets are anything that can be used to produce positive economic value or redeemed for cash. Examples range from cash, real estate, retirement accounts, stocks, bonds, etc.
- Liabilities are any type of borrowing of another entity’s assets that the borrower owes to that lending party and must eventually repay. Examples include car loans, personal loans, credit card debt, student loan debt, etc.
Your net worth is positive when a person’s assets outweigh their liabilities. One’s net worth is negative when their liabilities exceed their assets. People often take out debt to buy a home or to attend college, which can cause them not to have a positive net worth for long periods of time – which is ok. Especially as young professionals, it takes time to build one’s personal wealth, pay off debts, and create your personal finance system. Achieving a positive net worth is often a financial milestone for many people! Next, let’s dive into what liquidity is all about.
What is Liquidity?
Liquidity is all about how easily an asset can be converted to cash, at its equivalent value. On this spectrum, cash or any currency is the most liquid asset and real estate is the least liquid. Assets like a checking or savings account are often viewed as cash equivalents and are the next liquid assets. You can instantly pull out cash from an ATM or bank or wait a few days at most to withdraw larger sums.
Stocks, bonds, and cryptocurrencies are less liquid as they take time to be sold, may incur tax, and take time to transfer the proceeds from the broker to a bank account for access. Additionally, stocks and bonds must be sold during market hours. The lag period to redeem these assets for cash ranges from a few days to a week or longer. The longest I’ve had to wait to withdraw money from a crypto broker was 10 days. However, they are still fairly liquid.
Non-liquid assets include retirement accounts, such as 401(k) or Roth IRA which take time to liquidate and are subject to certain fees and conditions.
Note that the less liquid an asset is, the more likely it is to grow in value over time. The more liquid something is, the less valuable it is over time. Cash loses its value to inflation over time while stocks, bonds, and real estate usually appreciate over time. This is because more liquid assets are in more secure positions and exposed to little or no risk. However, the assets that are part of risky environments have the potential to generate higher real returns. For instance, savings and checkings accounts are fully insured by the FDIC and come with little risk, making them suitable options for wealth preservation. Whereas, equities are subject to the daily and long-term volatility of the trading markets and will have swings in value that can lead to a decrease or increase in their value. Returns do not come without their risk. When it comes to building your wealth, it is key to have a balance between both liquid and non-liquid assets, which we will cover later.
Cash, stocks, cryptocurrencies, and bonds are liquid assets. Assets such as a house, car, or retirement accounts are non-liquid assets. Now, let’s understand liquid net worth, how to calculate it, and why it matters.
What does Liquid Net Worth Mean?
Calculate Your Liquid Net Worth
Liquid Net Worth = Liquid Assets – Liabilities
Your total liquid net worth is likely to be much lower than your overall net worth or even be negative. If you are a young person with student loans or high credit card balances, it is typical to have a negative liquid net worth. Even if you are more established, having debt like a mortgage is quite common too. If your liquid net worth isn’t quite where you’d like it to be, don’t fret – we’ll cover ways to increase your liquid assets later on. As a measure of financial security, it can be uncomfortable to bring up but developing a plan and doing something about it is the best way to improve your situation.
Why It Matters?
It indicates your ability to deal with an unexpected financial situation or emergency. Let’s say you get into a car crash and have to repair your car and go to the hospital. Having cash and other liquid assets will help you do those things worry-free. Selling your car, rare Pokemon card, retirement savings, NFT, or family heirlooms would be difficult to do quickly, have an uncertain selling price, and should be the option of last resort. Also, selling off non-liquid assets, like a retirement account can have long-term consequences such as affecting your lifestyle options when you get older. The money you set aside for the unexpected comprises your emergency fund.
This fund should be kept separate from your regular accounts but easily accessible so you can get to your cash quickly in case the worst happens. I keep my emergency fund in a high-yield savings account with an online bank that offers one-day withdrawals. Building this fund was my first financial goal when I got out of college – having one is a key part of your financial health. It will also increase your liquid assets.
Recently, I was traveling in Europe when I had an unexpected medical emergency. Knowing that I had money set aside for such an occasion, I felt comfortable going to the hospital and seeking treatment without worrying about the cost. Knowing I had access to liquid funds made all the difference – thankfully my bill wasn’t too bad.
Liquid net worth also matters when you are evaluated by creditors, such as a bank. Let’s say you want to apply for a loan to start your own business. When you apply, creditors want to know your LNW to understand and manage the risk they take on if they grant your loan application. From their perspective, your liquid assets can help them recover part of their loan value in case of a default.
Having a supply of liquid assets can help you pull off a strategic personal finance move. You can use your cash to pay down more of your total liabilities than you would in a usual monthly payment for say your credit card or auto loan. Doing so will produce a number of benefits:
1) Your credit score will get a boost as your higher payment is an indicator of your ability to pay it back.
2) Remaining loan payments will have lower amounts of interest due as less of the loan principal is outstanding.
3) Timing a large payoff makes you look better in the eyes of creditors when applying for other loans or mortgages.
4) Having less debt to worry about increases the quality of your sleep.
A few years ago, I made a payment on my auto loan worth over three months of regular loan payments. As a result, my credit score went up about 30 points and my interest due on each subsequent loan payment decreased – saving me money in the long term. Plus, I’ve used the higher credit score to open additional credit cards to earn more rewards points and cash back from my spending. Overall, your liquid net worth is a telling number about our financial security – that reveals how much cash you have access to if you really needed it. If it’s not quite where you want it to be, let’s cover some ways to increase it.
How to Improve Liquid Net Worth
1) Take on a Side Hustle
Boost your income by taking on a side hustle in your free time. Dog walking, flipping items, tutoring, etc. are all great ways to make side money while building your skills and experience. You can even rent out a spare bedroom or rent your car via Turo. Having one can even help you explore a new field or to transition your career. With the Internet, it’s easier than ever to find or create your own side hustle. Your profits can go to your savings, investments, or payoff your debt – all actions that increase your liquid assets. Plus, the skills and experiences you accrue make you more valuable in your job and make a case for a raise or promotion. Also, you can write off or deduct certain expenses from your side hustle – depending on your tax situation of course.
2) Pay Down High-Interest Debt and Liabilities
High-interest debt adds to your liabilities and decreases your liquid net worth rapidly – due to compound interest. This is perhaps the most annoying form of liability. Credit card debt with high APRs makes your debt more pricey as you pay out rising amounts of interest each bill cycle – eating away at your cash. For example, if you have a $5,000 balance on your card with a 20% APR, then you would pay $1,000 in interest. Personally, I have cards with awesome rewards setups but their APRs range from 15-25%! That’s about 2x or 3x the average annual stock market return. High APRs are common in the rewards credit card space. I would be paying up the nose if I missed a payment! After having missed one card payment, I’ve made it a priority to pay off my bills a few times each month.
Making it a goal to pay off high-interest debt with an APR of say 15% will return that money back to you that you would have paid as interest – a reward for getting debt under control. It is also worth approaching creditors and seeking ways to consolidate debt or create debt repayment plans. Consider methods like the debt snowball to pay it off faster.
3) Cut back on unnecessary expenses
Let’s be honest, we all have unnecessary expenses. Many of us, including me, pay for too many subscription products each month. The average person pays $273 for subscriptions monthly. Others may spend too much on eating out, a gym membership, gadgets, or to-go coffee. Take a look at your credit card and account statements to understand your spending patterns. Track where you can cut spending and organize a budget that works for you. If you realize that the extra money spent on something doesn’t add to your life or happiness – it’s worth cutting out.
4) Negotiate better interest on debt
If you have long-term debt like student loans or a mortgage, you can seek out a better interest rate through refinancing. Doing a refi means you are replacing your current loan with a new one that comes with a new set of terms – with a better interest rate. Your old loan is paid off by the lender and replaced with a new one, sometimes with a different lender. However, refinancing comes with a catch.
Your lender charges closing costs, fees taken when you start a loan. Closing costs add up and range from 3 to 6% of your overall principal. Before deciding to refi, it is important to weigh the closing costs against the savings on interest payments to arrive at the best decision.
5) Be Mindful of Getting into Debt
Most of us will have to take on some type of debt throughout our lives. Whether it be student loans for college or a mortgage to buy your first home – debt is a part of our modern lifestyles, so let’s make it work for us. All of our debt should have a purpose. Being aware of why you want to take out a loan, the expected benefits, comparing costs to benefits (also non-financial ones), and challenging your thinking are key steps to engage in before signing for debt. Also do your research on where you can get the best terms and understand how it affects your overall financial situation. If you are paying off accrued debt, then taking on more may not be the best decision. In fact, taking on more debt while you are in it can make creditors doubt your creditworthiness and view you as a risk. They will only offer you loan terms with higher, unfavorable rates.
Personally, I used to be anxious thinking about debt, but shifting my thinking about what taking on that debt was doing for me and my future put me at ease. I realized there is good and bad debt, and that what I used it for mattered most. Taking out a loan for an extra car or to spruce up a house aren’t good reasons to get into debt. But taking out a loan to start your own business does.
The Bottom Line
Liquid net worth is a measure of your financial health. Regular net worth and liquid net worth are good measures of your overall financial position. Liquid assets are those that can be most easily converted to cash like savings accounts or stocks and bonds. They are most useful in an unexpected situation. We covered why your liquid net worth matters and several ways it can benefit you. We also covered ways to increase your amount of liquid assets. We hope you’ve found this information helpful in your journey to financial freedom.
FAQs – Frequently Asked Questions
Q: Where is the best place to hold my cash to maintain liquidity?
A: You can hold your cash in a number of places such as a checking account, savings account, or money market account. Though you won’t gain a real return on cash in these accounts.
Q: Are Roth IRAs liquid assets?
A: Yes, Roth IRAs are considered liquid as your contributions can be withdrawn at any time without taxes or penalties.
Q: Where can I put my cash to gain a better return?
A: You can invest in stocks or fixed income assets such as bonds which payout a set amount of interest. Bonds are less volatile than stocks too. You can buy into multiple bond types, including municipal, corporate, and TIPS (Treasury Inflation-Protected Securities). TIPs are federal government bonds with interest rates that adjust to match inflation and the markets and come in 5, 10, or 30-year options. For instance, if a TIPS bond offers a rate of 2% and inflation is 7%, it will pay 9% in interest for the year. In this way, a TIPs investor is promised a real return.
Another method is to save your money in a certificate of deposit or CD. Putting your money into one will guarantee you a fixed interest rate as long as the CD is active. Your rate of return is guaranteed despite any changes in market interest rates. Usually, the longer you tie your money into a CD, the better interest rate you will fetch.