What is Liquid Net Worth?
Liquid Net worth is the total value of all of a person’s liquid assets and liabilities. While Net Worth is the total value of everything you own, Liquid Net Worth can be thought of as the amount of cash you can quickly access. Understanding what liquid assets you own and how to increase your Liquid Net Worth can save you from financial disaster.
The Difference Between Net Worth and Liquid Net Worth
Whenever someone new earns the title of “Richest Man Alive,” people love to hear about it. It’s baffling to think that an individual can be worth hundreds of billions of dollars. But this is a reality for people like Jeff Bezos, Elon, Musk, and Bill Gates.
The problem with straight net worth is it misrepresent the reality of your financial situation. None of those billionaires could write a 100 billion dollar check because their Liquid Net Worth is much lower.
The Basics: Assets vs. Liabilities
There are two important words to understand when calculating Net Worth, liquid or otherwise: assets and liabilities. Generally, an asset is anything you own that has value; your house, car, grandma’s ring, and the number in your checking account are all assets of varying types. Liabilities are the debts that a person is responsible for paying. Typical examples are credit card debt, student loans, car payments, and mortgages.
Richard Kiyosaki, the author of Rich Dad Poor Dad, defines assets and liabilities a little differently. He calls anything that makes money an asset and anything that costs you money a liability. By his definition, your home is a liability because it incurs regular tax, insurance, and maintenance costs and only becomes an asset if it can be sold for a profit.
Kiyosaki’s view can be a helpful way to think about assets and liabilities. It allows us to focus more directly on acquiring money generating assets instead of assets that depreciate over time.
So what makes an asset liquid? There are two criteria that an asset must meet to be considered a liquid asset:
- It must be able to be quickly converted into cash.
- It must not incur a penalty or decrease in value when converted to cash.
Cash is considered the most liquid asset, though the amount of money in a checking or savings account is just as liquid assuming you can withdraw it all when you need it. Stocks and bonds are other examples because they can quickly be sold and turned into cash in hand.
Any other asset is a non-liquid or fixed asset. These things may have a high value but can’t be quickly sold or experience a loss of value when converted to cash.
Property is a prime example of this. Deals on homes and land often take months. Retirement plans are also fixed assets because withdrawing money from them before reaching retirement age incurs a hefty penalty, significantly decreasing their value. Vehicles can be sold quickly but lose value with each sale.
Why Does Liquid Net Worth Matter?
While billionaires’ net worth may make catchy news headlines, it has no real bearing on day-to-day life. Understanding your liquid net worth, on the other hand, will help you avoid financial disaster and take advantage of opportunities.
A high liquid net worth makes you resistant to emergencies. The higher your liquid net worth, the more prepared you are to face difficult situations like unexpected medical bills, natural disasters, or job loss.
Another significant benefit of high liquid net worth is the ability to take advantage of great opportunities. You might have the chance to invest in a startup, start your own business, or get a great deal on a major purchase because of your cash on hand.
How to Calculate Liquid Net Worth
There are a number of ways to calculate your net worth. Some budgeting software like You Need a Budget (YNAB) can even generate reports that do the calculation for you. If you’d rather do the math yourself, follow one of the two methods outlined below.
The Exclusion Formula
There are two main ways to calculate liquid net worth. The first, known as the Exclusion Formula, is the more straightforward option. Its trade-off is that it will be more of an approximation, and therefore less precise.
To calculate your liquid net worth using this method, add up the value of all your liquid assets and subtract the total of your liabilities. This method completely excludes any fixed assets, such as property, cars, or retirement accounts.
Liquid Net Worth = Liquid Assets – Liabilities
Consider someone that has a $200,000 house but still owes $100,000 on the mortgage. They’ve got an $8,000 car, $10,000 in their checking/savings account, $5000 in stocks, and owe $20,000 in student loans. Using this method, the house and car are ignored, leaving the checking/savings account and stocks as the only liquid assets. The mortgage and student loans are counted as liabilities.
$10,000 + $5000 – $100,000 – $30,000 = -$115,000
Using the exclusion method in this instance has resulted in a negative Liquid Net Worth, which indicates that this person’s liabilities are greater than their liquid assets.
The Penalty Formula
A different approach to calculating liquid net worth includes fixed assets at a discounted value. They’re included because they may be converted to cash quickly but will lose value when that happens. To use the Penalty Formula, add all your liquid assets, the penalized value of your fixed assets, and subtract your liabilities.
Liquid Net Worth = Liquid Assets + Discounted Fixed Assets – Liabilities
How do you calculate the discounted value of fixed assets? The simplest way is to subtract 25% of its value, although some use a different percentage based on asset type. This means that a $10,000 car would be valued as a $7,500 asset.
Let’s consider the same person from the example above. Using the Penalty formula will allow their house and car to be counted as assets, but only at 75% of their value.
$150,000 (house) + $6,000 (car) + $10,000 + $5000 – $100,000 – $20,000 = $51,000
This method results in a positive liquid net worth because it accounts for more assets.
How to Increase Your Liquid Net Worth
Lowering your expenses is a great way to increase your liquid net worth. Most people have at least a few (or many) unnecessary expenses they can cut: streaming services, eating out frequently, a latte every morning. Costs like this can add up. When you can reduce excessive spending, you end up with more cash in hand, which increases your liquid net worth. Budget software like You Need a Budget (YNAB) can help you with this!
Even if you cut out all luxuries, you can only reduce expenses so far. That means a better place to focus your energy might be on increasing your income. This could mean taking on an additional job, but it doesn’t have to. There are many ways to make money without a job. Increasing your income can be hard work, but it is the most reliable way to put cash in your pocket.
Create or Acquire Assets
If you’re able to invest cash into other sources, this can also increase your liquid net worth. Stocks, bonds, mutual funds, and money market accounts are all great liquid assets that can grow in value over time. Even starting a business can help because, in time, it will provide a second stream of income.
Acquiring fixed assets such as property, vehicles, and retirement funds can also increase your liquid net worth using the penalty formula, but keep in mind that their value is not nearly as accessible in emergencies.
Reduce Your Liabilities and Non-Liquid Assets
Reducing liabilities and non-liquid assets is crucial to increasing liquid net worth, especially if yours is negative. Paying off student loans before they accrue more interest is a great example. It may also mean downsizing to a house you can better afford or selling a car you owe money on and replacing it with one you can buy with cash.
These are significant decisions that you should give proper thought to but are effective ways to significantly increase your liquid net worth.
What is the Most Liquid Asset?
Cash is the most liquid asset. Money in a checking account is also very liquid because it can be accessed as easily as cash.
What is the Least Liquid Asset?
Property is the least liquid asset. Homes and land typically take months to sell, sometimes longer.
Is it Good to Have Liquid Assets?
Yes, liquid assets are very beneficial in the instance of a financial emergency or money-making opportunities.
Can Liquid Net Worth be Higher than Net Worth?
No. Net worth will include all assets and liabilities. Liquid net worth will consist of all the same liabilities, but only some of the assets.
Are Bank Deposits Liquid?
Typically, yes. Checking and saving accounts are considered liquid assets. Certificate of Deposits (CDs) are less liquid because they usually incur a penalty for withdrawing money early.
Does Liquid Net Worth Include my House?
Liquid net worth does not include your house’s equity as an asset. However, any remaining mortgage debt on the house will be considered a liability.
Is a Car a Liquid Asset?
No. While it is possible to sell a car very quickly, reselling a car always decreases its value. Cars are considered non-liquid assets because they can only be sold for less than they’re worth.
Is Gold a Liquid Asset?
Gold is often considered a liquid asset. Because it is always in demand, you can quickly and easily turn gold into cash.
Is My 401K a Liquid Asset?
401Ks and most other retirement plans are not liquid assets. To get the full value out of them, you must wait until retirement age to withdraw money from these accounts. Taking money out early incurs a steep penalty.
While celebrities’ net worth has no impact on our lives, understanding your liquid net worth can make a huge difference. Knowing the value of assets that you can quickly convert to cash creates a financial safety net when hard times hit while also allowing you to take advantage of potentially life-changing opportunities. When we plan to increase those assets and decrease liabilities, we can live the Wealthy Life and worry less about what curveballs life has in store.