How wealthy are you? Take the test and see…
Wealth can be measured subjectively, or objectively. What does this mean? Wealth creation expert and author of Money Magnet: How to Attract and Keep a Fortune that Counts, Steve McKnight explains.
Take Wayne for example. He pegs his wealth subjectively, based on what his friends seem to have (or not have). For instance, he drives a better car than Paul, but an inferior car to Sue, so he’s doing better than one and not as good as the other. The same rating can be applied to his house, holiday destinations, and so on.
Nicole on the other hand is seeking an objective approach. One option is the amount she is paid (i.e. her salary). The more she’s paid, the better off she is. Another is the market value of her assets. Yet another is her net wealth (a.k.a. net worth), which is the amount left over when Nicole deducts her liabilities from her assets.
How do you measure your wealth?
Subjectively like Wayne, objectively like Nicole, or perhaps a combination?
A problem with using a subjective approach is that the appearance of wealth is not the same as the substance of wealth.
Texans have a saying for those who fake their wealth: all hat, no cattle. That is to say, big on show, low on substance. For example, you might think your neighbour is doing well based on their new car, but if it is purchased using predominantly debt, then there isn’t ‘real wealth’ on display.
The substance of wealth is having the ability to survive without using debt, and without relying on income from employment; i.e. to be able to afford whatever you want, but not needing possessions to define your value.
Here are three objective approaches you can use to measure your wealth
- Under or over-accumulator of wealth
In their excellent book, The Millionaire Next Door, authors Stanley and Danko proposed this handy rule of thumb, which I have altered slightly for simplicity, to define how much net wealth the average person should have:
- Divide your current age by ten
- Multiply the result by your current annual income
Gavin is 35 years old and earns $75,000 per annum. According to Stanley and Danko’s rule of thumb, Gavin should have a net worth of $262,500 (i.e. 35 ÷ 10 × $75,000).
If you’ve managed to accumulate two or more times your target net worth, then you qualify as a Prodigious Accumulator of Wealth. If you only have half or less of the target accumulated, then you’re a so-called Under Accumulator of Wealth.
Somewhere in between? Then you are an Average Accumulator of Wealth.
- Survival days
An alternative is to calculate how many days you could survive if you stopped working and had to live off your net wealth. The calculation is:
- Divide your net wealth by your annual spending
- Multiply by 365 (days)
Anita has assets of $45,000, and debts of $13,000, so her net wealth is $32,000. She estimates she spends $800 a week, or $41,600 per annum. Anita could survive for 280 days (i.e. $32,000 ÷ 41,600 × 365).
If your result is less than 30 days, then you are precariously close to a dangerous financial situation. Six months is considered safe. Once you start getting into years then you are progressing nicely towards financial freedom.
The good thing about this method is that you can easily track your progress, and feel good about seeing your survival days balance increasing.
- Freedom days
Another calculation is what I call ‘freedom days’, which is the number of work days you have in reserve. The calculation is:
- Divide your net wealth by your annual pre-tax income
- Multiply by 260 (i.e. annual work days)
Ingrid earns $90,000 per annum and her net worth is $500,000. She has 1,444 work days or nearly four years in reserve.
Redefining net worth
While it definitely makes the results less flattering, I highly recommend varying the calculation of your net worth so that you only include your investment assets, while deducting all of your liabilities (i.e. lifestyle and investment).
This will cause consternation for those who have large amounts of their wealth tied up in their homes, but then again, most people aren’t planning on selling their homes – indeed, they hope to repay their mortgages from their income.
Beware mistaking the appearance of wealth for the substance of wealth, lest you get caught up in a race trying to keep up with the Joneses, only find they’re insolvent because they’ve been living off their credit cards. Instead, you’d be wise to ‘run your own race’, and to objectively track your progress according to your own circumstances, using a calculation that can clearly show you’re heading in the right direction.
A good saying to remember is this: what gets measured gets managed. If you want to be a better money manager, start with trying to better measure your money.
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