Investing For Your Future
Monthly IFYF Investment Message
February 2006
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Are you wealthy yet? Many people like to know how they're doing compared to other people and/or to benchmarks of financial progress. There is no "one size fits all" answer, however, because not everyone earns the same income or has the same household expenses. In addition, even with the same income and expenses, a 50-year-old earning $50,000 a year would have had many more years to save money than a 30-year old and would, therefore, be expected to accumulate more assets.
So how do people measure their individual financial progress? One way is to compare personal indicators of financial status to government statistics about the wealth of U.S. households. For example, comparing personal or household net worth (assets minus debts) to the median (midpoint) net worth of U.S. households or personal or household income to the median income for one's state of residence or occupation.
Financial magazines such as Money, Smart Money, and Kiplinger's Personal Finance periodically run articles that present household income and wealth data with which readers can compare themselves. Financial data about U.S. households can also be found in print and online in the U.S. Census Bureau's Statistical Abstract of the United States.
Another way to benchmark financial progress is to use a simple formula described in the book, The Millionaire Next Door, written by Thomas J. Stanley and William D. Danko. The book is based on surveys and interviews of American millionaires and describes misconceptions that the public and media have about wealth accumulation and the lifestyle choices of financially successful people. Contrary to popular perception, many people who are wealthy are extremely frugal and disciplined investors. They get more pleasure from owning appreciating assets than displaying a high-consumption lifestyle.
According to Stanley and Danko, a person's age and income are key factors related to their recommended net worth. To compute a personal benchmark of financial progress, they advise multiplying your pre-tax household income from all sources, except an inheritance, and dividing by 10. For example, a 50-year old with a $60,000 income would be expected to have at least a $300,000 net worth. A 30-year old earning $40,000 should be worth at least $120,000.
If you are doing well financially, Stanley and Danko consider you a PAW or prodigious accumulator of wealth. PAWs have about twice the expected level of wealth for their age and income levels and are in the top quartile for wealth accumulation. On the opposite end of the spectrum, under accumulators of wealth (UAWs) have a net worth less than half that of the expected value for their age and income according to the benchmark formula.
Being a PAW or UAW is closely associated with personal lifestyle decisions, including spending and saving habits and the frequency and selection of investments. The Millionaire Next Door found that many millionaires were disciplined investors who made regular purchases of high quality investments, such as blue chip stocks and stock index funds, for several decades until achieving millionaire status in their 50s or older. They invested early and often and reaped the rewards of compound interest over time. Many were also very frugal and did not spend extravagantly, even though they could afford to do so. For further information about finding money to invest, on the path to wealth accumulation, visit Unit 3 of Investing For Your Future at http://www.investing.rutgers.edu.