Are You Affluent?

Here are some interesting thoughts from Stop Acting Rich: ...And Start Living Like A Real Millionaire on how to determine whether or not your net worth is as high as it should be:

Simply stated, your net worth [augmented -- assets minus liabilities] should equal 10 percent of your age times your annual realized household income (0.10 x age x income = expected net worth.) If your actual net worth is above this expected figure, I consider you affluent, given your age and income characteristics.

Using this measure, I qualify as affluent. Not that it does much for me...

In the past, we've had discussions about a similar formula (maybe the same as the one he used in his first book?) and many people thought it discriminated against younger people. For instance, someone who's 22, just out of college with $30k in debt, and who recently took a job making $40k per year needs to have a net worth of $88k to be considered affluent. This level is very hard to reach without at least a few (if not more) years of working and saving.

So when is the formula accurate? After all, it tries to take into account both age and salary (the two issues that are the problem here.) Is it valid once people get to 30? 35? 40? Or maybe there's another/better way to keep score. Or maybe it doesn't really matter if you're "affluent" or not. What good does it do you anyway to know this?

What are your thoughts on this issue? And are you considered affluent using the author's formula?

Comments

[sahm]

How do you figure this if you're a married couple with one income? Must your net worth as a couple be double the amount to be "affluent" ?

[FMF]

sahm --

I think this applies per couple, since he mentions households in the book.

[indio]

My net worth is almost double the affluent number, but oddly enough I don't feel affluent. It's probably because I live in an affluent bedroom community to NYC and I would guess about 70% of the neighbors or schoolmates of my children are more affluent. However, I don't know if they are highly leveraged or not.

[Benjamin]

I first heard about this formula in Stanley's iconic book "The Millionaire Next Door". Instead of using the formula to define "affluence", Stanley refers to prodigous accumulators of wealth (PAW's) and under accumulators of wealth (UAW's).

I prefer looking at the percentage of one's income they are able to save/invest each month as a clearer indication of affluence.

[cmadler]

Any such calculation needs to have a non-linear aspect (logarythmic, exponential, something). A linear formula like this produces numbers that are too high for young people, as you pointed out, but also too low for older people; a 62-year-old with net worth of 6.2 times annual income is certainly not affluent! I'd start with two points: given the levels of student loans sometimes necessary today, acheiving a non-negative net worth somewhere between ages 25 and 30; and by age 65, at least 25 times annual income. The degree to which it's curved would need to be based partly on expected investment returns, and partly on an expectation of saving a higher percentage of income as you age.

[JACK]

The formula doesn't work in part because it assumes too much without even knowing it.

I'm 34 and let's just say that for me to have the net worth that it says I ought to have I would have had to save over 50% of my pretax income these past nine years to get there. You try doing that when you already have a large chunk going to taxes.

The formula doesn't just discriminate against the young, but especially against the young who are high-income earners. And the reason it does that is that once you hit 20 it assumes you could have saved double your income. The challenge is that it is unrealistic to expect a 20 year old to have saved double his starting salary in his first year of working. You get 10 more years before you have to have saved triple, etc. By then maybe you could have done it through salary deferral (that's just 30 percent of your decade's savings assuming your income was pretty stable, etc.)

And that's the other problem with the formula. It doesn't account for income growth in a reasonable way. You get a big jump in salary and the formula essentially presumes you have been making that all along.

I think it's not a worthwhile tool.

[JACK]

meand decade's income instead of decade's savings

[StLPastor]

Not affluent (close though, I hope to get there before 35).

But I sort of think that affluent also has to take into account some certain salary baseline-there are people in my congregation making about 30,000 as a family, while others making more like 200,000. Assuming age 50, Group A is affluent at 150,000, while group B is affluent at 1,000,000. I would feel a lot more affluent with 800,000$ and a 200,000$ income than 200,000$ with a 30,000$ income at age 50, but this suggests I'm wrong.

[Old Limey]

The formula is far too simplistic to be of any value whatsoever in my opinion.

How about judging wealth by the answers to a few simple questions?

1) Are you very happy and very content with your lifestyle at this point in your life?
2) Do you have excellent healthcare?
3) Do you live in a nice comfortable home in an attractive and safe neighborhood in a nice location?
4) Can you afford to have a very good and very healthy diet?
5) Are you financially well protected against adversities such as acts of nature and other disasters?
6) Will your retirement plans enable you to maintain an appropriate lifestyle as long as you expect to live?
7) Can you afford at least one very nice vacation each year?

A "Yes" answer to all of the above would indicate that you are in the top echelon of the population and just need to stay focused and on track.
Now for the key question:
If all of your income ceased today, how many years could you maintain your current lifestyle?

If it's a number considerably greater than your life expectancy then you're affluent, you can coast the rest of the way.
If it isn't, then you still need to keep saving hard and investing wisely, you're doing well but you're not done yet.

[neal@Wealth Pilgrim]

I don't get it.

If my neighbor and I are both 50 years old and have a net worth of $1 million, I'm very affluent if I made $50,000 but he's not if he makes $300k.

This seems to be a better measure of ability to live and save within your income level - not affluence.

He spends more - maybe he enjoys more too.

[BillV]

Spot on Old Limey.
these are the questions that really tell the tale.

Affluence is too relative a term. In one circle or neighborhood you might be considered affluent, but not in another where one might feel down right poor. The difficulty comes if you feel the need to measure yourself against others.

Old limey's turn the focus where it belongs (IMHO) and that is to yourself. Like you say OL if you can answer yes to the qx's you list, then you are doing darn well.

[VK]

I think the formula will provide a better value if it took cumulative lifitime earnings into account as opposed to just the current annual earnings (since based on current events, that could change any instant), this should add a non-linear element, as well as provide the younger people a better understanding of where they are with their finances. I have done no research but I would suggest a formula of 1% of (cumulative lifetime earnings * age).

[Funny about Money]

Uhmmm... That's pretty strange. At my soon-to-be-former income, I certainly do qualify as affluent, but...????? What on earth does that mean, really?

Now, let's see: if we calculate it based on my projected 2010 Social Security + part-time teaching income, in layoff-forced "retirement" that would make me "affluent" with a net worth of $182,000-plus.

Gimme a break!

Old Limey has got it right, especially in asking how long you could sustain your lifestyle (or, shall we say, an acceptable lifestyle) if your income stopped today. My financial adviser estimates my savings would support me for 150 years at a 4% drawdown; since I don't expect to last another 150 years, that begins to sound like "affluent."

[rxjohnk]

I agree with most on here. Formula is worthless without some more variables. However, using the formula gave a number that was approximately what my ASSETS are, not my net worth. My net worth is approximately 1/3 of total asset value.

[shadox]

Why would age even come into it? How is that relevant?

[Dan]

I agree that the formula doesn't work for all. I'm 26 and make just under $60,000/year. I would love for the creator of the formula to explain how I am supposed to pay off student loans, pay down my first car (as most in their twenties have to do), keep up a reasonable lifestyle, and have a net worth of $156,000.

I thought I was doing well at a net worth of 60k.

[Enough Wealth]

As an affluence indicator the formula seems pretty weak. It was better as a PAW/UAW indicator as used in the MND book - and even then it was only a much simplified version of the actual formuala that had been found from research. This simple formula is an OK guide to how much a 'typical' person could have saved after a decade or so of work. It doensn't work at all for young people, people who have just started working, people whose income has changed a lot (eg. PT > FT or vice versa), retirees etc. etc

Personally, I like comparing my NW to the top decile of household NW for my age, or to 1% of the cut-off for the annual BRW "rich list". I'm not so interested in comparing my 'affluence' to others, as I think those who currently enjoy a highly affluent life style may simply be supplementing their income with credit, or bringing forward expenditure at the expense of their retirement life style. ie. While I want to have a relatively high NW, I'm happy to live a less affluent life style than average.

[Financial Samurai]

I guess I'm affluent, VERY affluent according to this formula! Whoo hoo!

[Kenny]

The formula for Affluence or PAW is too general. But, this is just like the saying that if your BP is 100+Age, then your are doing OK. Well, it is ignoring a lot of variables.

Well, this 0.10xAgexIncome is doing the same, but if Affluence generally comes with age, except for a few. So, for those 20,30,and 40 year age group folks, keep doing the right thing, and you will approach it.

Like any other generalized formula saying a 30 year old should have their 70% of portfolio in Stocks and 30% in Bonds, that is too general too.

So, modify this formula to your hearts content to suit your age group, and if you are in the higher age group, then increase the ratio and do not leave it at 0.10. That is TOO LOW, considering that a 50 year old will live to 90 and will need money for another 40 years!!!!!! That is a LONG time.

So, guys, just deal with it unless you have a 'better' replacement formula (which I do not have). The PAW and other formulas in the book (and his other book) are also general.

But the man has done a LOT of research, so unless you can do 2 better on his research, just use this one!!!!!

Thanks.

Kenny

[Old Limey]

While we are on the subject of "Affluence", and I am certainly extremely fortunate to be in that category, we should also remember this.

America is the most affluent country in the world. How many of you realize that if the whole world were to have a lifestyle like ours and consume the earth's natural resources the way we do then we would need FOUR MORE Planets just like EARTH to meet the demand for Oil, Natural Gas, Coal, Timber, Fertilizer, Arable land, Water, Iron ore, Aluminum ore, Copper ore, etc. etc. etc.

Also consider that because of the population explosion the earth adds another 1 billion human beings every 12 years and that rising sea levels due to climate change are already submerging land in some areas of the world.

We all need to be very thankful that we live in the USA and are enjoying an affluent life style that is unmatched throughout human history. Even Kings, hundreds of years ago, didn't enjoy many of the benefits that we take for granted. I am glad that I won't be around to see the populations of China, India, and Africa become consumers like us.

[Concojones]

"Using this measure, I qualify as affluent. Not that it does much for me..."

I think this sums it up pretty well. What use is a formula that comes out of the blue? Everyone should define for themselves what "affluent" means, either in absolute terms ("what kind of lifestyle would that be?") or in relative terms ("am I in the top 20 or so percent of earners in my area").

[Mike Hunt]

Old Limey,

I would dare say that the USA is on a long slow slog to lowering her per capita comsumption so that resources will be more equitably shared around the world. It's true that the world resources are looked at like a zero sum game in this regard.

I read in the September issue of the Economist that the world population will peak just under 10 billion. Basically, as areas get more affluent fertility rates drop to around replacement levels only. So there is a bit of a self correcting mechanism.

That said, we are nearly 7 billion souls on the planet and it does seem very tight in global resources... I can hardly fathom a 50% population increase!

Negative growth will become a key phrase in the next generation. The current concept of growth at all costs is doomed to failure.

-Mike

[Mike Hunt]

I too find this metric (topic of this post) to be fairly useless.

By this definition I'm at least twice what affluent is at my current age, 36. Doesn't mean much though because I'm trying to get a big salary increase in my next job and that will make me closer to falling off the affluent definition. Similarly if I took a 50% pay cut I would be twice as better off in this definition.

A better modification would be to modify the formula and divide your current net worth by your actual annual living expenses and compare that to your age... even this is tricky since it's natural to spend more once you have more saved...

-Mike

[Crystal]

I scoffed when the formula said we'd be affluent with $204,000. We're 26 and make $78500 jointly, but we've only been making about that much for 4 years. I thought we were doing really well with a net worth around $130,000...oh well, I didn't feel affluent anyway. :)

Maybe a formula would need to take off the first 16-22 years of life somehow since kids and college students accumulate debt more than wealth. It would also need to take into account average investment returns since a 60 year old would hopefully be making something off his saved money over the years. I tried a few different calculations, but none of them accurately take into account the first 16-22 years of uselessness or 35-40 solid years of investment returns for people nearing retirement...

But I do think that formulas are just dumb ways of measuring wealth anyway. I liked Old Limey's list.

In general, are you happy? And will you be able to happily retire and support yourself? If so, congratulations to you!

[Old Limey]

Mike:
I agree with you and the Economist article that the population of the earth will be self limiting. It's as if the powers above are saying to us, "Either you do it yourself, or I will do it for you".

This is the same method that has happened millions of times for all of the species on the planet with less intelligence than us when faced with the reality that there's not enough food or water. The earth cannot support a human population, now expanding at an exponential rate, which is why I have personally questioned the common sense of wealthy foundations spending billions of dollars to further expand the birth rate in very poor countries by trying to combat disease and hunger when it goes against overwhelming natural forces. It's a controversial topic that goes right along with the other very controversial topics that have their friends and foes in this country, often based upon religious beliefs.
With resources enough for a sustained population of 10 million we are looking at about another 40 years at current growth rates before Mother Nature takes over and does for us what we are unable to bring ourselves to do. One charitable act that I was happy to participate in was giving money to the granddaughter of one of my wife's best friends. This young woman joined the Peace Corps, was sent to Benin in West Africa for two years, endured terrible living conditions, and worked in Aids education and the distribution of condoms.

[Terry]

Jack -

I think deducting, say, 20 from your age (to reflect ACTUAL years of earning and investing) would make a splendid refinement to the formula.

(I have a different objection to the formula, but to avoid the Wrath of FMF, further deponent sayeth not.)

[LotharBot]

Old Limey,

the earth's human population is not expanding at an exponential rate. It's expanding logistically (http://en.wikipedia.org/wiki/Logistic_function). To my eye, it passed the inflection point somewhere between 4.5 and 5 billion, which leads to an expected world population of 9-10 billion.

People like to create all sorts of "catastrophic" theories for how population will limit itself to that level (where "mother nature" kills off billions of humans, for example.) But those of us who've studied population modeling (I have an M.S. in applied mathematics, focused on mathematical biology) and who've seen the data for actual populations don't buy into it. Real populations (of many types, not just human) settle into their carrying capacity through reduced childbearing, not through the sort of catastrophes portrayed by hollywood's apocalyptic movies.

Combating disease and hunger actually helps REDUCE birth rates long-term. There's a short-term bump, but long-term, people change their lifestyles accordingly. Even the most basic level of affluence (food and not-dying-from-disease) leads to birth rates settling around replacement levels within a generation or two.

-------

On topic, the formula is horribly flawed, as many have already pointed out. It's like somebody decided that a person needed 4x annual income saved by 40, or 5x by 50, to be affluent and then they just fit a line through those two points. But someone reaching age 60 with only 6x annual income is in bad shape, while someone who is 20 with even 0.5x annual income is doing awesome.

I like Terry's idea of subtracting 20 from your age as a starting point to build a better formula. But I also think the formula needs to grow more sharply. To be affluent at 30, you need maybe 1.5x annual income saved. At 40, I'd say 5x. At 50, I'd say 10x. And at 60, I'd say 25x or more. A simple formula that fits this roughly OK-ish is 1/70 * (age-20)^2. OK, so it's harder than the original formula, but if you can read this, you're using a piece of electronics that includes a calculator anyway.

[Old Limey]

LotharBot:
Upon further investigation I agree that the world population cannot continue to grow exponentially as one might infer from examining an internet graph of world population over the last two millenia with only the Black Death (1347-1350) showing a tiny downward blip.

The following internet extract is no doubt more accurate:

A consensus?
The several agencies that try to predict future population seem to be moving closer to a consensus that:
The world population will continue to grow until after the middle of this century reaching a peak of some 9 billion (up from today's 6.6 billion) and then perhaps declining in the waning years of this century.

There are several countries that already have declining birthrates, particularly Japan and Russia. It's the poorest countries that are the problem, particularly Africa.

[LotharBot]

Limey,

people infer the curve as being exponential because the two types of curves look fairly similar until you near the steepest part of the logistic curve -- which we passed only perhaps 15-20 years ago. Since the graph is typically presented in such a way that that segment appears to be straight vertical (that is, less than a pixel wide) it's very easy to miss the telltale signs. A graph of population over 2000 years doesn't give you much detail right as it becomes most important. But look at just a 20th century graph, and you'll see the curve changes ever-so-slightly somewhere between 1985 and 1995. We've passed the middle, and are definitely looking at declining birthrates.

The poorest countries are going to be the last to see declining birthrates, because they're the last to see the factors that lead to declining birthrates (improved health care, education for women, nutritional advances, government and family stability, etc.) Some of those factors are being worked on and we'll see the effects in another generation. Other factors may take longer.

[Concojones]

"I would dare say that the USA is on a long slow slog to lowering her per capita comsumption so that resources will be more equitably shared around the world." (Mike)
Yeah, 20 years from now we'll all buy much less tangible stuff for our salaries, as was the case a generation ago. People weren't unhappier at the time. Of course, the process of downscaling may be painful (strikes, war? ...let's hope we can resist the urge).

"It's true that the world resources are looked at like a zero sum game in this regard. [...] Negative growth will become a key phrase in the next generation."
Negative on average, perhaps. But averages often don't say a lot. High demand for commodities will lead to higher production capacities, so the sectors concerned should do well. Investors and working professionals who are early to this game can actually benefit here.

[[email protected]]

Well, using the modified formula (it excludes home equity), I'm just barely over the number (small yay).

As for the number and formula, I don't think it's meant to be 100% accurate. It's a guide, a goal for people to strive for. So yes, it's biased against young people (college graduates are broke...). But it still has value!

Personally, I read "The Millionaire Next Door" as a kid and it helped me form my frugal habits that are working for me today.

I can't wait to read this new book that he has out!!!

[JoeTaxpayer]

I like Dr Stanley's work a lot. But, as others have stated, this equation fails.
It would take till 100 to have 10X income?
My goal is 20X to retire at 80% pretax income.

[Old Limey]

LotharBot:
Thanks for clearing that up. It's interesting that the elephants in Africa for example reduce their birthrate during times of great water shortage and they are real survivors. This reinforces my opinion that intervention by wealthy countries with massive handouts to alleviate hunger is not the longterm solution. As you point out, giving women full rights, improving education for all, improving healthcare, promoting birth control, and teaching them about improved farming techniques and nutritional values is the best longterm path to creating a population that is in equilibrium with available resources. It reminds me of the old proverb about giving a man a fishing rod and teaching him how to fish versus just handing out fish.

[R. Campbell]

Two quick promotions have moved me from AFFLUENT to NON-AFFLUENT. I guess I should have turned down the pay raises so that I could fit more comfortably into a formula.

2.8 x 50K = $140K (Yay!! I'm affluent!!)
3.0 x 82K = $246K (Darn. I'm behind the 8-ball).

All in good fun ;)

[PDubbs]

Really, the formula should account for age better. How about this:

Net Worth = exp((Age-35)/20)*1.5*Income

This isn't that practical for a back of the envelope calculation, but I find it more accurate. The author's formula is much more useful as a quick, general gauge.

Using the exponential function makes age more important the older you are. This is logical because the compounding power of money is more important than the amount you save. If this formula results in a number too high or too low for your tastes, adjust the linear factor of 1.5 up or down and see what you think.