Are You Wealthy?

The words “wealth” and “wealth management” are used frequently in advertisements for financial products (e.g., exchange-traded funds or ETFs and cryptocurrency) and financial services (e.g., specific investment advisory firms). This begs the questions “what, exactly, is wealth?” and “how do people know when they, themselves, are wealthy?” 

One online dictionary defines wealth as “an abundance of valuable possessions or money.” Another states that wealth is “plentiful supplies of particular resources” and notes that wealth can be held by individuals, communities, and countries. 

Other sources describe different categories of wealth including financial wealth (income and assets), time wealth (freedom), social wealth (strong relationships and social capital), and physical wealth (good physical and mental health). 

The remainder of this post will focus on financial wealth, specifically three ways to measure it to provide an answer the second question, above. Specifically, three wealth-measurement metrics will be explored and explained.

 

Net Worth Calculation

 

A common way to measure wealth is with a net worth statement. Net worth is calculated by subtracting debts from assets.  For example, $200,000 of assets minus $100,000 of debt equals a net worth of $100,000.

Three categories of assets are cash assets (e.g., bank accounts, money market funds, and certificates of deposit), investment assets (e.g., stocks, bonds, mutual funds, and ETFs), and property assets (e.g., house, car, home furnishings, and electronics). Two categories of debt are current debts (e.g., medical bills, credit card balances, and other debts expected to be repaid within a year) and long-term debts (e.g., car loans, student loans, and mortgages).

A good financial goal to strive for is to increase net worth by at least 5% a year through increased savings and/or reduced debt. Use the Net Worth Calculation Spreadsheet (in Excel) or this “paper and pencil” print worksheet to keep track of your progress. Some people also set specific net worth attainment goals such as $1 million before retirement.

 

The “Wealth Test”

 

In the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko, the authors outline a simple “How to Determine If You’re Wealthy” formula to determine the adequacy of a person’s net worth at any point in life. The formula works as follows: multiply your age times your realized pretax annual income from all sources, excluding inheritances, and divide it by 10.

For example, a couple, both age 50, with a combined annual income of $80,000 should have a net worth of $400,000, calculated as follows: 50 x $80,000 = $4,000,000 ÷ 10 = $400,000. 

The authors state that the figure derived from the formula is what the minimum net worth should be for a particular age and income combination. The more people exceed their formula-based figure, the better.

 

Online Calculators

 

A third metric for wealth considers, not only an individual’s or couple’s age and income, but where they live. After all, there is big difference in living costs between, say, Manhattan, Kansas and Manhattan, NYC.

 

The New York Times What Percent Are You? tool asks users to enter a household income. Then they click “Go” and results indicate where they place, income-wise, in percentile among U.S. residents. For example, household incomes of $30,000, $50,000, 100,000, and $200,000 are in the bottom 29%, bottom 49%, top 21%, and top 5% of incomes, respectively. Users can also hover over the U.S. map to get household income rankings for over 300 metro areas.

 

Another interesting calculator is Wealthometer, where users compare their estimate of the percentage of Americans with less wealth than they have. Users enter numbers for real assets, financial assets, and debt (ideally taken from a current net worth statement) and the number of household members. Results are presented in a bar graph showing the position of the user’s estimate of their comparative wealth with their actual position based on government wealth data.

 

What Not to Do

Some people judge their wealth in comparison to neighbors with expensive cars, clothes, and houses. This is a mistake. The neighbors could be in over their head in debt or, as Stanley and Danko describe in their book “ Big Hat, No Cattle.”

The best way to measure financial wealth is with objective metrics and to always remember that net worth ≠ self-worth.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

More Miscellaneous Insights From Recent Webinars

 

As I mentioned in three previous posts, I love learning new things and often attend webinars and podcasts to gain knowledge and/or continuing education credits for my CFP® and AFC® as well as to connect virtually with others. 

Below, in no particular order and on a variety of topics, are nine financial “nuggets” that I heard recently.

 

¨     The Key to Building Wealth- There is no “secret” formula for wealth accumulation. Rather, the way that most people accumulate assets and become millionaires is to save as much as they can as soon as they can. Wealth is built by investing over time and compound interest over four or five decades of regular deposits is the key to success. That said, it is important to acknowledge that many people get a late start. That is reality and late savers need hope, encouragement and options. Saving later in life is still much better than not saving anything at all.

 

¨     The Power of Empowerment- People often have more power than they think they have, can do with a lot less shame and blame about past mistakes, and need to feel that they are in charge of their life. Financial well-being begins with a strong foundation of positive cash flow. An analogy used in a webinar is that, just like you don’t put on perfume without first taking a shower, you shouldn’t buy investments without having a budget with positive cash flow. Budgeting is the cornerstone for financial well-being.

 

¨     Key Financial “Need to Knows”- A panel of personal finance teachers on a CNBC webinar for Teacher Appreciation Week described the following concepts that all students need to know: start investing today, invest with low-cost investments, check for licensed sellers and registered investments, develop and follow a budget, understand your retirement savings plans, and consider a target date fund as a retirement plan investment.

 

¨     COVID-19 Impacts- A speaker at the three-day Wall Street Journal Future of Everything Festival noted that a big post-pandemic issue will be the large amounts of money put into the economy and the inflationary stimulation this is causing. A second issue is the grief experienced by many people, which has focused their priorities and clarified what matters. Many more employees today are vocal about work load concerns and work-life balance. They have also realized that they can be pickier about ways that they “lean in” at work and don’t need to be at every event. They can pick and choose.

 

¨     COVID-19 Comebacks- We should all expect that the process of re-emerging from the pandemic will be awkward. CDC guidelines will continue to evolve over time and people have different levels of “cautiousness” as they have had throughout the pandemic. Companies in many industries (e.g., restaurants, ball parks, and airlines) are trying to anticipate how their employees and customers are thinking and to make them feel comfortable. Not every company will get it right.

 

¨     Retirement Plan Withdrawal Caution- A webinar, The Impact of COVID-19 on Retirement Savings, by Consumer Action, noted that the CARES Act made it easier for people to take withdrawals from their retirement savings plans to pay bills. That said, participants were advised not to do this unless they absolutely have to. Alternatives to generate cash include savings that is not in a retirement plan (if any), employer assistance (e.g., giving circles), family and friends (even if it is embarrassing to ask them), and tapping a home equity line of credit.

 

¨     Womens’ Finances- Women, the majority of U.S. nurses and teachers, have been “beaten down” by COVID-19. As a result, many have stated “I’m out at 62,” so they can collect reduced early Social Security benefits. There is concern, however, as to whether they will be able to live comfortably throughout the remainder of their lives. Using the Rule of 72 with 3% inflation, prices will double in 24 years (e.g., from age 62 to 86). A recent study found that 47% of women cannot afford a $400 emergency expense and 21% use a credit card for emergencies. Another Consumer Action webinar speaker ominously predicted “we will see caravans of homeless women in this country” (a la the movie Nomadland).

 

¨     Working Past Age 70- People should not plan on doing this when they are calculating how much they need to save for retirement. Ambitious plans can go awry. Ageism is a very real thing and those who plan extended careers must absolutely keep their skills and professional contacts up to date so they can provide value to an employer or clients (if self-employed). Two risk factors, besides ageism, are health and ability to work. Benefits of working longer are delayed withdrawals from savings, more time to save money, and increased formula-based pension and Social Security benefits.

 

¨     Getting Started is Hard- Many people don’t invest (or take other actions to improve their personal finances) because they don’t know where and how to start. Financial educators need to remember this and break financial actions down into a series of process steps and offer encouragement along the way. Another financial education tip is to make financial planning activities seem urgent and important. For example, investing is important because it is a proven way to build wealth over time. The #1 pre-requisite for making a change is a sense of urgency.