Liquid net worth is an unfamiliar term for most people. Many know about net worth, but few understand liquid net worth, what it means, and why it is important. This article will explore the term and unpack its usefulness.
What is liquid net worth and how is it calculated?
While net worth measures the value of all the assets you have (both financial and non-financial), liquid net worth measures how much cash you could access in short order. The calculation takes the assets you could quickly convert into cash and subtracts your short-term liabilities.
Here are the formulas for net worth versus liquid net worth:
Assets – Liabilities = Net Worth
Current Assets – Current Liabilities = Liquid Net Worth
What assets and liabilities are included in liquid net worth?
Assets that can be converted quickly and easily into cash typically include cash on hand, chequing accounts, high interest savings accounts, emergency funds, gold or silver coins, and even non-registered investment accounts.
Liquid assets do not include your house, car, retirement accounts, tax free accounts, GICs (guaranteed investment certificates), pensions, and any cash surrender value tied up in life insurance policies. The cash value associated with these assets is hard to unlock, or near impossible in some cases.
Meanwhile, current liabilities include lines of credit, credit cards, other near-term debts, upcoming monthly mortgage payments, student loan payments, car payments, taxes owing, and bills.
Current liabilities only include debt and expenses due in the next year. Therefore, the bulk of your mortgage payments, car payments, and student loans will not be considered in the current liability calculation.
Why is liquid net worth important?
This term is important because it represents the amount of money you can access on short notice. Unlike net worth, it accurately measures your ability to react to financial shocks or take advantage of opportunities. Maybe you lose your job, are presented with a great investment opportunity, or want to start your own business. No matter what, your liquid net worth will be there for you.
Unlike net worth, liquid net worth gives you a true measure of your financial stability. People with high liquid net worth are said to be “cash-rich”. It is an enviable position in the best of times. The recent economic shock and COVID-19 crisis has highlighted the importance of being cash-rich, or at least having some cache of liquid assets you could draw on.
No matter what the future throws at you, it will be easier to address challenges or take advantage of opportunities if you have some level of financial liquidity.
How do I stack up?
Nick Maggiulli at the blog Of Dollars And Data recently wrote an article comparing equity and liquidity by age and educational attainment. You can check out that blog post here and see how your finances stack up versus peers. But beware – comparison is the thief of joy and the road to jealousy. Remember that what works best or is possible in another’s situation may look vastly different in your own unique circumstances.
What can I do to increase my liquidity?
No matter how you stack up versus peers, the best course of action is to try and improve your situation. If you’re unsure of where to start, consider budgeting, tracking spending, and learning about how to live on less. You can also read about savvy saving strategies I use or check out the seven financial rules I live by.
Liquid net worth is arguably the most important measure of your near-term financial health. It is calculated by taking all the assets you can quickly convert into cash, and then subtracting your short-term liabilities. It represents the amount of money you can access on short notice. Unlike net worth, it accurately measures your ability to react to financial shocks or take advantage of financial opportunities. No matter what the future throws at you, you will be better prepared if you understand liquid net worth and are able to increase your liquidity. Good luck, I hope you are now on your way to becoming cash-rich!
Please keep in mind I am not a financial advisor and the opinions expressed are my own. My Money Moves does not provide financial advice – it is an informational website that details my own approach to my own money and personal finances. If you need specific financial help or guidance, please do your own research, and seek out a professional who can work with you to reach your goals.