In my 19 years in the financial planning vocation, I have probably met with over 5,000 families, households, couples and individuals in need of financial planning and money management. These families have a range of asset sizes from $10,000 (I like to call emerging investors) to $500M (and dozens of deca-millionaires, $10M+). Yes, that is right…Millions of dollars…with an “M”. You may be thinking…why deca-millionaires would need financial planning, let alone money management?! They seem to be doing a great job of building and creating wealth.
It’s Not about Asset Size
It’s interesting however, that I probably have met more millionaires than “average folks” that are barely making it or failing in their retirement plan! They have barely enough to sustain them in their retirement with their current lifestyle. You see, the critical “cog” here in having a successful retirement, is not about your asset size, rather your lifestyle and the cost to support it. There is an art to financial planning over your lifetime that seeks to balance your lifestyle throughout not only your working years, but all through retirement. In other words, you don’t want to have a “pumped” up lifestyle during your working years, and dramatically cut back during retirement; that does not make for a peaceful and joyful longest vacation of your life, known as retirement. They spend so much of their biggest wealth building tool known as their income, to live their dream lifestyle; they failed to set aside enough to sustain the same lifestyle when the income spigot turns off. What to do? Well, it’s time to adapt beer budgets to champagne tastes…good luck with that. So you see, it is not about asset size; a $10 Million dollar portfolio cannot sustain a $750,000 a year lifestyle for very long…(true case).
How do I Know where I stand Today? The Formula.
A great, recommended read I have for you if you want to understand the Millionaire Mind, is the landmark study done by Dr. Thomas Stanley, The Millionaire Next Door. In this book, Dr. Stanley gives you a glimpse of the lifestyles of those who figured out this “art” of financial planning. You often see your friends with the best, highest end cars…Porsches, BMWs, Mercedes, which make any gearhead drool with envy. They build a perception of real wealth. But is it? Before we give the formula, let’s define “net worth.” Net worth in our definition is the current value of one’s assets less liabilities. Some may define having a net worth of $1 to $10M as being wealthy, but remember the case earlier, net worth doesn’t tell the true story. Rather, it is more important to have a formula to calculate one’s expected level of net worth. You ready?
Multiply your age times your realized pre-tax annual household income from all sources except inheritance. Divide by 10. This, less any inheritance, is what your net worth should be.
To get your index score, divide your total net worth by your “expected” net worth which is the result of this formula above. The nice thing about this formula, is it completely neutralizes your income and age, and puts everyone in equal footing in measuring your propensity to build wealth.
The Score Chart:
Prodigious Accumulator of Wealth (PAW) >2.0
Average Accumulator of Wealth (AAW) 0.51 to 1.99
Under Accumulator of Wealth (UAW) < 0.51
Are you PAW or UAW?
A prodigious accumulator of wealth are those that have the midas touch…well, not necessarily, they are just good at managing finances that they are systematically building wealth. These are the folks that are the top quartile of wealth accumulation and have about twice the level of expected wealth. UAWs, on the other hand, or under accumulator of wealth, are in the bottom quartile. UAWs have less than half of their expected level net worth or lower. Make this challenging, don’t include your home equity during this calculation as your home is a “use” asset, it doesn’t turn into an investment unless you plan to sell your home to unlock the equity built up. How did you score?
Be truthful to yourself, as Dave Ramsey puts it, do you have stuffitis? “We buy things we don’t need with money we don’t have to impress people we don’t like.”. Is your hat much bigger than your cattle? What is your plan in preserving the same lifestyle when the income spigot turns off? There is of course, hope, and it starts with “awareness.” This starts with understanding the amount that goes in and the amount that goes out…you guessed it, the dreaded budget. Before starting any savings program, you need to be aware and as realistic as possible in what you can set aside in a savings program. There steps to building wealth such as building up an emergency fund first, paying off debt, and then, and only then, starting a disciplined investment program. By using this formula, you now have your target set for your expected level of net worth. GO FOR IT!
As for me, we are just barely above 1.15 (not including home equity) from our expected level of net worth…or an AAW. Ok, but not good enough. Time to talk with my wife!!!