Your net worth is one of many financial ratios that is important to measure. But, unfortunately, having a negative net worth is probably more common than you think.
A common example of someone who would have a negative net worth is a 20-year old who just graduated from college and needed to use student loans to pay for the bulk of this education. The average tuition in the US for in-state public schools is nearly $10,000 per year, which means graduating with $40,000 (or more) in debt is probable.
With $40,000 in debt and nearly no assets, it would make sense that a large number of young Americans have a negative net worth.
Though no matter your age, climbing out of a negative net worth situation is not impossible. There are steps you can take to improve your situation, which we will walkthrough below.
What is Net Worth?
You can calculate your net worth by adding all of your assets (what you own) and then subtracting your liabilities (what you owe).
This is what the definition of net worth looks like as an equation:
Net Worth = Total Assets – Total Liabilities.
An asset is anything you own that has value. The key thing you must realize is that an asset must be valuable. Some common examples include:
- Checking Accounts
- Savings Accounts
- Investments (like a 401k, Roth IRA, brokerage account)
- Real Estate Equity or Home Equity
An old piece of furniture or a used car with 185,000 miles on it are likely not assets you would include in your net worth calculation. They both hold close to zero value and likely could not be sold for money if needed.
A liability is anything you owe. Usually, a liability comes in the form of debt. Some common examples include:
- Credit card debt
- Student loan debt
- A mortgage or home loan
- A car loan
Putting it all together, to calculate your net worth, you subtract what you owe from what you own.
What Does Having a Negative Net Worth Mean?
Simply stated, having a negative net worth means you owe more than you own.
Your liabilities are greater than your assets.
Let’s go back to the recent grad example above and build it out further, assuming that the student also has some money saved up. Their assets and liabilities include:
- Savings Account: $3,000
- Checking Account: $1,000
- Brokerage Account: $1,000
- Student Loans: $40,000
The student hasn’t been working, so their savings and investments are limited but still total $5,000. With $5,000 in assets and $40,000 in debt, their net worth would be negative $35,000.
Though a recent grad is not the only person who can have a negative net worth. There are a lot of examples of people who may have a negative net worth. As another example, let’s look at someone in their 40s who has prioritized spending over saving throughout their life:
- Savings Account: $4,000
- Checking Account: $1,000
- 401(k): $10,000
- Credit Card Debt: $10,000
- Student Loans: $10,000
- Car Loan: $5,000
In the example above, the person has a lot of consumer debt and is still working through paying off student loans. Despite having $15,000 in assets, they still face a negative net worth of -$10,000 because of the $25,000 in debt they carry.
Is it Always a Bad Thing?
Having a negative net worth is not always a bad thing. In fact, I would say it’s expected for the student not to have a positive net worth.
Most students view higher education as an investment – you know you have to pay a hefty fee upfront with the hope that it pays back down the road with a better paying and/or more fulfilling job.
It’s not uncommon for most people who are a few years post-graduation to have a negative net worth until they can get their student loans paid off.
Even if you are older and fit more closely to the second example as someone who faces more credit card debt, it’s never too late to start turning around a negative net worth.
When asking if having a negative net worth is bad, the answer is always relative.
Obviously, having a $75 million net worth like John Legend is better than having a $100,000 net worth. And having $100,000 net worth is better than having $0 net worth. And $0 is better than -$10,000. And so on…
On top of that, the composition of your net worth matters. This would include its liquidity as well as its types of assets and liabilities.
Someone with a -$20,000 net worth who has $40,000 in student loans and $20,000 in assets is probably in a better financial position than someone who has $20,000 in credit card debt and no assets.
The important piece is that no matter where you stand, you are committed to improving your financial situation and reaching your personal finance goals – whether that entails building wealth in general or reaching financial independence by 30.
Steps to Take to Turn Around a Negative Net Worth
There are a few steps that you can take to turn around a negative net worth and grow your net worth in general. Growing your net worth is important if you want to build financial security and eventually retire.
The steps below are not necessarily in order like Dave Ramsey’s Baby Steps, but usually following these steps as they are laid out makes sense.
Track Your Net Worth
Peter Drucker is famous for his quote, “if you can’t measure it, you can’t improve it.”
Once you calculate your net worth today, you need to establish a plan to be calculating and tracking it every month continuously. Whether that includes a personal finance software or a simple spreadsheet (which you can get for free in the sign-up below), make sure you are looking at your net worth once a month (or at least once every 2-3 months).
Seeing your net worth go up over time can be motivation to keep improving. And seeing it go down will be the wake-up call to turn things around!
Have a Plan and a Budget
Normally, I don’t recommend a budget for everyone.
I don’t see a need to track every single dollar you spend if you are saving and investing enough money and generally hitting your financial goals.
However, if you do have a negative net worth, creating a budget is a wise move. As you balance the need to pay down debt, build up an emergency fund, invest for retirement, and spend wisely, having a budget can ensure you make the most of your income.
Below are some resources to help you create one:
Aggressively Pay Down “Bad” Debts
I would define “bad” debt as any debt with an interest rate above 5%.
So when you are paying off debt, it’s best to start with any debt above 5%, which usually includes things like credit card debt, some student loans, payday loans, and more.
Remember, just how assets can compound and grow over time, liabilities can too. That is why aggressively paying down these high interest debts is so important.
Any debt under a 5% interest rate, which could include student loans or your mortgage, can still be paid down quickly, but it’s not mandatory. This is because the opportunity cost to paying down debt is investing, and once you start to get to the 5% mark, it becomes more of a debate on if you can earn a better return in the stock market over the long run.
Cut Costs Where You Can
There are two approaches you can take when it comes to cutting costs and saving more money.
One is to focus on the “big 3” expenses – housing, transportation, and food.
These three expenses are where people typically spend the most and have the most to save. However, it also requires the most planning and effort to save in these buckets too. For example, saving on your housing (like through geoarbitrage) requires you to move.
So in the meantime or alternatively, you can also start to trim out smaller expenses. Mainly more minor costs that don’t bring you a lot of value or joy.
As you budget, cut costs, and save money, you also need to invest your money.
Put frankly, it’s not enough just to save, you need to invest. Here is why:
- $10,000 in a normal savings account (0.01% interest) will grow to $10,030 over 30 years.
- $10,000 in a high yield savings account (1% interest) will grow to $13,478 over 30 years.
- $10,000 in an equity index fund (7% return) will grow to $76,123 over 30 years.
Over the long run, investing is the best way to take advantage of compound growth to build wealth. You can view some more resources on investing below:
Increase Your Income
Increasing your income is easier said than done, but its a great avenue to pursue because the upside is limitless.
You can only cut so much in your spending before you are spending $0. However, there is no limit to how much money you can make.
Here are a couple of options to explore to increase your income:
For one, you can ask for a raise. Assuming you work hard and deserve a raise, it can be a great way to increase income without having to find a new job or take on extra work. Ramit Sethi has one of the best guides out there on how to ask for a raise. I suggest you check it out!
Second, you could take on a side hustle. A side hustle could include anything from mowing lawns to starting an online business. You can learn more about side hustles in any of these articles:
- 7 Clever Side Hustles to Make Money Online
- Increase Income with These Side Hustle Ideas
- How to Make $200 in One Day
Third, you could make smaller sums of money through odd jobs and apps. This would include things like taking surveys and playing games on your phone. Here are a couple of services to check out:
Negative Net Worth Summary
Is having a negative net worth always a bad thing?
Of course, having a higher net worth is nearly always better than having a lower one. But there are actions you can take to turn a negative net worth into a positive one to improve your financial health over time.
The important thing is to make an effort to improve your personal finances and reach your goals!