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« Best Financial Tips from FMF Readers, Part 3: Save by Visiting Your Library | Main | Seven Sure Ways to Bigger Returns »

September 08, 2005


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I have read this book, I'm wondering if the formula must be adjusted, however for the earlier years in your life... For example, mid to early 20's. Most people in their twenties still have no positive net worth, when factoring in a car payment, student loans, and especially the newly found MORTGAGE on the house they buy. I, for example, have a negative networth of around 180,000 - yet I am supposed to have a net worth positive of around 100,000. I don't think I've even made 100,000 total in my entire life yet!... There should be a way to adjust the formula for the younger years in life, when debt accumulation happens due to schooling and purchasing a home!

I have to agree that this "rule of thumb" is more offbase than most "rules of thumb," especially for those towards the beginning or end of their careers...

So if I get a large raise, then my wealth must jump upwards too, or I'm suddenly not doing good? Or if I get laid off, income drops to 0, then I'm infinitely wealthy? This makes no sense. A better formula would be based on some fraction of one's summed income up to this point in life.

W Royall --

Are you sure you're calculating your net worth correctly? For instance, if you have a mortgage for $100,000 but the property is worth $120,000, that item contributes $20,000 positive to your net worth. Same with a car -- it has a positive value too that should at least in part offset most of the debt (if not be more than it).

Others --

I'm open to formula suggestions that are better.

Robert --

Not a bad point. I'm not sure why they went with current income rather than a sum of all income. Maybe because most people can't remember this information? Who knows?

Flexo --

I think it's a decent guide and in the end, it doesn't really mean much anyway does it? Everyone's goals are different, they're in different life stages, etc. I use it as a benchmark to look at for myself, but I too have special circumstances that have to be factored into this equation.


I have to agree with the folks who question the validity of the rule of thumb for people early in their careers. It's especially problematic for young professionals. Take a young lawyer, for example. Three years out of law school, she might make $150K/year, at around age 30. Because she spent time in law school, she probably had no net worth built up when she started her job. But according to the rule of thumb, her net worth should be $450,000, or three times her current salary. That's just not realistic. The rule of thumb may only work once you've hit 35, or been working for some number of years (like 7-10).

Another way of stating the formula is "the net worth you would have if you saved 10% of your present income in every past year of your life." I found that helpful when thinking of the strengths and weaknesses of the formula.

How about this formula?

N = number of years you are in the workplace
S = current salary
W = current net worth
^ = raise to the power (below, we compute 1.03 to the N-th power)

calculate the ratio 0.3*W / (1.03^N - 1) / S

If this is bigger than 1, pat yourself on the back. If less than one, stop patting and start saving. (I am at 0.97, by the way, and continue to save).

The formula is based on the idea of saving 10% of your salary every year, yielding 8%, and also assuming your salary grew by 5% every year to get to its current paltry amount (after N years). Can tweak the assumptions to get a tweaked formula, but that kind of misses the idea of a rule of thumb. Note that for small N, (1.03^N-1) is approximately 0.03*N, giving the simpler ratio of 10*W/(S*N), which is just to say compare your net worth to 10% of your current salary times the number of years in the workforce.

Robert --

Check this out and see what you think:


I like the formula - I believe the authors intent with this formula is "sticker shock" to help younger readers become a PAW (prodigious accumulator of wealth). When I read this book a few years ago (fresh out of school) I was floored by the idea that I was so far behind on my net worth and it drove me to action. I still haven't reached this moving target but I am closing in on it and I think the habits this formula forced me to develop is greatest value of looking at it.

The book formula is a poor rule--unless it was designed to use a biased rule to 'shock' people into saving (aka as 2million notes above).

Using misleading information to cause (scare) people into behavioral changes because one thinks s/he knows what is best for all people is risky as one solution does not fit everyone's unique circumstances. Even if that behavior is considered most reasonably to be a "good" one.

Makes me wonder what else from the book is misleading.

(note: I am a most thrifty person & have nothing but good words to say about the value of wealth accumulation.)

For all that these formulas can be useful tools, I have to wonder whether they are ignoring two very important variables. Specifically, I think we should be considering number of years to financial independence and target wealth. There are some implicit assumptions in most of these formulas about retirement age and income in retirement as a percentage of income while working. Those assumptions aren't always valid.

I have no trouble with the concept of putting away a significantly higher percentage of one's income toward retirement savings and wealth-building in general. I suspect that the average reader of this blog is likely to agree. But that means that you don't fit the standard formula. You are living off of a lower percentage of your income now. For example, if you are saving 20% of your income towards retirement, you are living off of the other 80%. That means that a 20% decrease in your income when you retire won't change your lifestyle. However, if you want to retire at 50, your savings have to last longer, so you need to save more.

I'm 34, I have an job that pays well but under $100. My net worth is around $250. The key that a lot of people seem to be missing, is that you are NOT supposed to have student loans or a mortgage. Listen to Suze or Clark Howard. Hello!!! My dad has never bought anything he couldn't pay cash for and my mother only worked to help him in the office. She never had a job once I was born. The point of the formula is to SAVE, not SPEND!!!

btw - you aren't supposed to rely solely on saving off your paycheck. you are supposed to be investing that money in aggressive programs. My net worth exceeds that formula. I have 5 stocks that my 401K pays into and generates wealth from and I own a house. Those 2 assets are, so far, keeping me right on track and I've only been employed full time for 10 years.

This formula is challenging. I save about 36k per year of a 120k income. I would consider this much better than the average in the U.S. By this formula, my net worth puts me at being an AAW if at my age I made about 35k less, otherwise I am a UAW. Yet, I judge my net worth as a function of saving 15% of my gross income every working year since college, and having my accumulated investments grow by 9% per year. By my measure, for 2005 I should have saved about $18,000 and had a return on my investments of about $31,000 for a total increase in net worth of $49,000. I exceeded that and have since I started on this thing (except when I was in grad school). I just don't think the formula works. Maybe it would if it included a part where you subtracted 20-25 from you age since most people don't make much as a toddler, teen or very young adult.

I love this formula for a number of reasons.

It is based on actual data, not just wishful thinking and grand expectations. Since the sample group was mostly 40+, necessarily it is somewhat limited in application to younger people.

It is based on real current observables to tell you how you are doing in the present and how you are doing relative to others.

Most of the problems identified are quite minor. If your income balloned or disappeared this year, or you expect large fluctuations, simply use a reasonable average or expectation. If you save a large share of your income simply use your income less savings. If you spend much less than you earn, simply use your spending. There doesn't have to be any one definitive answer but if you are below 0.5 you are not doing well and if you are above 2.0 you are way ahead. It is just a gut check on your situation.

Generally, by age 30 you should be at 0.5, late 30s or 40, 1. It rises very fast once your income has surpassed your permanent spending level, typically in the mid to late 40s. Offspring in college may delay this somewhat.

How to determine if you are wealthy is an interesting topic but one author would say: "If you know how much money you have then you are not wealthy at all." Rather let me present a mindset where a person could determine if he is wealthy or not.
1. DETERMINE TO REALIZE THAT IF WE DEPOSIT OUR MONEY IN THE BANK WE ENTER INTO A CREDITOR (DEPOSITOR)-DEBTOR (BANK) RELATIONSHIP. A depositor depositing his money in the bank becomes the creditor that is why the bank (debtor) is obligated to pay interest income to the former.
2. DETERMINE TO REALIZE WHAT ALBERT EINSTEIN ONCE SAID THAT THE EIGHT WONDER OF THE WORLD IS COMPOUND INTEREST. Actualize what Albert Einstein once said by applying the formula: P = A X l.R X N. P is the total principal amount invested plus the interest, A is the total amount invested, l.R is the percentage of the rate of return per year, N is the number of times per year you deposit or invest your money. Let us put the formula in an actual application. Let us say you invest P 1,000.00 per year which is A, the rate of return per year is 5%, the number of years you invested is 15 years. What will be the total investments plus the interest earned? By applying the formula the solution will be P = A X l.R X N or $ 15,750.00 = $ 1,000 X 1.05 X 15 years, that means your total investment is $ 15,000.00, your interest income earned is $ 750.00, while the total number of years is 15 years. Earning $ 750.00 without lifting a single finger is a lot of money. What if you deposit $ 10,000.00 a year, the rate of return is 5% and the number of years invested is 15 years. The total amount of interest earned after 15 years is $ 7,500.00. Well, this is what Albert Einstein is saying that means you will wonder how fast your money will grow.
3. DETERMINE TO REALIZE THAT THE BUSINESS OF BUSINESS IS BUSINESS. Once a person enters into business he must devote his time and resolve at 100% in order that his business will succeed. There must be no favoritism as to friends, kins and relatives. All business dealings must be done for the success of the business alone. Personal matters must be out of the question.
4. DETERMINE TO REALIZE WHEN EATING - EAT ONLY WHEN YOU ARE HUNGRY AND SHOP WITH A FULL STOMACH. In the U.S. the amount spent for food alone is a staggering $ 15,000,000,000.00 every month and the survey is only confined to the urban areas. Hypertension is always attributed to obesity. Shop with a full stomach to avoid reckless purchase of foodstuffs actually not needed. Determine to follow this recommendation and you will save as much as 15% of budget for food alone.
5. DETERMINE TO COLLECT PRECIOUS ARTIFACTS, ANTIQUES AND PAINTINGS. The possession of Vincent Van Gogh's painting could be auctioned and sold for $ 268,000,000.00. The ownership of Krugerrand coin could be sold for $ 150,000.00 because of its gold karat content.
6. DETERMINE TO USE THE PHILOSOPHY OF "IT'S ALMOST THE SAME" BECAUSE THEY ARE LOT MORE CHEAPER. Individuals who use the philosophy of "It's almost the same" will save much money. If you buy a Mercedez Benz it might probably cost you $ 2,000,000.00 while if you buy a Ford car it will only cost you let us say $ 800,000.00, it's almost the same because after all they are the same car but with different brand and you saved $ 1.2 million which can be used for investment. If you eat in a five star restaurant it will cost you $ 1,500.00 while if you eat in a two or three star restaurant it will only cost you $ 500.00, it's almost the same because the purpose has been served that is to eat and you were able to save $ 1,000.00. In purchasing medicines buy with generic brands, they have the same efficacy but they are lot more cheafer.
6. CONVERT YOUR CASH TO OTHER FORMS OF CURRENT ASSETS TO AVOID SCAMS AND THEFTS. Cash is treated as liquid asset in accounting because it easily evaporates so knowing that status of cash convert it to other forms near to cash to avoid tempations to spend, to scams and thefts. You can either buy stocks and place it in marketable securities, time deposits, trust indentures and treasury bonds. In that way the cash becomes safe and withdraw it only in times of extreme necessity.
7. INVESTMENT IN THE GOVERNMENT IS ONE OF THE BEST FORMS OF INVESTMENT BECAUSE THEY SELDOM BECOME INSOLVENT. Buy treasury bills, bonds and stocks sold by government corporate financial agencies because they are always financially secured and seldom will go bankcrupt.
8. YOU CAN ONLY DETEMINE IF YOUR ARE WEALTHY IF YOU KNOW THE LAW OF DIMINISHING RETURNS. The law of dimishing returns advocates that once a business reaches its peak and have earned and attained prosperity the natural tendency is to go down. So while in the stage of prosperity, businessmen usually save their profits and cash so that in times of lean opportunities they have something to survive. What goes up must go down.

I think your formula is way off base. At the age of 60 and a salary of 70000 I would have to have put away 4.2 million to be well to do using your formula. Well that may be so for some individuals, however no one in our social group, which I consider the majority to be well off, do not have net wealth any where near that fiqure.


Well - I'm only about 130,000 behind... :)
I am only 22 though..

Interestingly though - that formula assumes that your Net Wealth will increase year-on-year by a steady amount (10% of your income) assuming that your income doesn't change.
So assuming you were level --> your Parking your NW in a 5% deposit and saving 10% would get you ahead of the curve.

The challenge is catching up to the curve - Assuming you start work at 20 - you need to start with a NW of twice your income in order to be 'on the curve'

@Bob - actually - I think the formula is valid. You are well off - but you are not a prodigious accumulator of wealth.

@2Mil - Wasn't it more for the Older UAW's? Ie - an exec on a high income who assumes they're doing well - until they are shown that formula and told they should have a >$5mil NW...


You did the formula wrong. If you earn 70k and are 60, the formula looks like this:

70,000 x 60 = 4,200,000

4,200,000 / 10 = $420,000

I think you forgot to divide by 10!!!

In any case, I think the other weakness in this formula that no one has pointed out is that for older people, it tends to be on the low side.

I don't think a net worth of 420K for someone age 60 is very much...especially for someone earning 70K a year.

All this spoken by a bunch of people who now have forclosed houses and reposessed cars and had all their net worth caught up in a housing bubble that was supposed to go up and up. Back in 2005 to 2007 they were trying to fault the formula because most people who read this did not want to admit they were not even close to this even though they lived in nice houses and drove new cars because they were in hawk up to their eyballs. In 2011, now we know this is true. Years of competing with the Joneses and trying to be something they were not has brought us to this point. That is why there are no more comments on this because there are less and less people who are even in the ball park on these numbers anymore. Welcome to the real world people and a big old middle class hangover of debt and lowered wages. To bad the party is now over in America.=-(

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