Believe it or not, “liquid net worth” is not a fixed definition and there are some difference of opinions on what it means and how to calculate it. We will run through the different ways to calculate it and give our own take on the best way to calculate liquid net worth.
The best way to approach the idea of liquid net worth is to break it apart and first define the terms “net worth” and “liquid” separately.
What Is “Net Worth”?
If you’re reading this article, you probably already know how to calculate net worth. But for the those that are not already familiar, the net worth of an individual or business is calculated by simply subtracting the total value of all liabilities from the total value of all assets.
Net Worth = Assets – Liabilities
Even if you already know what assets and liabilities are, let’s take a moment to revisit the definition. This might seem unnecessary, but as you will read later on when we get into the different ways to look at liquid net worth, you’ll see why these “nitty-gritty” details matter.
What is an asset?
Let me give you the Investopedia definition of assets, and then I will give you my own lay person’s explanation.
Investopedia Asset Definition:
“An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.”
Here’s our definition of an asset: anything that can be sold for money and/or can generate income. For example, a piece of land is an asset because it can be sold in exchange for money. There are some exceptions when land would not be an asset. If a piece of land is worthless (for example it has some environmental problems), then it would not be an asset because it cannot be sold for money.
Another example of an asset would be something that can generate income. A rental apartment is an example of an asset because it can generate income AND it can be sold for cash.
Obviously, money in a checking account or cash are assets because they already ARE money. They do not even need to be sold. Stocks would also be assets because (even though their value fluctuates) they can be sold almost instantly for money.
What is a liability?
Again, Investopedia defines a liability as “something a person or company owes, usually a sum of money.” Examples of liabilities would be a home mortgage (money you owe to a bank), a car loan, credit card debt or even an informal loan between two people.
Another example of a liability is an expense you have incurred but have not yet paid for. In business, this is often referred to as “accounts payable”. For individuals, you can look at this as simply unpaid bills.
Now let’s put these together with a simple example of a household’s total assets and liabilities to calculate net worth. Here’s a hypothetical household with typical assets and liabilities:
So when you add up this person’s total assets and subtract their total liabilities from that amount, you arrive at a net worth of $102,000. This is fairly straightforward but now let’s see how this differs from liquid net worth.
Liquid Net Worth Definition
A general definition of liquid net worth is as follows:
Liquid Net Worth = Liquid Assets – Liabilities
You’ll notice we slipped in a new term here which is “liquid assets”. So in order to calculate our liquid net worth, we’ll need to determine our liquid assets.
Liquid assets are assets that can be sold for cash in a very short period on time. Good examples of liquid assets would be cash, checking account balances, savings account balances, stocks, bonds and any other securities owned in a brokerage account that can be sold for cash right away.
Is My House A Liquid Asset?
This is where things start to get a little less cut and dry. A house (technically speaking) is not a liquid asset because it cannot be sold for cash quickly. Realistically it will take you at least a few weeks to sell your house. Therefore it should not be considered a “liquid asset” in the truest definition of the term,. However, you COULD sell your house quickly and raise money if you were to drop the price way below market value. If you offered the price way below the market price, you could find a buyer that is willing to close right away.
But identifying liquid assets that you own isn’t a simple “yes or no” answer. Liquidity is a matter of degree rather than binary. How much would you have to lower the price of a given asset from its market value to immediately convert it to cash? So … if you own a house and you would like to figure out your liquid assets (to determine your liquid net worth), you have to make an assumption of how much you would have to lower the price to sell it right away.
By the way, this is one flaw of the Liquid Net Worth metric when evaluating your financial health because it relies on using some estimates that might not be realistic and completely accurate. A local realtor might know a good estimate off the cuff but it’s still a guessing game.
For purposes of this hypothetical scenario, let’s assume a discount of 25% of the market value of your home.
Is My Car A Liquid Asset?
Again, this in not a “yes or no” answer but rather a question of to what degree your car is liquid. How much will you have to knock off the price to sell it and convert it to cash immediately? You could sell your car this afternoon by taking it to CarMax or a local dealer and they will make you an offer below where you might sell it if you spent a few weeks or months shopping around for a buyer off craigslist or facebook marketplace.
For an estimate of the liquid value of your car, put in the make and model and as much details as you can into Kelley Blue Book. After you get the value, subtract an additional 15%. This is not an exact science but it’s a good starting point. If you really want an exact figure, then go to your local CarMax and get a free quote for how much they will buy it from you. Just remember that this is not a fixed number and your car will lose value over time.
Is My Retirement Account A Liquid Asset?
Here we go again. This is not a simple yes or no question but rather about how much money you would need to discount from the current value of your retirement account in order to immediately turn it into cash that you use right now.
Even though it’s fast and easy to sell your stocks and assets in your 401K or IRA, you will have to take a significant discount to take the money out of the account. Not only will you have to pay taxes on your gains (which could be significant), you will also have to pay the IRS a penalty which is usually 10%. This assumes that you are below the retirement age of 59.
Here again we have to make some guesses about how much your capital gains are that you would have to pay taxes on. For now, let’s use the estimate of 35% (25% + 10% IRS penalty). If you wanted to know the actual number, you would have to dig into the history of your account and the cost basis of all the securities you currently have in there. This would be an enormous pain so let’s use the estimate of 35%.
Again, if you were really in a situation that you had to liquidate all of your retirement account and take the money out, you would try to minimize your tax expense as much as possible. To do this you would start pulling out assets that had the least capital gains. This is a topic for another conversation but the point is that calculating the exact liquid value of your retirement assets requires some assumptions.
Which Are My Total “Liquid Assets”?
To find out what other liquid assets you have, you need to look at everything you own and ask the question “how much money could I raise from this asset if I tried to sell it by the end of the week?” Some of you might have some random assets that you own and you’ll have to give your best guess and take a realistic discount from the market value to determine the liquid value. Once you have done that, you can add it all together to calculate your total liquid assets and finally get to your liquid net worth.
Using the same hypothetical example we used before, let’s now apply what we learned about liquid assets and calculate liquid net worth
So when we apply the discounts to the less liquid assets to determine total liquid assets, we arrive at total liquid assets of $174,750. When we insert that into the Liquid Net Worth Formula, we get $36,750.
Yikes … that’s quite a drop from the total net worth of $102,000. The reason for that is obviously because we are discounting many of the assets but not discounting our liabilities at all.
Why Don’t I Calculate My “Liquid Liabilities”?
I understand why your mind might be asking this question but “Liquid Liabilities” do no exist. However, there is a term called “current liabilities” that is relevant to this topic.
Current Liabilities is used in accounting to discuss the liabilities that a business would owe in the short term. Current liabilities would include accounts payable (an accounting phrase for outstanding bills), short term debt, and the current payments owed on their long term debt. We will return to this concept of current liabilities a bit further down in this guide.
Why Should I Care About My Liquid Net Worth?
Liquid Net Worth is a metric that gives you a decent “thumb in the air” idea of your current financial solvency. As I mentioned above, I think there are some flaws in this metric that might cause you to use other metrics or at least use liquid net worth with an asterisk next to it.
The first flaw in liquid net worth that it’s based on loose estimates about how much you could liquidate your less liquid assets for. This estimate will likely be very different from what you would get if you actually did liquidate all your assets.
The second flaw with liquid net worth is that I don’t believe it’s a realistic outcome. There are circumstances where you might have to get money fast and need to sell assets to get it. But realistically you would probably navigate the situation differently and not sell everything you own immediately.
You would do everything you could to avoid selling your home because you have to live somewhere. Unless you plan on living in a family member’s basement for free, you’re not going to save much money by switching from a mortgage payment to a rental payment to a landlord.
By the same token, you could sell your car but most people need their car to live and work; so selling your car is not a realistic scenario.
Even though I don’t consider liquid net worth to be entirely accurate or realistic, that does not mean it’s a useless number. It does give you a “quick and dirty” idea of your financial health and going through the exercise of calculating your liquid net worth is a good practice that keeps you in tune with your financial wherewithal.
Is there A Better Alternative To Liquid Net Worth
Even though Liquid Net Worth has its merits, I prefer to look at a combination of my Total Net Worth and my “Working Capital”. We have not discussed Working Capital yet so let’s take a look at what it means, how it differs from Liquid Net Worth, and how you can use it to measure your own personal financial situation.
What Is Working Capital And How Is It Different Than Liquid Net Worth?
Working Capital is a term that is used in accounting and it’s calculated by subtracting current liabilities from current assets. We already defined current liabilities above and you can probably get what current assets are. Current assets are those assets that can be converted into cash very quickly.
In business, it includes all your cash in the bank account, accounts receivable (accounting term which means outstanding invoices that other parties still owe you), and inventory. For an individual person or household, current liabilities would usually include cash, money in bank accounts, stocks, bonds and mutual funds in brokerage accounts (excluding your retirement accounts).
I much prefer to look at my total net worth and my working capital to quickly asses my financial health. Working capital does not have the flaw of guessing how much you need to discount your current illiquid assets to raise money. These illiquid assets will be more fairly valued when you calculate your total net worth.
Note: don’t forget to include your current payment owed on your mortgage and car loan when calculating your current liabilities.
So now that we understand liquid net worth and how to calculate it for ourselves, let’s answer some common questions and misconceptions about liquid net worth:
Does Liquid Net Worth Affect My Credit Score?
No, it does not. There are a lot of things that affect your credit score but liquid net worth is not one of them. Besides … the credit companies have no way of truly knowing what your actual liquid net worth is any more than you do. There are other metrics that are far more important to your credit score including your payment history and your credit utilization (among other things).
Does Liquid Net Worth Impact My Ability To Get A New Credit Card?
No, it does not. Credit card companies will look at your credit score and your income. They don’t see how many liquid assets you have but they can see your credit history.
Does Liquid Net Worth Impact My Ability to Get A Mortgage?
No, it does not directly impact your ability to get a mortgage but having a negative liquid net worth could be an indicator that you are not sound financially. This is something that a mortgage lender will sniff out in other ways not using liquid net worth. Other factors that are more important are your credit history, income history and verification, down payment (as a percentage of the total purchase price) and the appraisal on the home.
Does Liquid Net Worth Impact My Ability to Get A Loan?
Liquid Net Worth is not a term that a lender would use to evaluate your creditworthiness. However, it does matter indirectly. Examining all the assets you own and liabilities you owe is something that a lender will do when evaluating your application. For this reason, it’s not a bad idea to keep tabs on what your liquid net worth is so you can know what your financial health is.
Is My Liquid Net Worth Too High?
This is might sound like a silly question but it’s actually very thought-provoking. If your liquid net worth is really high, then it must be good because it means that you are on strong financial ground. While that’s true, it could be an indicator that you are not investing enough of your money in longer-term, income-generating and wealth-producing assets. However, given that liquid net worth INCLUDES your more illiquid assets (albeit at a discount), I don’t believe it could ever be too high.
I would argue that your working capital could be too high. It’s always good to have money on hand in the event of an emergency or if you lose your job, but having too much working capital would suggest that you need to invest more and put it into assets that will earn you more wealth but probably aren’t as liquid.
How Can I Increase My Liquid Net Worth?
This question is a more precise way of asking how can I earn more money, or trim my debt or cut my expenses. We have a lot of articles dedicated to these topics and in one way or another every article on this site addresses at least one of these questions. Before I give you more material to read, one good question to ask yourself is this:
“Are you already a frugal person who can’t squeeze out much more savings from my current monthly budget? or … are you a spendthrift that could find a lot of unnecessary expenses to cut?”
You know yourself well and it probably won’t take you more than a few seconds to answer this question:
If you’re a frugal person and your expenses are already cut to the bone, then I would focus on finding ways to get supplemental income. There are countless ways to earn more money but you need to figure out which is right for you given your skills, available time and interests. As a starting point, check our articles on ways to make money from home and how to make extra income if you already own 100 shares of a stock.
On the other hand, if you already know that you spend too much money on frivolous things, then that’s actually good news in this context. In my opinion, it’s much easier to cut expenses than it is to earn additional income. If you’re spending too much, there are a lot of steps you can take. Start by reading our articles on how to slash your unavoidable expenses.