Free Money Finance

How Much Does It Take to Be Wealthy?

Here's an interesting post from Bloomberg asking how much do you need to become wealthy?

The results:

• Millennials say you need $1.3 million to be financially comfortable and $2 million to be wealthy
• Gen X says you need $1.4 million to be financially comfortable and $2.6 million to be wealthy
• Boomers say you need $1.6 million to be financially comfortable and $2.7 million to be wealthy

Interesting how the older you get the more you think it takes to be wealthy. :)

Before you set a number, consider these net worth percentiles in the U.S.:

• 50th percentile: $97k net worth
• 75th percentile: $370k net worth
• 90th percentile: $1.2 million net worth
• 95th percentile: $2.4 million net worth
• 99th percentile: $10.4 million net worth

Now that you have those numbers, what would you say it takes to become wealthy?

I think you could argue that it takes more to be financially comfortable than to be wealthy.

For instance, $1 million makes you wealthy compared to most Americans -- only a bit over 10% have more.

But would you say you'd be financially comfortable with $1 million net worth? Maybe comfortable enough to relax a bit, but not comfortable enough to retire -- unless your spending was really low.

Anyway, what are your thoughts on the issue? What do you say it takes to be wealthy in America?

My Major FI Milestones

Gen Y Finance Guy recently listed his five major milestones of financial independence as follows:

1. Ground Zero ($0 Net Worth)
2. Six Figures ($100,000 Net Worth)
3. Double Comma Club ($1,000,000 Net Worth)
4. The Magic Zone for Max Happiness ($1,875,000 Net Worth)
5. Financial Independence ($3,000,000 Net Worth)

Here's when I hit each of these and my thoughts on them:

1. My Quicken data goes all the way back to 1994 and it shows I was at ground zero. I'm not sure if this really was the case or if I just didn't have the numbers entered into Quicken, but let's go with it.

I had been married for just three years at this point. We were learning about money and wanting to retire all of our debt, but we had two condos we had to sell (at losses) so we could buy a house (which we sold a year later for a loss.) Ugh.

2. By 1995 we had over $100k net worth, which makes me think the 1994 number of zero was simply for a lack of data.

By this time we had sold our homes, moved, bought a new house and were paying down the mortgage, and I had a nice, new job that paid me much more than I was earning previously. We were also maxing out my 401k at this time.

3. We passed $1 million in 2005 and, as they say, the first million was the hardest.

By this time I had changed jobs a couple times, survived the dot-com bust, paid off our mortgage, was earning a very good salary, and was saving a ton.

4. We hit the Magic Zone in early 2011 after fighting through the financial crisis (investing all the way down).

By this time we were actually financially independent, but I did not know it.

5. We hit $3 million in 2015 thanks to the investments we made during the crisis as well as our real estate.

From there our finances have been on a rocket ship upward and we are a hair away from the next million-dollar mark.

So, that's our path through the five milestones. Where are you on this journey?

The First Financial Metric: Net Worth

The following is an excerpt from the book Set for Life.

One’s net worth is simply the number of assets one owns, minus the debts one owes. Folks track net worth in a variety of ways, and have a variety of theories about the best way to do this. Here’s a common example of how a typical American might track his net worth:

Sam has the following assets to his name:

• A Honda Accord worth $20,000
• A home worth $300,000
• $7000 in cash
• $200,000 in retirement savings in a 401(k)
• Total assets: $527,000

Sam also has the following debts:

• A car loan of $17,000 on the Honda
• A mortgage for $240,000 on his home
• $4000 in credit card debts
• $30,000 in student loans
• Total liabilities: $291,000

Sam’s net worth in this scenario is $236,000.

The financial statement that shows your “net worth” would be the equivalent of a company’s “balance sheet.” In this case, Sam is worth about a quarter of a million dollars and might be feeling pretty good about himself.

So why is this number so important? Net worth boils down to exactly how many dollars an individual has to their name across all of their financial positions. It’s also the number most folks try to increase as much as possible. It gives the individual a clear picture of their financial position across all of their financial accounts and possessions.

Separating Real and False Net Worth

The goal of this book is not to increase one’s net worth, as it is commonly calculated, but instead to help the reader attain early financial freedom. Therefore, we must focus on buying and building real assets, not false ones. Commonly calculated net worth includes things like equity in homes, retirement accounts, and cars. These false assets do not generate income and are actually in some cases liabilities to the owner. They soak up dollars that could otherwise be deployed to buy real assets, or to extend one’s financial runway. A home, for example, comes with a mortgage payment. Far from expediting early financial freedom, the owner is forced to generate more investment income than someone without a large mortgage payment and monthly upkeep expense. The same is true for cars and other luxuries that many people list as assets. Do not focus on increasing net worth as commonly calculated if you desire early financial freedom. Instead, track your real net worth, as comprised of real assets and cash and cash equivalents less debts and obligations. Focus on building wealth that directly works toward your goals, rather than wealth that cannot be harnessed in the near term to produce income or reliable appreciation.

What does one seeking early financial freedom care if they have $200,000 in retirement accounts? If that person is under thirty years old, they may have trouble accessing those funds without penalty for over thirty years! That retirement account is a false asset which doesn’t have any direct impact on day-to-day decision-making, or really even long-term decision-making (if ten or more years is considered long-term). Retirement accounts may only be considered part of this equation if they can be accessed far in advance of retirement age, or are a meaningful part of the current financial decision-making process. While it’s not bad to have the retirement account, it’s not useful to one whose goal is to secure early financial freedom.

If the goal is to become financially free, then we only care about those aspects of net worth that are directly relevant to that goal. Real net worth excludes much of Sam’s net worth in the example previously discussed. That said, it’s certainly useful to remain up to date on your both your real and false assets. You should keep an eye on the value of your retirement accounts, home equity, car, other items, and resources you own that are of material value, just as you should know the value of your real assets and cash. If you aren’t paying constant attention in this game of finance, you will lose. Whether through theft, ticky-tack fees charged by sneaky banks or credit companies, or by making an obvious mistake, those who don’t pay close attention to their assets and to where their money is going will slowly lose in the game of money.

The solution? Track both types of net worth—track your commonly calculated net worth and your real net worth. For example, you might track the former with one software tool and the latter with another.

If you don’t know your net worth (real or commonly calculated) at the moment and are not regularly checking up on it, then this might be one of those tasks that you set about completing immediately. There’s no point in playing the game of finance if you can’t even keep score.

Calculating Real Net Worth

We’ve already demonstrated commonly calculated net worth for Sam. Here’s how Sam would calculate his real net worth:

Sam has the following real assets to his name:

• $7000 in cash
• Total usable assets: $7000

Sam also has the following debts:

• A car loan of $17,000 on the Honda
• A mortgage for $240,000 on his home
• $4000 in credit card debts
• $30,000 in student loans
• Total liabilities: $291,000

Sam’s usable net worth is negative $284,000.

How did this happen? Well, Sam made several key mistakes that far too many middle-class Americans make:

• He bought a financed car.
• He bought a luxury home with a huge mortgage.
• He got himself a financed degree.
• He failed to build any significant wealth outside of a retirement account.

Folks, this is likely what most of America considers a strong financial position, and it’s absurd. A lifetime of “smart” decisions and Sam is in a $284,000 financial hole. Another way of expressing this is to say Sam has $284,000 in debts against his ability to make big life decisions that would disrupt his current income or lifestyle. This is why Sam has no choice but to continue to work his job or one very much like it for decades. He is clearly not on a path toward attaining financial freedom anytime soon.

Notice that while false assets are not included in the calculation of real net worth, debt associated with those assets is. Purchasing a false asset with debt is double trouble. The asset doesn’t assist in the pursuit of early financial freedom, and interest-bearing debt is assumed by the purchaser. Do not purchase false assets with debt if you seek early financial freedom! This is why buying luxuries on credit is such a drag on middle-class America’s finances. Financed cars, boats, trucks, TVs, computers, and the like are a double-whammy as they aren’t assets that serve the goal of financial freedom, and the debts must be counted against their financial position.

So What Should Sam Do?

Do you understand why parts I and II of this book are so important? Make the effort to move through those sections, and build after-tax cash reserves or their equivalents. Use those dollars to purchase real assets that generate income and are likely to appreciate.

Too many people attempt to move toward early financial freedom from a position like Sam’s. Sam is in far worse position than the guy starting from scratch. Sam has to reject choices he’s accepted as a smart, normal, and natural progression of adult life, and completely start over in order to begin building assets in a way that will bring about early financial freedom.

If your position is like Sam’s and you wish to move toward early financial freedom, you’ll have to accept the fact your financial choices to this point in life have resulted in a several hundred thousand dollar hole. You will need to begin to accurately track your finances with a clear understanding of your real net worth, and it might not be pretty. You will need to slowly and steadily begin to climb out of that hole, and accept that you’re at the first step of the financial journey and need to begin saving money—after tax—that can be used today. Otherwise, you will struggle to do anything other than maintain your current position in life.

Sam needs to get serious about building wealth and immediately make some drastically different choices if he wishes to achieve early financial freedom. Sam isn’t going to like any of this advice:

• First, he needs to harness the $60,000 in his home equity by selling his home and purchasing a house hack or far cheaper primary residence.
• Second, he needs to sell his car and buy a used one with $3000 to $7000 cash.
• Third, he needs to design an efficient lifestyle to begin saving thousands of dollars per month.
• Fourth, he needs to start paying down his personal debts (especially the credit card debt) and get them to zero.
• Fifth, he needs to stop contributing to his retirement account and instead focus on building real assets with surplus savings—assets that will help him bring about early financial freedom.

If Sam heeds this advice, he will spend the next several years rapidly building real wealth that gives him real options in life. No longer will he be chained to that mortgage, job, and vesting 401(k) interests. Sam will soon have tens of thousands, and not too much later will have hundreds of thousands of dollars in real, tangible assets like stocks and bonds, investment real estate, and a sizable cash position. In a few short years, he could buy back all of his prior luxuries with cash and have the option to walk away from work entirely.

Of course, this is fantasyland.

Sam isn’t going to sell his house and cramp his style. Sam isn’t going to sell his car. Sam isn’t going to cut back on his spending, so that he all of a sudden starts saving thousands of dollars per month outside of his retirement account. Unfortunately, Sam and people like him typically make excuses, not change. Sam will not give up his house, his fancy SUV, or even start packing lunch.

The best we can hope for is to plant a seed in Sam’s mind and to help Sam understand that most of his assets are really liabilities—or at best, are useless, if he wishes to attain early financial freedom. Sam will hopefully keep this in mind over the next few years, and when he gets a raise, won’t correspondingly increase his spending but use that extra money toward paying down debts. After a few more years and a few more raises, Sam will have paid off those debts and begin to start investing outside of his retirement account.

We can hope that Sam will slowly begin making changes in his life that move him toward early financial freedom. When Sam’s kids start school, he might find opportunities to use after-school programs instead of an expensive babysitter. In ten years, when Sam sells his home, he’ll buy a reasonable replacement, instead of the biggest, fanciest one he qualifies for. Slowly but surely, his position will improve, and one day, he will finally have a positive real net worth, and maybe, just maybe, he’ll bring some options back into his life.

Sam! I wish I could save you those decades. I wish I could impress upon you the financial consequences of your decisions in those early years, and the abundance that could be yours if you let go of your biggest “assets” and harnessed the wealth you’ve trapped in them to produce real returns elsewhere.

If only you had avoided those purchases! If only you could have invested in a house hack! If only you could have accumulated some cash so that you could make a big trip, travel the world, or otherwise do the things you really wanted in life! But, in failing to do that, I hope at least, that you begin to build a little wealth outside of your home equity and retirement accounts. I hope you focus your financial strategy around increasing that wealth from now on. And I hope that eventually, slowly but surely, you’re able to buy some freedom back into your life. I hope that you buy yourself the power to decide whether and where to work, and what you do during the best part of your day, during the best part of the week, during the best years of your life.

If you resemble Sam, you’ll likely need to make a number of changes in many important parts of your life to pursue early financial freedom. And, you will need to honestly calculate your own current position and track the changes over time, with a clear understanding of the consequences of your decisions.

Three Steps to Building Wealth

Investopedia lists three simple steps to building wealth as follows:

• You need to make it. This means that before you can begin to save or invest, you need to have a long-term source of income that's sufficient enough to have some left over after you've covered your necessities.
• You need to save it. Once you have an income that's enough to cover your basics, you need to develop a proactive savings plan.
• You need to invest it. Once you've set aside a monthly savings goal, you need to invest it prudently.

Hmmmm. These three sound familiar.

The site ESI Money has these three steps listed as the key parts of his site. In fact, they are even in the name. ESI stands for:

• Earn
• Save
• Invest

Basically the same steps as what Investopedia lists.

Of course the path to wealth is simple and well-known.

I have written my own post on how to get rich in three easy steps and books like The Millionaire Next Door: The Surprising Secrets of America's Wealthy and The Richest Man in Babylon do the same (though they have more steps).

But the basics are always the same:

• You need an income of some sort -- the higher, the better. And you need to work on growing it. 
• You need to spend less than you earn. 
• You need to invest what you save to grow it and drive your net worth.

That's it. Three simple (but not easy) steps.

You Can Build a Fortune on a Small Income

I've shared a host of bad news over the past couple months (mostly related to how little Americans know about managing their money), so it's time for some good news.

Here's a piece from Yahoo that tells how a librarian left $4 million to his university. Some details:

You wouldn't know it from his lifestyle, but Morin — who graduated from the University of New Hampshire before working in the school's library for nearly 50 years — was a multimillionaire. In fact, very few people did know, until he died in March 2015 at age 77 and bequeathed his entire $4 million fortune to his alma mater.

Morin's simple lifestyle allowed him to stash most of his income in a checking account and certificates of deposit, and his advisor helped him contribute to mutual funds and annuities, the Boston Globe reported: "Morin also bought several life-insurance policies over the years, all intended to benefit the university from which he earned a bachelor's degree in 1961."

So the guy was a librarian, not the highest-paying job out there. And somehow he managed to save/invest $4 million. How could he do this?

Well, he:

• Spent significantly less than he earned
• Worked for 50 years
• Invested wisely

Let's assume the following:

• He invested for 50 years
• He got an 8% annual return on his money

How much would he need to invest per year to get to $4 million?

Just under $7,000. Totally doable.

Based on his standard of living and his investments I'm guessing he saved much more each year and got a lower rate of return.

Whatever actually happened his life shows you can amass a tremendous amount of wealth if you save enough for a long time even with a modest return rate.

And you don't need to live on Fritos, cheese sandwiches, and frozen dinners like he did to do so.

You need to simply:

• Grow your career and any other income sources. Just a 1% difference in annual career earnings can mean an extra $1 million or more. 
• Control your spending. You don't need to be a miser but you need to select what you spend money on and keep it within reason. Doing this will widen your gap and give you much more to invest.
• Invest over a long period of time. You need some sort of growth vehicle like index funds to multiply your savings. Add in a long period of time and your investments will soar.

They are simple concepts to understand and easy to execute -- as long as you have discipline.

Become Wealthy by Reading

Here's a great piece that lists some statistics about how reading impacts your finances. 

The highlights:

• Individuals who read for self-education earned 21% more, as adults, than those who did not.
• Individuals who developed the habit of reading to learn earned more income, had more assets and had better finances by age 38 then their peers.
• 86% of the rich loved reading vs. 26% of the poor.
• 63% of the rich listened to audio books during their commute to work vs. 5% of the poor.
• 85% of the rich read two or more self-improvement books every month vs. 15% of the poor.
• 88% of the rich read 30 minutes or more each day vs. 2% of the poor.

A few thoughts on this:

• There's an old saying in business that, "Readers lead and leaders read." Almost all of the best executives I ever worked with consistently read for self-improvement.
• I love to read -- using "read" in a broad sense. I do still read books (more on that later), but as much of my "reading" these days is consumed in audio form, either audio books or podcasts. I "read" in my car, while doing lawn work, while taking early morning walks, etc. -- anytime I can do one thing and still listen to what's being said. I can't listen where my mind needs to be engaged in other things (like while writing an article, working out, etc.) so in those times I choose music.
• I subscribe to about 200 blogs (scouring the globe for great stuff to write on) in addition to the above.
• I do read a few magazines. I subscribe to Money, Kiplinger's, Business Week, and This Old House. Magazines are great for passing the time in a sauna. If you sweat and drip on them it's no issue (versus who wants to read a book after someone has perspired all over it?)
• I'm not sure when I developed the love of reading. I read comic books as a kid, then youth fiction, then teen fiction, then classic fiction. Eventually I moved to mostly non-fiction (after grad school) and haven't looked back since.
• I'm one of those people who buys a book before he's done with the previous book. Then he starts reading two books at once. Then he finds a third book and buys it and is now reading three books. Anyway, I have several books on my bookshelf now in some state of being read or being read again (that's another issue -- I re-read books I loved the first time, many of them being read 4 or 5 times).
• I visit the library often to see what's new, read what I want, and buy stuff I like and want to keep in my library.

The link between reading and earning is fascinating to me. It's not surprising as I'm sure most of us can see how the two would be related. But to have such a large impact as noted above is amazing.

For the curious, here are the books I have on my shelf right now that are in the "to be read", "reading", or "to be re-read" category:

• The Miracle Morning: The Not-So-Obvious Secret Guaranteed to Transform Your Life (Before 8AM) -- Finished not that long ago. Awesome book about how to achieve your life dreams by getting up earlier. Will be posting on it sometime.
• The Personal MBA: Master the Art of Business -- Is it better to get an MBA or just read and apply key books? This book argues for the latter.
• Franklin Barbecue: A Meat-Smoking Manifesto -- I'm the family grillmaster and want to get even better. I hope this book will help. :)
• Nightwing Vol. 1: Bludhaven -- Don't judge me! I LOVE Batman and all things Batman!
• Crucial Conversations Tools for Talking When Stakes Are High, Second Edition -- Got it to try and reason with an unreasonable boss, then didn't read it. Then I retired, but still plan to read it.
• The Bulletproof Diet: Lose up to a Pound a Day, Reclaim Energy and Focus, Upgrade Your Life -- Half way through it. Not sure if it's legit or a bunch of bull (I've seen articles saying both). I am on a health kick so I'm interested in different viewpoints. Not sure what to think here yet.
• The Bogleheads' Guide to Investing -- I've read this one a couple times, so this is a re-read. I'll read it mostly for nuggets I want to pull out and post about.
• Stop Acting Rich: ...And Start Living Like A Real Millionaire -- Another re-read for the blog but this one I've only read once. GREAT book by the author of The Millionaire Next Door: The Surprising Secrets of America's Wealthy, one of my all-time favorite books.
• How Much Money Do I Need to Retire? -- Re-read. best book on retirement planning I've ever read.
• How to Make Your Money Last: The Indispensable Retirement Guide -- I've read this book and will be posting on it some. I agree with 50% of it and am still thinking over the other 50%. Should make for some great blog conversations! :)
• The 7 Habits of Highly Effective People: Powerful Lessons in Personal Change -- After all these years, Amazon still lists this book as #64 out of all books in sales. There's a good reason for it. It's worth reading and re-reading over and over again. I've read it several times, listened to it, and been through the classes back in the day. AWESOME content.
• Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Ind ependence: Revised and Updated for the 21st Century -- Read this a long time ago and kind of blew it off. Then re-read it recently and saw how great of a book it is. I'll be posting more on it sometime in the future.
• Living Forward: A Proven Plan to Stop Drifting and Get the Life You Want -- I bought this during the pre-release so I got the audio free, which I listened to. LOVED it. Great book on setting and achieving life goals. Hope to read it again.
• The Leadership Challenge: How to Make Extraordinary Things Happen in Organizations -- Was recommended by a friend of mine who has experience in executive leadership. Listened to the audio book, loved it, then bought the book. I planned to listen to the audio and take notes in the book at the same time. Then I retired, so we'll see if I get around to it. :)

I know, it's a long list!

How about you -- are you a reader? If not, why? If so, what are you reading now (or planning on reading)?

You Can Retire Early on an Average Income

After posting a series of bad news items like Americans have low net worths, way too much credit card debt, and are terrible at money management, here's finally some good news.

Here's a family who is bucking all the trends. They are sending 13 kids to college, are debt free, and plan to retire early. Good for them!!!

So you're thinking "they must make a pretty hefty salary, right?"

Nope. Here are the details:

Rob and Sam Fatzinger, lifelong residents of Bowie, Md., lead a single-income family in one of the country’s most expensive regions. Rob’s income never topped $50,000 until he was 40; he’s now 51 and earns just north of $100,000 as a software tester.

So how did they do it? They simply spend a lot less than they earn:

Frugalism is often about math, determination and thinking a bit differently. A few key principles: How much you save, as a percentage of your paycheck, will foretell when you’ll be able to build your own business or retire. Small financial changes can make a big impact. And it’s not really about your income; it’s about your savings.

Then they invested the difference between what they made and what they spent. And their investments grew:

And then there’s the “miracle” of compounding interest, the gift that keeps giving as your investment’s interest spawns its own interest, time and again.

And by paying off debt, they have been able to save even more:

Since the mortgage was paid off in 2012, Rob and Sam have turbo-charged their savings rate, now investing about $3,000 a month.

It really comes down to the basics of good money management:

• Spend less than you earn (the more the better) to create a gap of savings
• Invest that savings and have it grow
• Watch your net worth climb

So if these people can do it with...

• An average income most of their lives
• 13 kids and all the associated expenses
• Living in an expensive area of the country

...don't you think most Americans could as well?

Of course they could -- if they just had the discipline these people have.

How the Wealthy Got Rich

Here's a post listing the five habits of the wealthy that helped them get rich. Their list includes:

1. They take risks.
2. They invest in themselves.
3. They associate with those they want to emulate.
4. They have a dedicated morning ritual.
5. They review their goals consistently.

My thoughts on each of these:

1. I'm not a big risk taker. In fact, I'd say I'm risk adverse/very conservative. That said, the few times I have taken what I consider to be a decent risk, it's paid off. Most notably, my rental properties are now the biggest source of my early retirement funds.

2. Yes, yes, and yes. I have consistently read throughout my working career in an effort to improve myself. And as I did, my career blossomed. Reading later translated into listening (audio books and podcasts) so I could consume even more material. For over 25 years my car was my university. Yes, I could have listened to music or talk radio, but I preferred to listen to non-fiction books. IMO this was one of the key reasons I was able to grow my income so dramatically.

3. I know the "old saying" that your income is the average of the five people you hang out with the most, but this has never been the case for me. Most of my friends are average, middle class people who make a lot less than I do. However, I did try to learn from the more successful people I'd meet at business events, seminars, church, you name it. I am always open to taking the wisdom of those who are where I want to be.

4. I've been reading/implementing The Miracle Morning: The Not-So-Obvious Secret Guaranteed to Transform Your Life (Before 8AM) and I agree, there is power in a morning ritual. Combine that with getting up earlier than usual and you can get far more done than the average person -- and thus get far better results.

5. I have annual goals that I break down into daily habits. I actually set goals for these habits and track them via a point system on a spreadsheet. I know, it's a bit anal-retentive. But I know myself. If I set goals, monitor them, and have a reward (the points), I'll accomplish what I want to. If I don't, I won't. I set the goals at the end of each year and update major tasks quarterly. It works for me.

How about you? Do you follow any of these habits?

Americans Have Low Net Worths

After posting Americans Have Way Too Much Credit Card Debt, here's another set of facts that show the average American isn't very good with money.

Time lists the average net worths of Americans by age as follows:

• Less than 35 years old: $6,676
• 35-44 years old: $35,000
• 45-54 years old: $84,542
• 55-64 years old: $143,964
• 65-69 years old: $194,226
• 70-74 years old: $181,078
• 65 years old and older: $155,734

Not great numbers.

But wait, it gets worse.

Here are the net worth numbers excluding home equity:

• Less than 35 years old: $4,151
• 35-44 years old: $14,226
• 45-54 years old: $25,005
• 55-64 years old: $45,447
• 65-69 years old: $43,921
• 70-74 years old: $31,823
• 65 years old and older: $20,366

So when you look at it, Americans have saved very little once the value of their homes is excluded.

That's not good for retirement.

Here's Time's commentary on this situation:

"Generally, the rule of thumb is that retirees should plan on tapping retirement saving to the tune of 4% annually. However, following that advice means that if you’re retiring with a $100,000 retirement nest egg, you’ll only be taking out $4,000 per year. If you combine that income with Social Security income — the average retiree receives $1,333 per month — then you’re talking about less than $20,000 per year in income. That’s unlikely to be enough to live on."

Uh, yeah.

Again, not a shocker that it's bad news.

Overall, Americans need to live within their means and widen the gap between income and savings. Then they need to invest the gap so it grows into a substantial asset base. Those few steps would go a long way to correcting the disturbing numbers shown above.

Average and Median Net Worths

Here's an interesting article from CNN Money. It has a bit of "down with the rich" tone that I dislike (they say the U.S. has the "top rank in one net worth measure -- wealth inequality") but it lists average and median net worths for Americans, two numbers I don't recall having seen together previously.

The facts:

• Average American Net Worth: $301,000
• Median American Net Worth: $44,900

As they point out, a few very wealthy individuals bring up the average and that's why there's a big difference in the two numbers.

A few other interesting facts:

• Americans' median wealth puts us in 19th place in the world, below Japan, Canada, Australia and much of Western Europe.
• The median wealth of American families was $77,300 in 2010, a nearly 40% drop from 2007, according to Federal Reserve statistics. (due to the economic crisis)
• Australians have the highest median net worth, coming in at $219,500.

The article notes that "those down under have a mandatory retirement savings program, where they must squirrel away more than 9% of their income for their Golden Years, and they carry relatively low credit card and student loan debt." No wonder they have higher net worths -- they spend less and save more!!!

The piece says it's easier to borrow in America which eats away at a person's net worth. Yes, yes it does, especially if it's uncontrolled.

I was taken aback by the low net worth number. If most people have net worths in the $30,000 to $60,000 range, that's pretty poor IMO. What are these people going to do in retirement? How are they going to make it?

Anyone else have thoughts on these numbers?

How Much Do You Need to be Rich?

This article from the NY Times is interesting for a few reasons:

1. It equates being "rich" with your annual income (at least in part), a frequent mistake by the mainstream media.

2. It verifies something we've addressed frequently here: the more you have, the more you think it takes to be rich.

3. It shows that even those who likely are rich (higher net worths), don't think they are.

It lists what people at various incomes think is needed (in net worth) to become rich as follows:

• Annual income under $25,000 -- Need $293,000 to be rich
• Annual income $25,000 to $60,000 -- Need $394,000 to be rich
• Annual income $60,001 to $120,000 -- Need $426,000 to be rich
• Annual income greater than $120,000 -- Need $501,000 to be rich

So, that's America's opinion. What's yours? If you had to list a net worth at which someone becomes "rich", what would that be?

Or can it even be done?

Sure, we can go by averages and the like and look at the top 5% or even the infamous top 1%, but do things like expenses come into play?

And "rich" is a tough word to define anyway, isn't it? Does it mean wealthy enough to care for yourself or wealthy enough to buy a small country?

Personally, I think if you have enough assets to provide for yourself and those you care for, then you are rich. That could be $200,000 or $200 million. But maybe that's too simplistic of a view.

What's your take?

One Step that Leads to Wealth

Lifehacker shares a post from Budgets are Sexy (a site I love, BTW) that guarantees you'll become wealthy if you just take one of these simple steps:

1. Max out your ROTH IRA every year ($5,500)
2. Max out your 401(k) every year ($17,500)
3. Max out BOTH your IRA and your 401(k) every year! ($23,000)
4. Pay off your entire mortgage and save the future payments

And here's the thinking behind this:

You do any of those on rotation year in and year out, and I guarantee you'll reach financial freedom in 20-30-40 years from now. All depending on your expenses, and lifestyle, yada yada… (And if you're not in a position to invest large amount of money every month/year, at least start with SOMETHING. Even just $100 or $200 a month can do enough to snowball you towards your goals faster!)

I agree and disagree. I agree in the sense that if you do almost anything that allows you to invest several thousand dollars each year for 40 years, you'll be wealthy at the end of those four decades. I disagree (a bit) because it's not that simple. There are several steps most people would have to take to get even close to saving $23k a year, especially considering the average household earns about $50k a year.

And while I appreciate the simplicity of the advice, I prefer multiple steps toward wealth. Saving/investing plus growing your income plus  keeping your cost of living low and so forth.

What's your take on the list? Good or bad?

Net Worth Gains through the Years

I love, love, love Quicken and have been using it for years -- almost two decades now. One thing I like so much about it is that it allows me to track my net worth and see my progress over time.

I thought I'd share my net worth gains by year (from Quicken) to demonstrated how the path to growing your net worth is not one straight climb. Sometimes it's up a bit and sometimes it's up big. And sometimes it's even down. Here are my results.

Over the past 17 years, my net worth has had a compound annual growth rate (CAGR) of 12.5%. But the gains versus the prior year have never been 12.5% exactly. Instead, they are as follows:

• 1997 - 15.6%
• 1998 - 22.8%
• 1999 - 18.6%
• 2000 - 14.2%
• 2001 - 9.7%
• 2002 - 4.8%
• 2003 - 28.3%
• 2004 - 17.5%
• 2005 - 7.2%
• 2006 - 19.9%
• 2007 - 13.3%
• 2008 - -15.7%
• 2009 - 28.8%
• 2010 - 20.9%
• 2011 - 7.0%
• 2012 - 15.9%
• 2013 - 19.5%

A few comments:

• I've only had a couple bad years -- both driven by bad years in the stock market. 2008 was my only down year and I think we all know what happened to cause that. 2002 wasn't that great either because the dot com bubble burst.
• In the early years my gains were mostly driven by my savings rate. We made much more than we spent and the difference went to growing our net worth (we invested the money for later growth.)
• The last few years have been driven by the stock market. I kept investing all through the 2008 crash and those funds are up dramatically since then. In fact my best year was 2009, the year after the crash. It's noteworthy that my second best year was 2003, just after the bubble burst.
• Four years had gains above 20%. I love those years. :)
• As for absolute dollars, 2013 was the best. Almost a 20% gain on a significant net worth is awesome. I hope I have a few more of those in my lifetime.

Ok, so not much to learn in this post, but kind of fun to look at the numbers.

How about you? Does anything stand out as you look at your net worth results?

2013 Net Worth Review

Each year on FMF I post a review of my net worth and detail the ups and downs of the previous year. Here are my 2013 net worth highlights:

• Net worth ended 2013 at another all-time high, up 19.5% versus the previous year. This was well below the S&P 500 return of 29.6% because a good portion of my net worth is in investments or categories that are not designed to grow quickly (or even at all.) For instance, my real estate holdings are designed for income, not growth. I could assign them an appreciation amount (based on current market conditions, they are up 20-40% since I purchased/improved them), but have chosen not to. And assets like my house, cars, and cash investments either don't gain value (at least any I recognize) or lose it (I have one car completely depreciated and the other will be done this year).
• In addition, I continued to add a liability to my net worth. My kids are in high school and college isn't that far off. I have always included the value of their 529s in my net worth, but now that those dollars will be spent within the next several years, it's time for me to recognize the expense side. So I created a liability for college costs in 2012. I added $60,000 in "debt" in 2013, dragging my net worth down further.
• On the plus side, I am a strong saver and the index fund investments I did have performed very well. And a 20% gain on what is now a fairly sizable net worth is a substantial amount of money in itself.
• I had record net worth highs for eleven of the twelve months in 2013. That certainly made for a nice year. :)
• This year's performance brings the compound annual growth rate of my net worth to 14.79% over the past 17 years (I started tracking it in 1996).
• I should hit my crossover point in a year or two. That said, I have re-done my retirement plan and upped my goal significantly. My current plan is to work for 10 more years (I like my job, so why not?) and retire at 60. That said, I may get there and decide to work another 10 years. :)
• My rental income was low as I made substantial investments in the properties. I also had several months where units were not rented because they were being remodeled. I should have all the major efforts completed by the end of May and all units at their max earning capacity by summer. I will give a more-detailed update once the smoke clears, but first I need a post on the third property I have purchased.
• At the end of the year, I bought a new (literally) house in my new city for roughly twice what my old one cost. It wasn't my preference to sink so much into a non-performing asset, but it was the best option we had given our location, preferences, etc. FYI, we paid cash for it and continue to have no debt.
• I've already shared many of my resolutions for 2014, but I'll add a couple more: 1) invest all the cash from my 401k rollover into appropriate index funds (I'm about half way done) and 2) Add another $60k in "debt" for college costs -- which should get me "fully funded."

In addition to the information above, here are a few fun facts I thought you might enjoy:

• 88% of my 2013 income was from my career (which this year was two jobs split almost in half.) I expect this percentage to go down as my rental units come up to speed.
• Of my income, 39.6% went to taxes. This includes payments for 2012 taxes in April, payment of quarterly estimated taxes in 2014, and "regular" deductions from my paycheck. I'm expecting a refund this year as I paid Social Security taxes twice at two different jobs (and paid the max on each of them.) In addition, I sold some securities last year to buy rental units and that drove my income artificially high, so I'll actually have a lower income this year.
• 25.7% of my income went to giving. This was split between my church and three major charities we support. We used to give a small bit to 25 or 30 charities and now we give a lot to three.
• The remaining 34.7% went to spending and saving. There was roughly an equal split between the two.

That's it for this year! How did your net worth perform on 2013?

Two Books that Will Change Your Financial Life

I get asked all the time if I can recommend a good book on money management. I can actually name two, but more on that in a minute.

I have read hundreds of books on all sorts of financial topics -- general money management, investing, retirement, and on and on. Unfortunately the vast majority of them aren't worth the paper they are printed on. They are poorly written and contain little valuable information.

That said, there are many books that stand out for one reason or another -- and I mean this in a positive way. They do have good information and are worth anyone's time in reading.

However, there are only two books that I believe warrant a whole-hearted endorsement from me. They are both general money management books and both, if read and applied, will change a person's financial life for the better (they have changed mine, that's for sure). In fact, if applied over a lifetime, they will almost certainly make a person wealthy.

The Millionaire Next Door

I first read The Millionaire Next Door: The Surprising Secrets of America's Wealthy shortly after it was published in 1996. I was out of graduate school, married, and a few years into my career. I had been working on eliminating debt from my life (yes, including my mortgage), but this book pushed my financial vision into over-drive.

The book's message is that most millionaires in America aren't the ones living in huge homes, driving expensive cars, and taking extravagant vacations. In reality the average American millionaire is just your typical guy next door. He's unassuming and someone most people would never pick as being wealthy. That's what made this book such a phenomenon -- its findings turned conventional thinking on its head.

The book highlights seven common denominators among those who successfully build wealth. They are:

1. They live well below their means.

2. They allocate their time, energy, and money efficiently, in ways conducive to building wealth.

3. They believe that financial independence is more important than displaying high social status.

4. Their parents did not provide economic outpatient care.

5. Their adult children are economically self-sufficient.

6. They are proficient in targeting market opportunities.

7. They chose the right occupation.

After reading the book, I applied every one of the learnings above except #5 (since I don't have adult children). And my finances benefitted greatly from doing so.

The Richest Man in Babylon

Shortly after reading The Millionaire Next Door, I stumbled upon The Richest Man in Babylon: George S. Clason's Bestselling Guide to Financial Success: Saving Money and Putting It to Work for You, an equally life-changing personal finance book.

The Richest Man in Babylon is a parable of a wealthy man in ancient Babylon who gives a friend "seven cures for a lean purse" as follows (along with a summary of each):

Cure #1: Start Thy Purse to Fattening - Save 10% of your income.

Cure #2: Control Thy Expenses - Keep spending low.

Cure #3: Make Thy Gold Multiply - Invest to grow your wealth.

Cure #4: Guard Thy Treasures from Loss - Don't lose money when you invest - protect your principal.

Cure #5: Make of Thy Dwelling a Profitable Investment - Own your own home.

Cure #6: Insure a Future Income - Turn your wealth into a retirement income.

Cure #7: Increase Thy Ability to Earn - Study to become wiser so you can make more money and manage it better.

Just look at those tips! All of them are extremely solid! I think we've heard a lot of these from the millionaires we've talked to.

Applying the concepts in these two books did one thing for me: made me a much, much better money manager. But really, if a person just read and applied either one of them over a decent period of time, he would be wealthy.

That's why I can wholeheartedly recommend these books to ANYONE looking for a good book on personal finances. If you haven't read either of them, do so immediately. Then do your loved ones a favor and have them read these -- especially your kids, relatives you have that are graduating college and high school, and so forth. Doing so will change their lives forever and the earlier someone begins applying these principles, the better!

Six Steps to Make the Most of Your Finances

You've heard of the Pareto principle, right? It states that, for many events, roughly 80% of the effects come from 20% of the causes (or effort.) This holds true in all sorts of situations.

In business, 80% of the profits are usually generated by 20% of the products. At church, 80% of the serving is done by 20% of the members. At non-profits, 80% of the giving is done by 20% of the population. This example holds true in almost every case -- whether you're talking about selling cars, training for a marathon, or going to school. No matter the subject, a select few of the (sometime endless) potential steps are the key ones that generate the vast majority of the impact.

Managing your finances is no different. You don't need to know complex tax strategies, complicated investment formulas, or the legal ramifications of one estate planning strategy versus another. If you simply focus on a few key steps and apply them faithfully over time, you can become wealthy.

What are these principles that give you the most financial bang for your buck (or time/effort in this case)? Here's my list:

1. Spend less than you earn.  Many people seem to have forgotten this rule, but it really is that simple.  You must spend less than you earn if you ever hope of making any financial progress. If you don't you'll be going backwards no matter how much you make. Of course there are two parts that make this tip work: 1) make a good income and 2) control spending.

2. Grow your career. It's much easier to spend less than you earn, as well as grow your wealth, if you maximize your income -- and your career is by far your largest source of income. If you work at making the most of your career, it can mean a few extra million dollars over the course of a working lifetime.

3. Earn extra income. Many people can become wealthy simply from their career earnings. But if you want to super-charge your finances, you'll need to do better than that. You need to earn extra income that can supplement what you make from your job. Fortunately, I've listed 11 great ways to earn extra money to give you a head start.

4. Save.  The difference between what you make and what you spend is your gap. You want your gap to be as large as possible so you have cash available to grow your wealth. Your first step is to save enough for a good emergency fund, The second step is to start accumulating funds for your other life goals: retirement, college, major purchases, and so on. A great place to start is to maximize your employer's retirement match. If your employer matches your contribution up to a certain amount, invest at least that amount every year.  You are essentially doubling your money and taking advantage of a great employment perk.  Plus, you will save on taxes. What's not to love?

5. Invest wisely. Saving is not enough. Once you have saved you must grow those savings to be able to generate substantial wealth. Fortunately getting a good return on your money isn't that hard. I use index funds because they are simple, easy, and, after expenses, beat the vast majority of other investment alternatives.

6. Avoid money mistakes. Even if you take all the steps noted above, your finances can be derailed if you don't avoid the 10 worst money mistakes anyone can make. Not  having enough insurance, buying too much house, getting into debt, and a whole host of financial killers are out there waiting to suck up your hard-earned wealth. Avoid them like the plague because that's what they are -- financial plagues looking to kill your progress towards financial success.

So that's my list -- and the steps that most millionaires have taken to become wealthy -- the 20% (probably less) of the personal finance steps you can take that will get you 80% (or more) of the results you seek. And in America, 80% of the financial results means that you will be very well off indeed.

For those of you who have done well financially, did I forget anything?

The Flow of Wealth

As I have moved into real estate investing in an attempt to generate income for when I retire, I have been thinking about the "flow of wealth" over the course of a person's lifetime (or at least the flow someone who manages his money well will experience). Here's how I see the flow taking place and changing over time:

Income First

This stage is early in a person's working career. They are focused on their job, trying to buy a house, paying down debt (usually from college), and so forth. They are using their income to become established financially and there's not much left over after the basics are covered. Unfortunately many people have a broad view of the "basics" and thus spend much of their lives in this phase. IMO, you should be in this phase for five years at the most.

On to Wealth-Building

Over time, the person gets a handle on his expenses/debts and his income starts to climb. He begins seeing a bit left over and works on growing his wealth. He saves and invests more and more each year, increasing his net worth over decades until he has created significant wealth for himself. This is the bulk of a person's lifetime -- perhaps 40 years or more in length.

Back to Income

Once a person has accumulated enough wealth and wants to retire, his challenge is to transfer this wealth into income, at least in part. He will likely need to spend part of his wealth as well as income that wealth generates in order to provide for himself in retirement. Or, if he is ambitious and has the financial ability, he could develop a plan where he lives only on the income the assets generate (I plan to do this using real estate and dividend investing. For those of you interested, here are the details on my real estate holdings so far: Property 1 and Property 2).

I'm currently between the "wealth-building" and "back to income" stages. Where do you fit on this spectrum?

Money 101: How to Measure and Track Wealth

This piece is part of a series I'm calling Money 101 and is designed for those who might not be as advanced in their personal finance knowledge and experience.

One key to building wealth is to measure it and track our financial progress. Just like there's no way to tell what's happening in a sporting event without a scoreboard, you can't measure your success in wealth building without some sort of tracking.

Income is Wrong

In almost every article written by the mainstream media, "wealth" is used interchangably with "income." While the amount of money you earn each year (income) does have a major impact on whether or not you have the opportunity to accumulate great wealth (and how quickly/how much), the two are far from the same thing.

I believe this mix up occurs for two reasons. The first is ignorance. Most of the people reporting on personal finances know very little about the subject -- at least managing money on a day-in day-out basis. Sure, they might be educated or have read several books on the subject, but they are (generally) not wealthy and as such don't know the ins and outs of how to grow great wealth and track it.

The American public is no better. Most believe that someone making $100,000 a year in income is "rich" while someone making $30,000 a year is "lower-middle-class." But if they knew that the person making $100k spends $125k a year and the "poorer" person spends $25,000 a year, they might think differently. But Americans rarely consider the expense side of the equation (which accounts for the poor state of finances many have.)

The second reason is data availability. Income data is readily accessible in large amounts and thus easy to use in articles and posts. It doesn't make it right, but it's the truth.

True Measure of Wealth

There is one true measure of wealth -- how much you own. It's called "net worth."
 
Net worth in its simplest form is assets less liabilities. You add up the value of the assets you own: investment accounts, banking accounts, retirement funds, real estate, and the like. Then you subtract every debt you owe: mortgage, car loan, credit card balances, student loans, etc. The difference is called your "net worth". It's the amount you truly own. It tells how "wealthy" you are.

In my opinion, net worth is the single-most important financial measure to track. It not only tells you how much you own, but when looked at over time it lets you know whether your wealth is increasing or decreasing and by how much. It's an accurate and (unfortunately in bad times) ruthless measure of how you're doing in growing your wealth.

As such, it's vital that you measure your net worth on a regular basis.
 
Tracking Your Net Worth

There are different ways to track your net worth. You can use the old-school method of a simple sheet of paper, a more modern option like a spreadsheet, or an automated selection like Quicken. Which option you choose doesn't really matter. As long as you're consistent, you'll be able to determine if your actions are growing your wealth or not.
 
Personally, I track mine monthly. Each month in Quicken I update the performance of my investments, put in my income and spending, and run a net worth report. I then record it in a spreadsheet and compare it to the other months of the year as well as my status for the same month the prior year. (I know, this last part is a bit overkill, but I'm that kind of tracker.) Doing this gives me a quick report card on how I'm doing managing my money and highlights where I might need to make changes. In addition, I record my final net worth at the end of each year (and have done so since the early 90's.) That's how I know that my net worth has grown at a compounded annual rate of roughly 14.5% since then.
 
I used to update my net worth weekly, but that was simply too obsessive -- even for me. In addition, there were too many wild swings (up big one week, down big another) as the market went up and down, big bills were paid, etc. Looking at it only once a month seems to level the swings a bit. As such, this time frame works best for me.

Monthly tracking is probably the most frequent you'd want to monitor your net worth (any more frequently doesn't really give you enough time to see progress.) Others measure their net worth quarterly or twice a year. I recommend that you check it every three months at the very least. Whatever your timeframe, just be sure you review your net worth regularly. 

Bottomline: Tracking your net worth (and then responding based on what you find) on some sort of regular schedule is a must for any serious money manager, and doing so is a vital habit in the quest to become wealthy.

Where is Your Wealth?

Here's a piece from CNN that details where Americans keep their wealth (what there is of it -- the median net worth is $69k). The summary:

The composition of that wealth has changed over time. Back when Ronald Reagan was president, home equity made up nearly half of young adults' net worth, while interest-earning accounts, like those at a bank, accounted for a quarter of senior citizens' wealth.
 
Those figures are very different today, with retirement account assets playing a larger role in the portfolio of Americans of all ages. This comes as folks become ever more dependent on 401(k) accounts -- which companies started offering in the early 1980s -- to see them through their Golden Years as traditional pensions dwindle.

Here's how my net worth breaks down:

• Retirement investments (401k and IRAs): 41%
• Real Estate: 22%
• Non-retirement investments: 20%
• Cash and cash equivalents: 15%
• College savings: 7%
• Debt: -6%

And a few notes:

• Retirement investments - Includes my current 401k plus other 401ks that my wife and I have rolled over to IRAs.
• Real Estate - Includes value of our home as well as investment properties.
• Non-retirement accounts -- Our investment accounts at Vanguard, much of which has funded my real estate investing.
• Cash and cash equivalents - Includes amounts in checking accounts, savings accounts, and CDs (emergency fund money) as well as cash on the sidelines in preparation for future real estate purchases.
• College savings -- 529s and Coverdell accounts.
• Debt - I don't have any official debt. I paid off my mortgage 15 years ago and pay cash for my cars. But I have created a liability line in Quicken (where I track my net worth) for future obligations I know are coming: college expenses for the kids, tax payments, and giving (yes, I purposefully create a "liability" for giving commitments I have made in advance.)

So I guess I fit the mold of having more money in retirement accounts and less in real estate (compared to past years). That said, I see the real estate portion growing a bit more -- maybe to 30% or so.

What's your net worth breakdown look like?

2012 Net Worth Review and Giving Update

Each year on FMF I post a review of my net worth (here's the one from last year) as well as list the charities supported by FMF (here's the list from last year) during the previous year. This year I'm combining the two into one post.

Net Worth

Here are my 2012 net worth highlights:

• My net worth ended 2012 at another all-time high, up 15.9% versus the previous year which was very close to the S&P 500 return of 16.0%. Note that this includes my entire net worth -- including the value of items that didn't go up during the year (like my house, my cars, and cash investments), which weren't inconsequential in total value. It also includes my savings during the year.


• In addition to this gain, I added a liability to my net worth. My kids are in high school now and college isn't that far off. I have always included the value of their 529s in my net worth, but now that those dollars will be spent within the next several years, it's time for me to recognize the expense side. So I created a liability for college costs. I booked a good amount of costs in this year, so much so that if I had not included it, my net worth would have been up another 1.8% to 17.7% overall.


• I had record net worth highs for nine of the twelve months in 2012. That certainly made for a nice year. :)


• This year's performance brings the compound annual growth rate of my net worth to 14.52% over the past 16 years when I started tracking it in 1996.


• If my net worth continues growing at this rate, I should hit my crossover point in three years. In addition, I made up ground I lost last year in my retirement net worth goal and now I am a bit ahead of projections.


• My growth projection for 2013 is actually a bit lower than that at 11.8%. It includes an 8% growth estimate for my investments plus savings from both my income as well as my rental real estate holdings.

Charities

One of my resolutions last year was to concentrate my donations on fewer charities. I certainly accomplished that this year. In addition to my church, here are the charities FMF supported in 2012:

• Eagles Summit Ranch
• House of Mercy
• Meijer Gardens
• Salvation Army

That's it for this year! How did your net worth perform on 2012?

How to Reach $1 Million

CNN Money recently ran a series on how to get to $1 million in net worth. They featured several articles, each purporting to help you accumulate $1 million on their own. The ideas: investing, owning rental real estate, launching a business, saving money, and climbing the corporate ladder. Each option came with a few suggestions to make the most of each method to get to $1 million.

Overall the tips were pretty basic and fairly weak IMO -- as well as not being very realistic. Not very many people can get to $1 million in net worth with just one of the ideas above. But used in combination they can make you wealthy. However that's not as much of an attention-grabbing headline. :)

If someone asked me how they could get to $1 million in net worth, here's what I would tell them:

• Start by picking the right college and the correct major. The "right" college is the one that maximizes the trade-offs between costs and benefits (with the benefit being career-long earnings). The "correct" major is one that you like (not love) that can earn you a great living.


• Cash in your degree to get a great first job with a brand-name company. I've told why this is important previously, so I won't repeat myself, but if you want details, see Five Steps to Six Figures in Seven Years.


• Work to maximize your career. It's your #1 financial asset, so growing it can have HUGE benefits to your finances.


• Earn extra money. Add to your career earnings by making money on the side. There are many ways to do this. For some of the most popular (and easiest) ways to earn some extra cash, see 11 Great Ways to Earn More Money and 7 More Great Ways to Earn More Money.


• Keep your spending as low as possible (enjoying life, of course, but not spending everything you have.) The combination of an ever-growing income and low expenses will increase the gap between the two -- and your gap is what you need to fuel your net worth growth.


• Invest your gap as soon as you can and for as long as you can. My investments are in index funds (including stocks, bonds, international stocks and the like) and real estate. Yours may or may not be the same, but whatever you do, develop a plan to make sure your gap money grows as much as it can.


• Avoid major money mistakes. You can take all the steps above and still derail your finances by making one (or a few) of the worst money moves anyone can make. Avoid them like the plague because they can be the death of your net worth.

If you take these steps over the course of many years (and repeat them again and again), you will become a millionaire. And it's likely you'll become a multi-millionaire eventually.

Anyone have anything to add?

Your Financial Health

The following is an excerpt from Securing Your Financial Future: Complete Personal Finance for Beginners courtesy of Rowman & Littlefield Publishers. All Rights Reserved.

If you want to know how tall someone is, you have them stand on a level surface, back against a wall, then make a mark on the wall and get out a tape measure. If you want to know how much someone weighs, you have them stand on a properly calibrated scale. Simple, right?

But what if you wanted to measure someone’s financial condition? When I said earlier that our goal is to achieve a strong financial position, what did I mean by that? How is personal financial strength measured? What is the equivalent of inches or pounds when it comes to personal financial health?

It’s an important question, because you won’t be able to tell if you’re succeeding unless you’ve got a way to measure your progress. To find your way using a map, the first step is identifying the you-are-here point—and knowing where you are requires a measurement.

The way we measure personal financial health is called net worth.  Net worth isn’t an opinion or an impression; it is a very well-defined measure with a specific definition that is widely accepted. We’ll describe how to calculate it shortly, but before we do, most people find it helpful to understand it conceptually first—and for that, we need an analogy.

The Net Worth Bathtub

Think of an ordinary bathtub. When you turn on the faucet, water runs into the bathtub. The water will stay in the tub until the drain is opened. This tub has a really big drain, and it is adjustable. So it is possible to drain the water out more slowly than it is coming in, faster than it is coming in, or at exactly the same rate. Got it?

You’ve probably already figured out that the faucet represents money coming in. This is income from all sources: the paycheck from your job or jobs, your lottery winnings, gift checks from your grandparents, whatever. The drain, of course, is money going out: paying your bills, buying airplane tickets, money in wallets that you lose, and so on. Obviously, when water is coming into the tub faster than it is draining out, the water level in the bathtub will rise; when water is draining out faster than it is coming in from the faucet, the water level will fall.

Now here is the point: when it comes to personal financial management, what we care about most is the water level in the bathtub. The water level in an individual’s bathtub represents that person’s net worth. Other terms for a high water level are rich or wealthy. So the object of the game is to increase your net worth. Fill up that bathtub! All that we have talked about, and will talk about, are strategies to increase your net worth. Any financial decision that you make should be made with net worth in mind.

Some very important realizations are apparent from the bathtub analogy; in fact, they’re so obvious that they hardly need to be pointed out. If you want the water level in the bathtub to rise, then the drain has to be adjusted to a rate that is slower than the faucet is running. And the longer the drain is running slower than the faucet, the higher the water will rise. Stated a different way, it isn’t the absolute rate that the drain and faucet are running that is important—it is the relationship between the two.

Common Misconceptions

Even though these implications are quite readily apparent when it comes to bathtubs, it is amazing how murky people’s thinking can get when applying the same ideas to personal finance. The two most common misconceptions are to confuse either the faucet or the drain with the water level. Let’s look at them one at a time:

Misconception #1:  The faucet is all that matters. A fast-running faucet means a really high income, right? In many different ways, the faucet gets so much publicity that it is easy to see how some people get the idea that this is really the only important goal. In our culture, a high income is regarded as prestigious or even glamorous. Controlling expenses and being thrifty (or watching the drain closely) are often regarded as the opposite—only for those with very low incomes.

Anytime income tax rates are in the news, the news media like to refer to people in the higher income tax brackets as “the rich.” This serves to further the misconception that high income automatically means high net worth.

High earners in the upper tax brackets may or may not have parlayed that high income into substantial wealth; it depends on how well—or not—they have managed their drain.

Misconception #2:  The drain is all that matters.  A fast-running drain means lots and lots of spending. If we see someone who is driving a luxury car, maybe even has a few extra cars, lives in an expensive home, and takes a lot of extravagant vacations, it is not uncommon to hear their neighbors conclude, “Oh, that person is really rich!” (In fact, one of the main reasons that this person buys all those things may be precisely because he or she wants the neighbors to say that.)

The idea that a wide-open drain is proof of a full bathtub is regularly reinforced culturally, too. It is a favorite theme of advertisers; after all, it doesn’t do the advertiser any good when you tighten your drain controls. Their job is to get you into a “spend spend spend” frame of mind. It’s also a favorite theme in most popular entertainment. A rich-looking hero speeding away from his or her mansion in an ultra-hot sports car probably captures your attention a little better than one who is huddled over a spreadsheet, intently preparing next month’s budget. Just remember: your financial life is not fictional. Advertisers and media have their agendas, and that’s fine—you have your own.

Despite these misconceptions, the truth is pretty easy to understand when you think about the bathtub analogy. Neither the faucet, nor the drain, is the be-all and end-all when it comes to increasing net worth; it is the relationship between the two. A fast-running faucet provides a better opportunity to increase net worth, but it won’t happen without proportionate drain control. Watching expenses carefully may not be portrayed as something that wealthy people need to be concerned with, but controlling spending is essential to building a high net worth.

A famous book titled The Millionaire Next Door by Thomas J. Stanley featured detailed, survey-based descriptions of the lifestyles of the wealthiest people in the United States. In fact, the subtitle of the book is The Surprising Secrets of America’s Wealthy. By now, you might be able to guess what the surprise is: the most common profile of America’s wealthy does not conform to either the big faucet or the big drain stereotype. In fact, it is surprisingly common for those with big faucets to fall into a big-drain habit that leaves them with only modest water levels. Instead, it is quite a bit more common for wealth to be built by consistent drain control. Most of America’s wealthy turn out to live in much less expensive homes than they could afford, to buy used cars, and to generally avoid any spending that could be considered extravagant.

Does this surprise you? It is certainly a very different picture than the way that “wealthy” is usually portrayed in the popular culture. But it makes sense when you think about it, using the bathtub analogy. In a way, it is a classic illustration of the old saying “You can’t have your cake and eat it, too.” America’s wealthy have their cake. America’s biggest spenders have eaten most of theirs, and now it’s gone.

Take a minute to think about this . . . it is really important for this point to sink in. Once it does sink in, you’ll never think about spending money in the same way again. You’ll stop associating spending with what it can buy you today; instead, you’ll view spending as lost opportunities to save, invest, and grow your net worth. This way of thinking will then become a powerful transformational habit for you. If you want the freedom to retire early, or to weather any kind of unanticipated financial storm, or to be in a position to help those close to you if needed, you’ll want to have most of your cake left. That means that you’ll have to keep a careful eye on how much of it you eat—plain and simple.

The Two Ways To Track Financial Success

How do you know if you're reaching your financial goals or if you're making financial progress? And what can you do to get to where you want to be at a faster rate? These questions get to the heart of one simple matter: you need to keep track of your finances by calculating two simple measures on a regular basis.

These two measures are net worth and cash flow. Knowing them will tell you how you are doing financially. They will also give suggestions on actions you can take to improve your financial situation. With these two key metrics alone, you can measure and track your success in growing your net wealth.

What is net worth?

Net worth is simply the total amount of assets that you own less the value of the debts you owe. Another way to think of it is it's what you would have left over if you sold everything and paid off all your debts.

Written as a formula it looks like this:

Total assets - Total liabilities = Net worth

For example, if you had a $200,000 home, $50,000 in a Roth IRA, $20,000 in credit card debt, and a $100,000 mortgage, you would have a net worth of $130,000 ($250,000 - $120,000).

Net worth reveals your true wealth. In today's media we often hear "wealth" described in terms of income (how much someone makes annually.) But it's not what you EARN that makes you wealthy, it's what you KEEP. This is what net worth measures.

Taken at a point in time, net worth tells you little. Sure, it can let you know if you are in positive territory (own more than you owe) and give you a relative comparison to how others are doing, but those uses are rather limited. Net worth is most useful when it's tracked over time. In this way you can see if you're making financial progress -- if your wealth is increasing. This is why Free Money Finance's tagline is "grow your net worth." Because if you're growing your net worth, you're making financial progress and becoming more wealthy.

As such, it's vital that you measure your net worth on a regular basis. Personally, I update mine once a month (which is pretty easy to do using Quicken) and this is probably the most frequent you'd want to monitor your net worth (any more frequently doesn't really give you enough time to see progress.) Others measure their net worth quarterly or twice a year. I recommend that you check it every three months at the very least.

What is cash flow?

Cash flow measures the amount of income you make less the expenses you pay. It's what you have left over each month after you pay all your bills.

Written as a formula it looks like this:

Total income - Total expenses = Cash flow

For example, if you earn $2,000 a month after taxes and have expenses of $400 for food, $300 for a car payment, $500 for rent, and $500 for all other costs, your monthly cash flow is $300 ($2,000 - $1,700.)

Cash flow is a bit more complicated to track than net worth because it involves so many different moving parts. For instance, income can be made up of several sources such as salaries, dividends, interest, side jobs, hobbies, and any other payments that you receive. Expenses involve everything from taxes and mortgage/rent payments (generally among the largest costs most people have) to small purchases like a daily coffee, a magazine subscription, a sandwich, and everything in between -- anything you spend money on.

People track their cash flow over different periods of time depending on their stage in life, financial constraints (such as when income is made, when expenses are due, etc.), personal preferences, and the like. I recommend younger folks (people in their 20's and early 30's) and those who are close to having a cash flow at break-even (where income equals expenses) or, heaven-forbid, a negative cash flow (where expenses surpass income) track and record their cash flow once a week. Those who have a bit more space between income and expenses and those who have proven to be able to manage and control their finances with less tracking mechanisms can measure their cash flow less frequently like monthly or once a quarter.

I measure my cash flow once a month. Again, it's quite easy to do using Quicken. I suggest people look over their cash flow status at least once a month at the very minimum.

How net worth and cash flow work together

Tracking both net worth and cash flow is important because of how they work together to improve your financial standing. Your cash flow drives the assets you can purchase and debts you can pay off. Through careful planning of your cash flows every month, you are able to grow your net worth -- your true wealth. Here's how the cycle works:

• Each month, you make income from various sources.


• Each month, you have expenses from various commitments.


• The difference between income and expenses is what you have left over -- your cash flow.


• This cash flow is an asset -- which then adds to the "good" side of your net worth.


• In addition, you may have made debt payments from your cash flow that month that lowers the "bad" side of your net worth.


• If you create a surplus in this way month after month, you will grow your net worth over time and thus become wealthier over time.

In the examples above you have $300 every month left over in cash flow. In addition, let's say of the $1,700 in monthly expenses you had, $400 went to debts and decreased liabilities you had. As such, your net worth increased by $700 that month ($300 + $400). If you did this for a year, your net worth would increase by $$8,400 a year ($700 per month * 12 months).

Tips for growing your wealth

If you've followed along so far, you've probably realized that the formulas are pretty simple. If you want to become wealthier (which means increasing your net worth), there are only a few steps you can take to do so. They are:

• Earn more income. This has the result of increasing your cash flow and thus allows you to add more money to your assets and/or pay off more debt every month -- both of which increase your net worth. For ideas on how to make more money, see 11 Great Ways to Earn More Money.


• Decrease/limit your expenses. This has the result of increasing your cash flow and thus allows you to add more money to your assets and/or pay off more debt every month -- both of which increase your net worth. For ideas on how to lower your expenses, see my various "saving money" categories in the FMF archives (at the bottom).


• Do both. You can significantly improve your finances if you do both of the above -- grow your income AND decrease your expenses. This super-charges your cash flow and allows you to grow your net worth at an even faster rate.


• Increase the value of your assets. This involves managing your assets so they grow in value at a faster rate than they might if left on their own. For instance, $100k left in a CD might earn you 1% a year, contributing an extra $1,000 to your net worth annually. But the same $100k invested in an index fund could earn you 8% a year or $8,000 total. See how the actions you take can grow your net worth? Of course this is a very simplistic example and there are many other factors to consider. But for the purposes of this post it illustrates nicely the benefits to your net worth when you work to grow your assets.

Putting it all together

For the more experienced FMF readers, this post has probably provided few new insights. But for others, this information may be overwhelming. If that's the case, let me simplify the entire process for you. Here's a list of what you should do with the information above:

• Calculate your net worth. Do it soon so you know where you stand. Then set in place a regular update (like monthly) so you can monitor your progress.


• Calculate your cash flow. Do it soon and also plan to update it at least once a month if you fit the circumstances I've noted above.


• Look over your cash flow to identify ways you can grow your income and decrease expenses. Make a list of next steps to take and start knocking them off one-by-one.


• Look over your net worth and see if there are any assets you can grow. While it's difficult to increase the value of some assets (like your home), others (like investments in stocks and bonds) can often be sources for additional growth. Start to educate yourself on the potential options for making what you own work as hard as possible for you.

In the end, by tracking these two simple measures on a regular basis, you can take steps to significantly grow your net worth over time and ultimately meet almost any realistic financial objective you set for yourself.

2011 Net Worth Review

Once a month I update my net worth in Quicken (by adding in any expenses, updating my fund prices, etc.) And once a year I give you all a review of how I did the previous year. This is my wrap up for 2011. Here are the highlights:

• My net worth ended 2011 at an all-time high, up a "decent" 6.98% versus the previous year. Note that this includes my entire net worth -- including the value of items that didn't go up during the year (like my house, my cars, and cash investments), which weren't inconsequential in total value. This compares favorably to the market (S&P 500), which was flat. My gains were fueled by my savings throughout the year.


• I had record net worth highs for the first four months of 2011, with my peak at the end of April. From there the market headed down, down, down with every month lower than the previous one until October. In the end, my net worth on December 31 was the second-highest month end net worth of the year.


• This year's performance brings the compound annual growth rate of my net worth to 14.43% over the past 15 years when I started tracking it in 1996.


• This year I had my third-worst percentage gain in net worth though it was the seventh-highest in absolute dollars gained. Overall, my net worth is up 66.6% since the end of 2008 (which, BTW, was the only year I've had a loss in net worth.)


• If my net worth continues growing at 14.43% each year, I should hit my crossover point in five years. That said, I did not hit the retirement net worth goal I set in April, so I'll be playing a bit of catch-up this year to get back on track.

Overall, an "ok" year. If anything it reminded me to keep my savings rate high and keep plugging away. To make this happen, I'll keep doing the same old things: growing my career, spending much less than I earn, saving a ton, and investing in index funds. Hopefully the market will help me out at least a bit in 2012. ;-)

Compute Your Net Worth Once a Year

The following is a guest post from Marotta Wealth Management. I actually compute my net worth once a month. I'll be discussing my year-end 2011 net worth soon on an upcoming post.

Since the end of last year, the U.S. markets went up and then down and then back up to end the year sideways. Market volatility was especially pronounced in the European Union as sovereign debt and the struggle to enact austerity measures whipsawed the markets, although not as a result of any changes in the underlying fundamentals.

If you are within 20 years of retirement (age 45 to 65), it's critical to get your retirement planning updated. Computing your net worth annually is like taking a sextant reading to chart your course toward financial security. The changes of the past year provide another incentive to take stock of where you are in relation to your goals and readjust your asset allocation and savings rate.

Net worth gives you a snapshot of how much money would be left if you converted everything you owned into cash and paid off all your debts. Compute your net worth by creating four lists.

• Liquid assets: An asset is something you own that has significant value. A liquid asset can be sold in a matter of days. Include personal bank accounts (checking, savings and money market), certificates of deposit, bonds, mutual funds, stocks and exchange-traded funds. Use values as of December 31 of the previous year so all of your amounts are calculated on the same day.

• Nonliquid assets: Nonliquid assets are those things you own that incur a penalty when they are sold. Include the value of your retirement accounts (IRAs, 401ks, 403bs, SEPs, profit-sharing plans and pension plans). Add real estate investments as well as the market value of your home. Use the assessed value.

Other nonliquid assets may include proprietorships, partnerships or company stock in a firm that is not publicly traded. Add the cash value of any life (nonterm) insurance. Some people include jewelry, collectibles, cars and boats in this category. Although these items often have a high retail value, their true worth is often a small fraction of their initial cost. I do not recommend including personal property.

• Immediate liabilities: List what you owe to creditors. Immediate liabilities include credit card debt, car loans, student loans, other loans and any bill or debt that must be paid within two years.

• Long-term debt: For most people, long-term debt is primarily their home mortgage, but it may encompass other real estate or business loans.

The first time you gather all of this information will be challenging, but it gets much easier each subsequent year. By keeping an annual record of your net worth, you're creating a valuable financial planning tool.

Next compute three additional values. For your total assets, add your liquid and nonliquid categories; for your total liabilities, add your immediate liabilities and long-term debt; and finally, for your net worth, simply subtract your total liabilities from your total assets.

Use these net worth numbers to compute other values useful for reaching your financial goals. For example, your emergency reserve (liquid assets minus immediate liabilities) should be at least half your annual income. Any extra can be invested more aggressively for appreciation. Your debt load ratio (total liabilities divided by total assets) should be under 35%, with your home mortgage comprising most of your debt.

If you are trying hard to pay off your mortgage ahead of schedule instead of making a huge effort to save and invest, your attempts are laudable but mistaken. The quickest path to wealth includes holding a home mortgage you could pay off but you choose not to in order to take advantage of the tax benefits. The rich leverage wisely and invest.

A net worth statement helps you measure your progress toward retirement. At age 65 you can only withdraw 4.36% of your portfolio to maintain your lifestyle. In other words, to keep the same standard of living, you will need about 23 times what you spend annually.

Take your net worth and divide it by your annual take-home pay. The result shows you how many times your annual standard of living you have amassed in savings. If you are younger than 40, the number probably comes to less than five, which is adequate for now.

By age 45, you should be worth about seven times your annual spending. More sophisticated retirement planning includes the difference between taxable, tax-deferred and Roth accounts as well as Social Security guesses and defined benefit plans, but the method described here will approximate your progress. This list shows by what age you should have saved different multiples of your annual spending.

    Age: 26; Annual Spending Saved: 1
    Age: 31; Annual Spending Saved: 2
    Age: 34; Annual Spending Saved: 3
    Age: 38; Annual Spending Saved: 4
    Age: 41; Annual Spending Saved: 5
    Age: 43; Annual Spending Saved: 6
    Age: 45; Annual Spending Saved: 7
    Age: 47; Annual Spending Saved: 8
    Age: 49; Annual Spending Saved: 9
    Age: 51; Annual Spending Saved: 10
    Age: 53; Annual Spending Saved: 11
    Age: 54; Annual Spending Saved: 12
    Age: 55; Annual Spending Saved: 13
    Age: 57; Annual Spending Saved: 14
    Age: 58; Annual Spending Saved: 15
    Age: 59; Annual Spending Saved: 16
    Age: 60; Annual Spending Saved: 17
    Age: 61; Annual Spending Saved: 18
    Age: 62; Annual Spending Saved: 19
    Age: 63; Annual Spending Saved: 20

If your net worth is higher, congratulations! You may be able to retire earlier than 65. For every 1 unit you are over, you could consider retiring about a year earlier. Conversely, for every 1 unit you are under your age's benchmark, you may have to work an additional year beyond 65.

Between ages 40 and 50, your net worth should increase by 1 unit of your annual spending every two years. That means your current net worth divided by your take-home pay should be 1 unit greater than it was two years ago. And if you are between age 50 and 65, your net worth should have increased this year by 1 times your take-home pay.

Want to retire younger? Try lowering your standard of living. Most retirees spend about 70% of the gross salary they earned while working. If you can live off 50% of your take-home pay, it's not as essential to save as much.

Need to catch up? Save more than 15% of your take-home-pay. Determine how far you are behind and what additional percentage you can save each year. For example, at age 30, you should be worth 1.5 times your annual income. If your numbers don't match that ideal, an additional 0.3 times your annual income will help you get there. You could save an additional 10% of your income (for a total of 25%) for three years. If that's too much, try saving 20% (an additional 5%) for six years.

Money makes money. By the time you reach your 40s, you should have enough investments to be earning about half of your annual spending each year. Early in life what you save is most important for building wealth, but as you approach age 40 what you earn on your investments becomes critical. While you are young, the best advice a professional can offer is to "save." As you amass significant wealth, it is more pressing to "manage" well what you already have.

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Some thoughts from me:

1. I will be updating my retirement plan soon and will report my progress to you all.

2. I like the fact that he emphasizes saving based on retirement SPENDING and not on current INCOME (which in many cases are not closely related).

3. My net worth is at 24 times my annual spending, so I guess I'm ready to retire. ;-)

4. Key point: "Want to retire younger? Try lowering your standard of living. Most retirees spend about 70% of the gross salary they earned while working. If you can live off 50% of your take-home pay, it's not as essential to save as much." Exactly!!!!!!

5. "Money makes money." Usually this is true. This year, the way the market was up and down, not so much.

Your Lifetime Balance Sheet

The book Risk Less and Prosper: Your Guide to Safer Investing features an interesting look into what it calls your "lifetime balance sheet." It lists both assets and liabilities that every person has at the start of their working careers. The summary is as follows:

Assets

• Financial Assets -- presumably given to them if they have it before they have even started working
• Human Capital -- the ability to work and earn income

Liabilities

• Pre-Retirement Consumption Spending -- food, clothing, shelter, vacations, etc.
• Other Goals -- college for the kids is one, not sure what others are (savings for cars and the like maybe?)
• Retirement Spending -- what you'll need to spend to live in retirement

Given these, here's how the process goes over a lifetime:

• You have little, if any, financial assets when you start your working life.


• You then begin to work (using your human capital) and earn an income.


• Much of this income goes to pre-retirement consumption spending and other goals. The rest is saved as financial assets.


• As time goes on, you (hopefully) grow your income (human capital) while keeping your pre-retirement consumption spending as low as possible. This allows you to put more and more into your financial assets. (BTW, as you work you're also building up your Social Security "financial asset.")


• When you retire (assuming you no longer work at all), you simply have one asset (financial assets) and one liability (retirement spending) remaining. The hope is that the former is larger than the latter. ;-)

It's an interesting/different way to look at net worth IMO. Instead of simply looking at accumulating assets from a strictly financial point-of-view, it looks at the value of time and how you turn that time into money. I have a friend that says every dollar you have represents some time that someone has given of their life in order to earn it, which is so true. And the book's take above really highlights this fact.

The information also reinforces basic financial principles that need to be applied to be sure that final relationship (financial assets to retirement spending) turns out in your favor. These are:

• Maximize your lifetime earnings by doing a great job throughout your career. Doing so can help you generate millions of dollars more than you might have otherwise earned.


• Keep spending under control. If you don't it doesn't matter how much you make because you'll simply spend it all.


• Save as much as you can for as long as you can. This will help the financial assets you do generate to grow as large as possible on their own.


• Avoid the worst money mistakes anyone can make. If you don't, all your hard work and savings could easily be down the drain.

It's pretty simple stuff really (so simple that it can be boiled down to one formula or two sentences. Almost anyone can do it (assuming that they have at least a minimum amount of income), but many do not have the discipline to. Yes, the principles are simple, but they aren't easy.

Focus on Net Worth Over Income

Dr. Thomas Stanley tells us that those who have become wealthy do so in part because they focus on net worth over income. His thoughts:

Attitude is the greatest difference between millionaires and the rest of us.  I've also learned that the rich follow certain rules.

Rule #2:  Emphasize net worth; de-emphasize income.  Most millionaires measure success by net worth, not income.  Instead of taking their money home, they plow as much as they can into their businesses, stock portfolios and other assets.  Why?  Because the government doesn't tax wealth; it taxes income.  And the more income you bring home for consumption, the more the government takes.

A few thoughts here:

• We've covered numerous articles where the writer (usually a mainstream media-type) talks about the "wealthy" and then goes on to define them by how much they MAKE -- not how much they HAVE/KEEP. I think most FMF readers know that there's a big difference between the two.


• Yes, having a good income will help you grow your net worth and you should work to make your income as high as it can be IMO (that's why I write about it so often.) But your real wealth is what you keep, which means that in addition to earning a lot you need to control your expenses, so your gap is as large as possible.


• While having a good income will help you grow your net worth faster, you don't need a high income to amass a relatively high net worth. Here's one real-life example, but we've discussed many more throughout the years. If you want to see more, you'll need to go through my "spend less than you earn" category. It's a combination of people who make a lot and spend it all and those who make far less and yet grow their net worths.


• We've covered the fact previously that having a high income often doesn't lead to a high net worth. Main reason: those who make a lot tend to spend a lot. If you make $1 million a year and spend $1.1 million, you're going backwards financially.


• From day #1 FMF has been about "growing your net worth." Notice how it's my tagline, just under the logo on the top of the page. ;-)

Dr. Stanley also shares this comment -- which we've also covered previously -- but that I always find interesting:

The typical millionaire next door has a total annual realized income that is only about 8% [median] of his total net worth; the average is less than 7%.  This is a rather consistent finding across all the nationwide surveys that I have conducted except for those in The Millionaire Mind.  Actually these people are living on significantly less than 8% of their wealth because they save over 15% of their income.

Here's where I stand on these measures:

• My annual income is 12% of my current net worth.


• I save way more than 15% of my income each year.

How about you? Where do you stand on these measures?

What's It Take to Be "Rich"?

Continuing our discussion of trying to put some sort of absolute number (or even range) on subjective words about the amount of money someone has, today we'll talk about what it means to be "rich." here are some thoughts from MSN Money on the subject:

What's rich? A recent survey of millionaires put the number at $7.5 million.

This fits with what we've seen from other studies/surveys -- that people think "rich" is one or two economic levels above where they are. So if you ask millionaires what they think, you get $7.5 million as the answer. Ask people who have net worths of $50,000 or so, and I can guarantee you that the number will be much lower.

And some more info:

A Gallup poll found the median definition of rich in the United States was an annual household income of $122,000 -- which is still close to the threshold income for being in the top 10% of households. To be honest though, you're just squeaking by if you make that much in high-cost areas like New York City or San Francisco.

Again, we see the "one or two levels above where I am" philosophy at work. The median income is around $50k, so of course the average person would say a $122k income makes people rich.

Then again, they're using income to determine wealth, so the study is flawed in that way already. As we know, a high income gives you a better chance of having a higher net worth (which is a closer determinant of wealth/riches IMO), but high income often doesn't translate into a higher net worth (because people tend to spend what they make, no matter their income level.)

Also, it's worth noting the cost-of-living issue raised in their comments. Quite true.

More from MSN Money:

Narrowing the focus to the top 2% of households -- to match the 2% of people that self-identify as rich in the Gallup poll -- puts the income threshold at $360,435, according to an analysis by the Tax Policy Center.

Yep, it just keeps getting higher.

The rest of the piece goes on to detail the ways people can become "rich" -- how they can get a net worth of $7.5 million. They cover working for a company/business and investing, but ultimately conclude that the "best" way to becoming rich is by starting your own business.

Then they end with this:

One final point: At the end of our conversation, Sullivan made an interesting observation. The fact is most Americans don't want to get rich. Sure, they would like the money. But they don't want to make the sacrifices necessary to have a shot at becoming really wealthy: the enormously hard work, missed birthdays, long days and forgone vacations and weekends.

Personally, I think being rich is well below the $7.5 million threshold and that many (most?) people can become "rich" with a lot less effort and sacrifice than what's portrayed above. Don't get me wrong, there will be hard work, discipline, and decisions to put off now so later you can thrive. But it doesn't mean you have to give up the rest of your life to achieve it. There can be balance and success/wealth/riches at the same time. But it does require self-control, perseverance, and commitment, and IMO most people are either unwilling or unable to adopt these qualities in their lives. Thus they are not and never will be "rich."

But what is "rich" anyway? ;-)

Net Worths by Age Groups

The book The 10 Commandments of Money: Survive and Thrive in the New Economy lists median, top 25%, and top 10% net worths by age groups. I thought I'd list them and comment on each group. Let's start with median net worths:

20 to 29 years old -- $6,400
30 to 39 years old -- $51,200
40 to 49 years old -- $133,100
50 to 59 years old -- $229,300
60 to 69 years old -- $256,300

Yes, sadly these are median net worths, not bottom 25% net worths. Fairly pathetic IMO. It kind of shows you how well Americans are doing at managing their money (which isn't well at all.)

Here are the top 25% numbers:

20 to 29 years old -- $35,000
30 to 39 years old -- $184,000
40 to 49 years old -- $371,000
50 to 59 years old -- $605,000
60 to 69 years old -- $710,400

These aren't bad. Wish they were the median numbers. If that was the case, most Americans would be rather set for retirement.

Finally, here are the top 10% numbers:

20 to 29 years old -- $132,000
30 to 39 years old -- $436,000
40 to 49 years old -- $840,000
50 to 59 years old -- $1,350,000
60 to 69 years old -- $2,030,000

Now we're talking! ;-)

I'm above the top 10% numbers...for the age group that's one level ABOVE the age group I'm actually in. And I'm approaching the number for the age group two levels above my age group -- hope to be there within a year or so. Guess these principles work, huh? ;-)

So, how does your net worth stack up? And where would you like it to be?

Net Worth Update, April 2011

As most of you know, I update my net worth monthly (using Quicken) to keep track of where I stand financially.

I completed this task for April 2011 just this past weekend and the results were so good I just had to share some highlights with you:

• The market has been on a tear as of late, driving my net worth to the highest level ever (if it would keep up this pace for a bit, I'd be at my minimum retirement number in a short period of time.) :-) In fact, April was the eighth consecutive month that my net worth has increased and during those eight months my net worth has risen 25.8%.


• Given the results above, I'm on track to hit my recently developed five-year retirement goals (and then some.)


• I started tracking my net worth in January of 1996. Since then, my net worth has been up and average 14.94% per year. Not bad -- especially now that the numbers are larger. It's much easier to have a 50% gain when your net worth is $50,000 than it is to post out a much smaller gain when your net worth is much higher.


• The low point in my net worth was 2008, when it fell 15.7% -- the only year I've had a reduction in net worth.


• Since then, my net worth is up 68.3% and is now tracking along the same line/projection it was before the market meltdown. In other words, I didn't miss any progress with the downturn, it returned strong enough to make up for the losses. Key to this was that I poured a ton of cash into the market when it was down (cash we had on the sidelines because we thought we were going to buy a new home.) That money was invested and is up big-time (as you might imagine).


• Of course, what goes up, must come down, so I don't expect this strong pace to continue in a straight line upward. The market will go down at some point, then up again, then down again and so on, and it will take my net worth with it. Thus is the nature of financial life once you get to the point where your investments are the majority of your net worth. Not that I'm complaining, just lamenting a bit about the days when saving alone was enough to keep my net worth going up no matter what the market was doing. ;-)

How about you? I'm sure many of you are doing quite well too given the market's performance. Please share your results with us all.

2010 Net Worth Review

Once a month I update my net worth in Quicken (by adding in any expenses, updating my fund prices, etc.) And once a year I give you all a review of how I did the previous year. This is my wrap up for 2010. Here are the highlights:

• My net worth ended 2010 at an all time high, up 20.9% versus the previous year. Note that this includes my entire net worth -- including the value of items that didn't go up during the year (like my house, my cars, and cash investments), which weren't inconsequential in total value. This compares favorably to the market (S&P 500), which was up 12.8%. My gains were fueled by the market's rise as well as my savings for the year.
• I had all-time net worth highs for the months of September through December. In fact, at the end of August my net worth was relatively flat (just up a bit for the year.) Then the market went on a tear, up 19.9% since the end of that month (and took my net worth with it.)
• This year's performance brings the compound annual growth rate of my net worth to 14.94% over the past 14 years when I started tracking it in 1996.
• This year I had my fourth-highest percentage gain in net worth and second-highest in absolute dollars gained. The best year (on both those measures) was last year. Overall, my net worth is up 55.7% since the end of 2008 (which, BTW, was the only year I've had a loss in net worth.)
• If my net worth continues growing at 14.94% each year, I should hit my crossover point in five years. :-)

Overall, a great, great year -- I hope there are many more like it. To do my part in trying to make this happen, I'll keep doing the same old things: growing my career, spending much less than I earn, saving a ton, and investing in index funds.

Compute Your Net Worth Once a Year

The following is a guest post from Marotta Asset Management. I actually compute my net worth monthly as part of the two main financial measures I track. I'll be sharing an update of my net worth later this month. I've also included some of my comments at the end of this piece.

Since the end of last year the markets are up about 13%.  Putting the last two years together the markets are up about 44%. Those are huge gains for two years. You may not have been on two years ago, but now you should reevaluate again. The wave has propelled you miles toward your goal, and at least once a year you should measure your progress.

Everything in the financial markets has changed again: materials, emerging markets, real estate, foreign small cap, even the dollar. If you are within 20 years of retirement (age 45 to 65), it's critical to get your retirement planning updated. Computing your net worth annually is like taking a sextant reading to chart your course toward financial security.

Net worth gives you a snapshot of how much money would be left if you converted everything you owned into cash and paid off all your debts. Compute your net worth by creating four lists.

Liquid assets: An asset is something you own that has significant value. A liquid asset can be sold in a matter of days. Include personal bank accounts (checking, savings and money market), certificates of deposit, bonds, mutual funds, stocks and exchange-traded funds. Use values as of December 31 of the previous year so all of your amounts are calculated on the same day.

Nonliquid assets: Nonliquid assets are those things you own that incur a penalty when they are sold. Include the value of your retirement accounts (IRAs, 401ks, 403bs, SEPs, profit-sharing plans and pension plans). Add real estate investments as well as the market value of your home. Use the assessed value.

Other nonliquid assets may include proprietorships, partnerships or company stock in a firm that is not publicly traded. Add the cash value of any life (nonterm) insurance. Some people include jewelry, collectibles, cars and boats in this category. Although these items often have a high retail value, their true worth is often a small fraction of their initial cost. I do not recommend including personal property.

Immediate liabilities: List what you owe to creditors. Immediate liabilities include credit card debt, car loans, student loans, other loans and any bill or debt that must be paid within two years.

Long-term debt: For most people, long-term debt is primarily their home mortgage, but it may encompass other real estate or business loans.

The first time you gather all of this information will be challenging, but it gets much easier each subsequent year. By keeping an annual record of your net worth, you're creating a valuable financial planning tool.

Next compute three additional values. For your total assets, add your liquid and nonliquid categories; for your total liabilities, add your immediate liabilities and long-term debt; and finally, for your net worth, simply subtract your total liabilities from your total assets.

Use these net worth numbers to compute other values useful for reaching your financial goals. For example, your emergency reserve (liquid assets minus immediate liabilities) should be at least half your annual income. Any extra can be invested more aggressively for appreciation. Your debt load ratio (total liabilities divided by total assets) should be under 35%, with your home mortgage comprising most of your debt.

If you are trying hard to pay off your mortgage ahead of schedule instead of making a huge effort to save and invest, your attempts are laudable but mistaken. The quickest path to wealth includes holding a home mortgage you could pay off but you choose not to in order to take advantage of the tax benefits. The rich leverage wisely and invest.

A net worth statement helps you measure your progress toward retirement. At age 65 you can only withdraw 4.36% of your portfolio to maintain your lifestyle. In other words, to keep the same standard of living, you will need about 23 times what you spend annually.

Take your net worth and divide it by your annual take-home pay. The result shows you how many times your annual standard of living you have amassed in savings. If you are younger than 40, the number probably comes to less than five, which is adequate for now.

By age 45, you should be worth about seven times your annual spending. More sophisticated retirement planning includes the difference between taxable, tax-deferred and Roth accounts as well as Social Security guesses and defined benefit plans, but the method described here will approximate your progress. This list shows by what age you should have saved different multiples of your annual spending.

• Age: 26; Annual Spending Saved: 1
• Age: 31; Annual Spending Saved: 2
• Age: 34; Annual Spending Saved: 3
• Age: 38; Annual Spending Saved: 4
• Age: 41; Annual Spending Saved: 5
• Age: 43; Annual Spending Saved: 6
• Age: 45; Annual Spending Saved: 7
• Age: 47; Annual Spending Saved: 8
• Age: 49; Annual Spending Saved: 9
• Age: 51; Annual Spending Saved: 10
• Age: 53; Annual Spending Saved: 11
• Age: 54; Annual Spending Saved: 12
• Age: 55; Annual Spending Saved: 13
• Age: 57; Annual Spending Saved: 14
• Age: 58; Annual Spending Saved: 15
• Age: 59; Annual Spending Saved: 16
• Age: 60; Annual Spending Saved: 17
• Age: 61; Annual Spending Saved: 18
• Age: 62; Annual Spending Saved: 19
• Age: 63; Annual Spending Saved: 20

If your net worth is higher, congratulations! You may be able to retire earlier than 65. For every 1 unit you are over, you could consider retiring about a year earlier. Conversely, for every 1 unit you are under your age's benchmark, you may have to work an additional year beyond 65.

Between ages 40 and 50, your net worth should increase by 1 unit of your annual spending every two years. That means your current net worth divided by your take-home pay should be 1 unit greater than it was two years ago. And if you are between age 50 and 65, your net worth should have increased this year by 1 times your take-home pay.

Want to retire younger? Try lowering your standard of living. Most retirees spend about 70% of the gross salary they earned while working. If you can live off 50% of your take-home pay, it's not as essential to save as much.

Need to catch up? Save more than 15% of your take-home-pay. Determine how far you are behind and what additional percentage you can save each year. For example, at age 30, you should be worth 1.5 times your annual income. If your numbers don't match that ideal, an additional 0.3 times your annual income will help you get there. You could save an additional 10% of your income (for a total of 25%) for three years. If that's too much, try saving 20% (an additional 5%) for six years.

Money makes money. By the time you reach your 40s, you should have enough investments to be earning about half of your annual spending each year. Early in life what you save is most important for building wealth, but as you approach age 40 what you earn on your investments becomes critical. While you are young, the best advice a professional can offer is to "save." As you amass significant wealth, it is more pressing to "manage" well what you already have.

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Some thoughts from me:

1. It's interesting how he says your net worth should be a multiple of your spending and then later suggests that your net worth should be a multiple of your income. Those are two different things -- assuming you're not spending your income exactly to the penny. I think the former measure is a better one.

2. My net worth is 26 times my annual spending (it's way less as a multiple of my annual income.) Does this mean I'm ready to retire? ;-)

3. "By the time you reach your 40s, you should have enough investments to be earning about half of your annual spending each year." If you were invested in income-bearing assets, correct? I have enough net worth, but the assets don't churn off income since I don't need/want them too -- I want them invested for growth at this point.

4. "Early in life what you save is most important for building wealth, but as you approach age 40 what you earn on your investments becomes critical." True. Early on, your net worth will be driven by how much you can save since that amount will be far more than the growth on your (relatively small) investments. As your investments grow, however, they dwarf your ability to save and become the force that controls your net worth (for good or for bad.)

Hard Work is the Key to Mega-Wealth

Here's an interesting post from Dr. Thomas Stanley about perceptions of the mega-wealthy (those in the top 1% of wealth holders in America -- a net worth and income of more than three times that of those profiled in The Millionaire Next Door) in high school. The summary: few (10% to 12%) were thought of as being smart/intellectually gifted/the smartest in their class. And only 20% were seen as the "most likely to succeed." But interestingly enough, the fact that they weren't the smartest kids played a part in driving them to success -- by making them work harder. And it's this quality that ultimately led them to their high levels of net worth. The details:

School experiences often motivated millionaires to succeed financially.  These experiences helped them forge tenacity.  Fully 76% said that they were influenced by understanding that hard work is more important than high genetic intellect in achieving success.  And most millionaires never allowed poor grades to destroy their goal to succeed.

These people also listed the following factors as the top five in determining their success:

• Integrity
• Discipline
• Social skills
• A supportive spouse
• Working harder than others

I did well in school and have had a good career so far. I don't have wealth anywhere close to what these people have, but I'm doing fine. I give much of the credit for doing well in the academic and work worlds to the fact that I've been willing to work harder than most others. In school, I was the one putting in three to five hours of study each night to ensure I knew the material/completed the assignments (I didn't "get it" all by simply reading the lesson one time -- as some people did.) And once I entered the work world, I spent a lot of time and effort developing my skills and doing my job with excellence. As a result, I've seen a good amount of career and pay growth.

I'm not saying this to brag -- in fact, it's just the opposite. I view myself as probably slightly more intelligent than average. And as a business person, I'm probably at the average. But because of my willingness to work hard (and the discipline that it takes to do so), I have been successful in both school and in my career. I think this is a hopeful message for many of our kids today (as well as parents.) For those that simply can't "get it" academically (versus those who don't want to make the effort to understand -- there is a difference), they still can be successful if they are willing to work hard. And for some (many?) in the workforce today, this provides an example that they might just be able to pull themselves out of a bad situation (or even improve a good situation) -- even though they aren't the brightest in their company -- if they put in the extra time and effort required to excel.

Of course everyone who works hard doesn't become wealthy. There are millions of hard-working people who make low salaries. So the "hard work" needs to be channeled into the right venture -- into something that has the potential to get a good return for the effort put into it. Otherwise, all the hard work in the world is probably for naught.

How about you? Has anyone here had a similar experience to mine?

Will Someone Please Tell the World that There's a Difference Between Income and Wealth?

Ok, I've had enough. After reading article after article, seeing interview after interview, and hearing sound bit after sound bite, I have to say something. WILL SOMEONE PLEASE TELL THE WORLD THAT THERE'S A DIFFERENCE BETWEEN INCOME AND WEALTH?

Just so we're clear, here are the definitions from Dictionary.com:

• Income: the monetary payment received for goods or services, or from other sources, as rents or investments.
• Wealth: a great quantity or store of money, valuable possessions, property, or other riches.

In other words, "income" is what you earn. It's what "comes in" to your family through your work. For most of us, it's the salary we get from our employers.

On the other hand, "wealth" is our net worth -- what we own less what we owe. It's assets minus liabilities. It's what we have left if we sell everything we have and pay off all our debts.

Somewhat related is the word "rich." Someone is "rich" if they have "wealth or great possessions; abundantly supplied with resources, means, or funds; wealthy: a rich man; a rich nation." In other words, a rich person is someone with a high level of wealth/high net worth.

Here's how they work together:

• You make an income.
• From that, you pay the costs of your needs, wants, and desires (food, clothing, shelter, vacations, cable TV, debt, etc.)
• The difference is what I call the "savings gap." This is the amount you transfer to your net worth (as an asset) to increase your wealth (net worth.)
• From there you invest your assets to continually grow your net worth.

See how they are different? Of course you do. Anyone who's been reading this blog knows they are not the same thing.

Then why do so many others use them as synonyms? Specifically the debate about whether or not to extend the Bush tax cuts has been a minefield for improper usage of these words. Want some examples? Let's start with Newsweek. Their thoughts (here's a re-worked version with much of the same info):

I have two pieces of bad news for the over-$250,000 crowd. First, the reversal of some of the temporary Bush tax cuts is probably inevitable, given the Republican fiscal clown show of the past eight years. Second, I regret to inform you that you are indeed rich.

The Census Bureau earlier this week reported that the median household income was $50,223 in 2007—up slightly from the last year but still below the 1999 peak. So a household that earned $250,000 made five times the median. In fact, as this chart shows, only 2.245 million U.S. households, the top 1.9 percent, had income greater than $250,000 in 2007. (About 20 percent of households make more than $100,000.)

Notice how he keeps saying that people who make $250,000 a year (an INCOME figure) are rich (a NET WORTH or WEALTH figure)? Ugh.

Here's the technically correct way to re-write his first comment:

I have two pieces of bad news for the over-$250,000 crowd. First, the reversal of some of the temporary Bush tax cuts is probably inevitable, given the Republican fiscal clown show of the past eight years. Second, I regret to inform you that you indeed have a high income.

And here's another piece from the geniuses at Newsweek:

The 700 or so members of a Massachusetts-based group called the Responsible Wealth Project have spent the last several months courting politicians to make their case, arguing that the country simply cannot afford to keep tax cuts for the wealthiest Americans and that, as billionaires and millionaires, they hardly need that cash. NEWSWEEK’s Nancy Cook recently spoke with one of the group’s members, the cofounder of Seventh Generation, Jeffrey Hollender. Hollender talked about his disdain for the current tax code, the need for more compassion among the wealthy, and the way being rich often seems relative.

NEWSWEEK: So why do you oppose extending the tax cuts for families that make more than $250,000 a year? Hollender: This is a time when the wealthiest Americans need to give back to the country.

Again, they talk about "wealthy" people (even mentioning "billionaires and millionaires") -- which is a measure of net worth. But how do they determine who is wealthy? By an INCOME measure? Ugh again.

Here's the technically correct way to re-write his last comment:

NEWSWEEK: So why do you oppose extending the tax cuts for families that make more than $250,000 a year? Hollender: This is a time when the highest-earning Americans need to give back to the country.

But it's not just Newsweek. Here are some thoughts from our president:

Obama says they should rise for families making more than $250,000 a year but he has made extending them for middle-class families a top policy priority.

"This is actually an area where Democrats and Republicans agree," he said. "The only place where we disagree is whether we can afford to also borrow $700 billion to pay for an extra tax cut for the wealthiest Americans — millionaires and billionaires. I don't think we can afford (that) right now."

Again, income and wealth/net worth terms are used interchangeably -- as if they were the same thing. They are not!!!

Here's another example. A popular personal finance writer who should know better. Her thoughts:

We're rich, all right. So is everybody else who makes six figures a year.

That's saying, "We have a high net worth, all right. So does everybody else who makes six figures a year." This is NOT TRUE!!!!

To be correct, she'd have to say: "We have a high income, all right. So does everybody else who makes six figures a year." 

Some of you are probably saying, "Come on, it's just semantics. Anyway, if someone has a high income, then they are going to have a high net worth. So what's the problem?"

The problem is that net worth/wealth/riches and income are different terms and have different meanings. And the facts are that people with high incomes often don't have high net worths. Why? Because as income increases, so do expenses. People tend to spend what they make and thus don't accumulate wealth no matter what they earn. Sure, high-earners have a much better POTENTIAL to have high net worths, but this potential often isn't realized because they can't control their spending.

So, to be accurate, we need to say things like:

• Those who make $250,000 a year or more have high incomes (not "are rich" or not "are wealthy.)
• We're going to tax the rich, the millionaires and billionaires, by creating a new tax on wealth/net worth (I'm not saying this is something we should do or that I advocate, but I say it just to be technically correct -- this is how you tax "the rich.")

So why are the terms mixed up so often? I've come up with the following possibilities:

• The people using the terms don't really understand the differences in meanings.
• The people using the terms understand the differences in meaning but are purposefully trying to bias the conversation.
• The people using the terms don't really care to be specific.
• The people using the terms think that those who make a lot are wealthy (have high net worths) as a result.

I do NOT want this to degrade into a political conversation about how poor of a money manager Bush was or how Obama simply wants to stick it to "the rich." What I'm interested in is a conversation around the differences in the terms, why people who should know better aren't more careful with their language, and if it even makes a difference. Perhaps I'm being too much of a personal finance whack-job... ;-)

Update: After I wrote this piece and put it into my blog software (about a week ago), I found this piece from Yahoo (via Forbes no less) that lists "Where Americans Are Getting Richer." As you may guess, they define "richer" by increases in income. They're killing me!!!!!!!

How My Income Stacks Up

A month or so ago I told you all about how my net worth stacked up against people at the same age and income as me. Well, now there's a nifty calculator that allows me to do a similar comparison with income.

This piece from Slate has a calculator about halfway down that's titled "where do I stand?" You put in your zip code and your income and out pops an income comparison between you and those that live in your area of the country and world. Here's a summary of where I net out:

• I make roughly four times more than the average/median income in my zip code, state, and country.
• 96 percent make a lower income than I do.

Before we proceed, let me say that this isn't about bragging. It's about (like this blog has always been) what I'm doing financially and why I advocate certain moves and not others. It's also about me sharing as much about my personal finances as I feel comfortable with (this is, after all, a blog.) So let's forget the size of the income for now and focus on what conclusions we can draw from it.

Here are my specific thoughts:

• The way I have increased my income should not come as a surprise to anyone. I've focused on growing my career, starting with getting a great degree and then taking specific steps to maximize my income. I've developed a standard formula for doing this and it's been working for me for 20 years.
• In addition, I've grown my side income. At various times I have made extra income as a writer and blogger (though I give away all the proceeds from FMF) as well as through various other pursuits.
• I've controlled my spending and living expenses as my income has increased, widening the "savings gap" between income and expenses (one MAJOR key IMO: I haven't had a mortgage for YEARS.) It's this ever-growing gap that has allowed me to save and give as I've wanted to.  
• I've been saving for quite some time now, which is a boon for my investments. If I can keep this up I'll be looking at early semi-retirement sooner rather than later.

In the end, the keys to becoming wealthy are fairly simple -- grow your income, save, and work to maximize your investments. It is these simple principles that have served me well for a couple decades and ones I hope do the same for you over time (unless you're Old Limey, of course -- he's well ahead of us all financially and doesn't need the help.) ;-)

Will Time Make Us All “Rich”?

The following is a guest post by MasterPo from The Po File.

In today’s social and political environment harping on “the rich” seems like a daily sport. Never mind that most of the pundits and commentators lambasting “the rich” are themselves among the highest rich in the country by anyone’s definition! But let us not digress…

As it stands, at the time of writing this the commonly accepted and PC way of definition “the rich” are those with incomes of $250,000 or more. (In some conversation that number is reduced to $200k, $150k, $125k, and even $85,000(!).) It is unclear to MasterPo how or why such a line in the proverbial sand is used (and certainly not clear how or why such persons are now considered public enemy #1!)  but that seems to be the standard of the day so let’s work with that figure.

The question is: As time marches on will $250,000 still be considered “rich” after applying years even decades of inflation erosion on purchasing power?

MasterPo normally doesn’t like to resort to number crunching models to make a point. But math is absolute and unquestionable. And a subject like this requires clear illustrations.

The time value of money should be SOP to all investors. As such the basic compound growth formula should also be so basic to all investor as to be able to do the math in yourself:

T = P(1+i)^t

Where “P” is the starting amount (principle), “I” is the rate of growth (annualized), “t” is the number of periods in years, and “T” is the final total after compounding. It’s just basic high school algebra.

Now let’s apply this to the thesis of “the rich”, time, and a real world example.

According to the National Association of Colleges and Employers (as reported by the U.S. Bureau of Labor Statistics) the average starting salary for a college graduate with a Bachelor’s degree in Computer Science is $61.407 as of July 2009 (latest statistics available as of writing this).

So if we presume a mere 3% annual inflation, applying the above formula, then someone born today and graduating college at age 20 would need a starting salary of $111,000 (rounded) to be equal to today’s starting salary.

Let us go further and presume someone graduating 20 years from now and starting with $111,000 salary works for 10 years and receives an annual raise of just 3%, also matching inflation only. At the end of 10 years that person will be making $150,000 (rounded).

That’s pretty darn close to the magical $200,000 mark knocking on the doors of “the rich”.

Take it one step further: Let us now presume this person meets someone else of similar career background, one thing leads to another, and it’s wedding bells time. Now you have a married couple each making $150,000, or now $300,000 combined income – well over the $250,000 “rich” mark!

And if we presume 4% annual inflation then the numbers become $135k, $199k, and $399k respectively in the scenario above.

Plus this does not take into consideration any massive jump in inflation or hyper inflation. Just one year of 10% inflation throws these figures even higher!

MasterPo knows some critics of scenario will try to make the argument that by that time government will have adjusted tax brackets and various other thresholds to account for inflation adjustments. Can you really count on that? History proves that thresholds for determining “the rich” are coming down and not going up! (MasterPo won’t even go into a discussion of misleading if not outright false inflation calculations.)

Too many people today, either by short sightedness or sheer class envy, just don’t think about policy ramifications on income levels higher than their own. Not really much of a surprise as people are constantly being hounded that anyone who makes more then they must have stolen it somehow. But as this illustration shows just the power of inflation, as low as it may be, can and will rise people will into levels of “the rich” without actually being “rich”.

It’s always amusing to blame your woes on someone who has more than you. But sit back, relax, have a beer and play some Xbox. You don’t have to worry. You will never be “rich” – or will you?

The Net Worths of US Presidents

The Atlantic listed the net worths of all the US presidents a few months ago and I'm just getting around to highlighting the piece. Here are some notable entries:

1st president: George Washington (1789-1797) Estimated net worth: $525 million

3rd president: Thomas Jefferson (1801-1809) Estimated net worth: $212 million

16th president: Abraham Lincoln (1861-1865) Estimated net worth: Less than $1 million

26th president: Theodore Roosevelt (1901-1909) Estimated net worth: $125 million

32nd president: Franklin Delano Roosevelt (1933-1945) Estimated net worth: $60 million

33rd president: Harry S. Truman (1945-1953) Estimated net worth: Less than $1 million

35th president: John Fitzgerald Kennedy (1961-1963) Estimated net worth: Although he never inherited his father's fortune, the Kennedy family estate was worth nearly $1 billion dollars

44th president: Barack Obama (2009-present) Estimated net worth: $5 million

My thoughts:

• Most were very wealthy. Probably because what made them successful and able to become president also made them the sort of people who make a lot of money.
• JFK was the wealthiest, though he never got his hands on the family fortune. After him, I believe George Washington was the wealthiest president. Kind of surprising to me.
• Several presidents tied for last with net worths "below $1 million." They are (in addition to Lincoln, Teddy Roosevelt, and Truman): James Buchanan, Andrew Johnson, Ulysses Simpson Grant, James Abram Garfield, Chester Alan Arthur, Woodrow Wilson, and Calvin Coolidge. Still, only 10 out of 44 who had "low" net worths still demonstrates that most presidents are fairly wealthy.
• Obama is a young guy and I'm guessing he'll add substantially to his wealth in years to come (most likely after his presidency.) He'll probably write a book (like all the other presidents) and make a ba-zillion dollars. I think that's about $4.72 per hours considering he's working round the clock as prez. ;-)

Anything you see that's interesting?

How My Net Worth Stacks Up

CNN Money's net worth calculator lists median net worths of Americans two different ways -- by age and by income. Here are their results by age:

Less than 25: $1,475
25-34: $8,525
35-44: $51,575
45-54: $98,350
55-64: $180,125
65+: $232,000

And the results by income:

Less than $25k: $1,250
$25k to $49k: $34,375
$50k to $74k: $168,500
$75k to $99k: $301,475
$100k to $124k: $301,475
$125k to $149k: $644,100
$150k or more: $1,122,900

A few thoughts on these results:

• I continue to be amazed at how low net worths are almost across the board.
• I'm guessing that there are big ranges within the age groups. After all, someone who is 35 should have a significantly lower net worth than someone who is 44, right? And yet they are in the same age grouping. Then again, if someone is a poor saver, nine extra years isn't going to result in many gains.
• These are median, not average, net worth numbers. As we know, there's a big difference between the two and median numbers give us a better picture IMO of what's really the case for most Americans.
• I am waaaaaaaaaay ahead (multiples of the median) of the net worth numbers for my age. I'm 50% or so ahead of the median net worth for my income. The reasons for the latter not being as good are 1) I've been good at growing my career (and thus my salary) and 2) I chose to give away a decent amount of my income. If I adjust my income to post-giving levels, my net worth is about three times above the median.

How about you? Where does your net worth come out? (I'm guessing most readers are well above the medians for their age and income.)

Big Difference Between Average and Median Net Worths

Here's an interesting post from Thomas Stanley (the Millionaires Next Door author) that sheds some interesting light on average versus median net worths in the US:

The average net worth of an American household is $434,782. However, there is a major problem with this wealth figure.  When it comes to expressing the net worth/wealth of a household the average figure is very misleading.  The presence of high net worth households, billionaires like Buffet and Gates, for example, highly skews the distribution and thus the average in an upward direction. 

The median measure of household net worth paints a much more accurate picture of the character of wealth in America than does the average.  The median is that of the typical household, the mid point range of all of the more than 115,000,000 households ranked from bottom to top along the net worth scale. 

Today the median net worth of an American household is $91,304.  It now costs more than this amount for a one year stay, drugs excluded, in a high grade nursing home. Therefore, less than one half of the households in this country do not have enough to pay for such a service even if they sold everything they owned and worked for.

The $91,304 net worth figure also is indicative of something else.  The typical American worker who becomes unemployed today has only about two years of wealth to live on before he hits economic ground zero.

Most American households are nowhere near being financially independent.  Nor will most be able to retire in comfort.  Yet there is more bad news.  What if the equity in homes and motor vehicles is factored out of the median net worth figure?  Then the median figure is about $34,000 or about 2/3 of the annual median income generated by a typical American household today.

A few thoughts on these points:

1. Ugh. $34,000. I am almost speechless...

2. Not surprising to me. I've quoted various stats/research showing that net worths in the US were low (though specific data is sometimes hard to come by). And you know what I think of the average American's ability to save/invest. This just confirms it.

3. As one commenter pointed out, it's not that Americans don't have high incomes, it's just that we spend too much of it. We've discussed previously that there are reasons why high incomes don't translate into high net worths. Yep, overspending. And overspending is the worst money move anyone can make.

4. The numbers are for the total population and are not age-adjusted. I'm guessing that older people would have higher median net worths and younger people wouldn't be as well off. That said, the numbers are so low that no one age group is likely to be doing that well even when separated from the pack.

5. Personally, I'm way above these net worth numbers (both median AND average). I'm sure many of you reading this today are as well.

6. As the post goes on to say, these numbers have huge implications for our country. Who takes care of an aging population that's living longer but doesn't have the financial resources to pay for their own care? It's a big, big issue for our country and one that's likely too big for the government. The author's solution? We all need to save and prepare to take care of ourselves and our own families -- and not leave it to others.

Social Security a HUGE Asset -- Should It Be Counted in Your Net Worth?

In my post titled Too Many Relying Too Much on Social Security, there were a couple interesting comments regarding the value of Social Security. Here's the first one:

According to The Pension Right Center website, the average monthly Social Security benefit paid to retired workers in 2010 is $1,168.60, or $14,023.20 a year. To earn that much in income from income investments at today's interest rates would require a very sizable nest egg. (You'll need a $1,087,070 income-producing investment portfolio, to receive an income of $14,023 per year at a yield of 1.29%) That is way more moolah than most current retirees have managed to save up over their working lives. So since most people earn much less than this in investment income per month by definition, SS would then make up a significant percentage portion of their monthly income.

And another:

My wife and I both took SS at age 62, her income was far lower than mine and together we receive $2,085/mo from SS. I am currently earning an average of 4.563% tax deferred interest from CD investments and an average 4.844% tax exempt income from muni bond investments. In our case $2,085/month would require that we own $516,515 of muni bonds in our Trust account. Alternatively we would need $548,323 of CDs in our IRA accounts to generate the same income as SS. You are thus quite correct that SS is a significant benefit.

So depending on the amount of interest you can earn, Social Security (as it currently stands) is a GIGANTIC asset -- worth somewhere between $500k and $1,000,000 on average. Given this, the average American actually has a decent net worth -- if you add these numbers to the mix.

So here's an interesting question: should you (and do you) add these numbers into your net worth calculations? Yes, I realize that doing so will have little impact on what you are likely to do financially day in and day out, but is there a place to recognize the fact that you "own" this major asset?

For instance, if my net worth is $200,000 and I want to be conservative, should I say my net worth is $700k ($200k I own plus $500k from Social Security)? Or maybe we discount SS a bit since it's likely that benefits will be reduced in the future. So I give it a value of $300k -- and now say that I have a $500k net worth?

Yes, it's a theoretical question, but an interesting one, right? What do you think?

The Eight Money Ratios, Part 1

The book Your Money Ratios: 8 Simple Tools for Financial Security lists eight money ratios that are designed to help us all determine where we stand financially. They're so good that the Wall Street Journal called them "some of the best tools we have seen for gauging where you stand." So I thought I'd list each of them as well as tell you where I stand on each measure.

The Capital to Income Ratio

The first ratio is the capital to income ratio, which I've already detailed previously in an excerpt. It basically measures the amount of wealth you should have accumulated based on your income. In essence, the formula for it is:

Net worth (not including home equity) / annual income

And here's how to tell where you should stand. The first number is your age. The second number is your Capital to Income Ratio (the multiple of your annual income you should have accumulated)

• 25 years old -- CIR: 0.1
• 30 years old -- CIR: 0.6
• 35 years old -- CIR: 1.4
• 40 years old -- CIR: 2.4
• 45 years old -- CIR: 3.7
• 50 years old -- CIR: 5.2
• 55 years old -- CIR: 7.1
• 60 years old -- CIR: 9.4
• 65 years old -- CIR: 12.0

So, if you're 35 years old and make $30,000 a year, you should have at least $42,000 in net worth ($30,000 *1.4).

I'm closest to 45 years old, so I should have 3.7 times my annual income in net worth. I actually have 5.4 times my income in assets despite the fact that 1) I make a decent income, 2) they don't allow me to count the value of my (totally debt-free) home in the calculation, and 3) I give away a decent amount of my salary every year. So IMO the numbers are rather low. But then again, I'm more of a saver/investor so it figures I'd think as much.

The Savings Ratio

The second ratio is the savings ratio, the amount of your pay you should be saving every year at different ages. Here's a list of the ages  and the minimum percentage of your salary/income you should be saving at each age:

• 25 years old -- 12%
• 30 years old -- 12%
• 35 years old -- 12%
• 40 years old -- 12%
• 45 years old -- 15%
• 50 years old -- 15%
• 55 years old -- 15%
• 60 years old -- 15%
• 65 years old -- 15%

As I've discussed, we're way above saving 15% of our income -- and we have been for years. Our average savings per year for the past five years is roughly 1/3 of our income -- over twice what it needs to be to be "good."

So these percentages seem low to me. The author uses them because they will get you to the correct Capital to Income Ratio for your age. But since I think those are low as well, it goes without saying that I think the savings numbers are low.

A few more bits of information to round out this ratio:

• The author does suggest that you should save more than these percentages because returns can not be guaranteed. So by saving more, you're being conservative and guarding against poor investment returns. He recommends an extra 3% to the numbers above.

• The savings rates are pre-tax numbers, so they are on your gross income.

• The savings rate does include both your savings as well as any employer match you might get in a 401k.

So what do you think of these ratios -- good or not so good? And where do you stand compared to them?

What the Top 10% Have and Earn

A reader and I had an interesting conversation a week or so ago about what it takes to be wealthy. We talked about both net worth (which is wealth IMO) and income (which may or may not be related to wealth) and what the top percentages of people in America own and earn. I thought the information in one of his comments was very interesting, so I thought I'd share some excerpts of it with you all. Here goes:

It seems that it requires somewhere in the realm of $300,000 to be in the top 10% of Americans in wealth.

The top 10% of income earners make $120,000 per year.

Interestingly, the top 1% of households average about 15 million dollars per family.

It is always a little mind blowing to be reminded of how different the top 1% is from the rest of the country.

It's also worth looking at his sources a bit more for some additional information. For instance:

The top 1% had average wealth of $15 million per family in contrast to the $22,800 average wealth of the least wealthy 50% of families or the $313,500 in wealth for families ranked between 50% and 90%.

I was also fascinated by this:

Only 17.8% of all U.S. households make more than $118,200 a year.  Only 2.67% make more than $200,000.  The fact that only 34% make more than $65,000 is astounding given how expensive other cost of living items have gotten over the past decade.  That is why the middle class is feeling squeezed from all different sides.

What is even more fascinating, is how even amongst the super wealthy income is not distributed evenly.  There are approximately 146,000 (0.1%) households with incomes exceeding $1,500,000 a year.  Even at that, the top 0.01% of households had incomes of $5,500,000 and accounted for 11,000 households.  The 400 highest tax payers in the nation brought in a stunning $87,000,000 a year.  Now that is wealth.

So what does this all mean? Not much really -- at least not much when it comes to managing your money. It is interesting to see where everyone stacks up and compare yourself to the masses. Doing this, it turns out that I'm "wealthy" (as is anyone with over $300k in net worth). But that's only relative wealth, not the I-have-so-much-money-I-can-do-whatever-I-want wealth most people think of as being "wealthy."

Where do you stack up in these numbers?

Has Your Net Worth Recovered?

Here's an interesting piece from the Washington Post that says Americans' net worths have not yet recovered from the crash over the past couple of years. In fact, while wealth has been increasing,  there's still a good way to go to get back to even for most people. The highlights:

Americans are recovering their shrunken wealth - gradually. Household net worth rose last quarter, mainly because the healing economy boosted stock portfolios. But the gain was slight. And it was less than in the previous two quarters.

The Federal Reserve said Thursday that net worth rose 1.3 percent in the fourth quarter to $54.2 trillion. It marked the third straight quarter of gains. But economists say consumers would need a stronger and more prolonged increase in their wealth to persuade them to ratchet up spending.

Net worth had risen by a more robust 4.5 percent in the second quarter of 2009 and an even faster 5.5 percent in the third quarter.

Even with the gain, Americans' net worth would have to rise an additional 21 percent just to get back to its pre-recession peak of $65.9 trillion.

So what happened? Why are these people still down so much? Did they pull their money from the market after it went down and missed the run-up? Have they lost jobs and had to dip into savings? Are the true values of homes now being reflected? Why are Americans as a whole still down by over 20%?

I ask this because I'm back and have a net worth higher than ever. My wealth took a big hit during the downturn, but I stuck it out, invested more all the way through the decline and back up again, and now I'm doing better than ever. From some of the comments on the site, I know many others have had similar experiences.

So what's dragging down so many people that as a nation we're still off by 21%?

Financial Algebra

A week ago I posted Two Simple Equations that Lead to Financial Success, a piece that listed the following as being the guides to financial success:

• Income – expenses = surplus

• Surplus x many years = wealth

The other day at lunch I started thinking of these two equations and how they could be combined. For instance, they two could be re-written as one as follows:

(Income – expenses) x many years = wealth

Or, even simpler:

(Income – expenses)many years = wealth

Or maybe this is better (to clearly indicate that income needs to be greater than expenses):

(Income > expenses)many years = wealth

Or if we wanted to add symbols, how about this?

($ > - )#yrs = $$$$$$

Am I missing something? Is there a better/easier way to express the equations?

And for those of you wondering, yes, I am a total nerd...

The Two Financial Measures that Determine the Health of Your Finances (AKA Two Financial Measures to Track Your Finances)

The following is a re-post of a piece I originally wrote for Dumb Little Man.

I wasn't really sure what to title this post (as you can tell from the double title I did choose), but here's the gist of what I was trying to get at: there are two basic measures that I believe people need to track when it comes to their finances. These measures will both guide your money-related decisions as well as monitor your progress (for better or worse) as you try and grow your personal wealth. They are:

• Net Worth
• Cash Flow

Net Worth

Net worth in its simplest sense is assets less liabilities. IMO, it is the single-most important financial measure for us all to track (it gets the edge over cash flow since cash flow could be viewed as a subset and/or feeding into net worth). Net worth tells you whether or not your wealth is increasing and by how much. It's an accurate and (unfortunately in bad times) ruthless measure of how you're doing in growing your wealth.

There are different ways to track your net worth, but which you choose doesn't really matter. As long as you're consistent, you'll be able to determine if what you're doing is helping to grow your wealth or not. As such, tracking your net worth on some sort of regular schedule is a must for any serious money manager.

Personally, I track mine monthly. Each month in Quicken I update the performance of my investments, put in my income and spending, and run a net worth report. I then record it in a spreadsheet and compare it to the other months of the year as well as my status for the same month the prior year. Doing this gives me a quick report card on how I'm doing managing my money as well as highlights where I might need to make changes. In addition, I record my final net worth at the end of each year (and have done so since the early 90's.) That's how I know that my net worth has grown at a compounded annual rate of roughly 16% since then.

I used to update my net worth weekly, but that was simply too obsessive even for me. In addition, there were too many wild swings (up big one week, down big another) as the market went up and down, big bills were paid, etc. Looking at it only once a month seems to level the swings a bit. As such, this time frame works best for me.

Now I'm not saying that monthly is how often you should review your net worth -- simply that you need to review it regularly. Whether it's monthly, quarterly, semi-annually or whatever, you simply need to check it on a regular basis and make adjustments based on what you find.

Cash Flow

Cash flow is simply income minus expenses. It's the amount you have left over after you earn all you can and then spend all you need/want to spend. The difference is then what you can save and/or invest. This is the amount that fuels the growth of your net worth. It's this difference that buys the homes, investments, and the like that drives net worth higher and higher.

This is why I talk about the two parts of creating a strong cash flow -- maximizing your income and limiting your expenses -- so often. If you can grow the former and keep the latter in check, your cash flow will skyrocket, fueling your net worth to new and glorious heights.

The budget is the method most used for tracking/setting/managing cash flow. My belief is that in the early years of managing your own money, a budget is invaluable. It will help you see where your finances are going and how they are spent. It will help you catch things that otherwise might not be noticeable. It will help you make good financial decisions. I highly recommend having a budget for people just starting out handling their money.

After you become a bit more proficient in managing your money, I think you can go to a less detailed and less frequently updated budget. If you've proven that you can manage your money (and especially control your spending) a budget isn't needed nearly as much to ensure your cash flow remains strong.

For the first decade or so of our marriage we operated on a detailed budget that was frequently revised. We created it at the beginning of the year, tracked it through each month, and updated it at the end of each month based on the previous month's results. It took a good amount of time and effort to this, but as I detailed above, doing this had some great benefits and was well worth the effort.

But as time went on, our budget became less detailed and was updated less frequently. It started by being revised quarterly, then twice a year, then once a year. Now we're at the point where we don't have an "official" budget. Our 15+ years of spending put into Quicken is our budget. Other than unique spending each year (like buying a new couch or taking a big vacation), we pretty much spend what we spent the prior year. We've demonstrated that we can manage our spending so tracking it so closely is not needed to make sure our cash flow keeps pumping out the money.

Those are the two financial measures that I think are most important for all of us to track and manage. If you can create an ever-growing distance between what you make and what you spend and if you can convert that difference into savings, investments, and other assets, your net worth will grow like crazy. It really is that simple.

Investment Return

The one other measure that I considered adding to this list is the return on your investments. After all, once you've spent years socking away money into investments like index funds, the growth or decline of those investments will be the single-biggest factor determining the direction of your net worth. That said, I didn't include it for two reasons:

1. I view the return on your investments as a subset of "managing your net worth." If you're tracking your net worth and analyzing it on a regular basis, you will come up with some steps you'll want to take to growing your net worth and making the most of your investments will be one of those. In other words, it's tracked and/or looked at simply by reviewing your net worth regularly.

2. The return on your investments is not the biggest determinant of how well your investments will perform -- the amount of time you invest is much more important. As such, the sooner you can get your cash flow to the point where it allows you to invest a good chunk of money, the better off you'll be. Sure, return can make that performance much better, but TIME is the key factor that will make your investments grow the most.

How about you -- what measures do you track? Do you agree or disagree with how I do it?

Are You Better Off than a Decade Ago?

MSN Money asks if you were better off at the end of 2009 than you were at the end of 1999. They try to make some arguments as to why this isn't such an outlandish question including:

• Wages haven't risen that much
• Spending has increased (everyone now HAS to have a cell phone, web access, multiple cars, etc.)
• Debt has increased thanks to credit cards
• Housing prices are flat in 2009 versus 1999
• People are saving much less

These things lead them to the following:

Regardless of whether you want to blame falling incomes or our increasingly profligate habits, the end result is the same. Net worth -- assets (real estate, stocks, cars) minus debts (mortgages, credit cards) -- rose just 5% after inflation in the past 10 years, to $53.1 trillion, according to data from the Federal Reserve. 

So I thought I would address this question myself and let you do so as well. Here's where I stand in 2009 versus 1999:

• My income has increased 61% in those 10 years (BTW, 2009 was not my highest-earning year. If I take the highest, my income was up 125%. For those curious, my work salary has consistently gone up, but I had a side business and investments that did very well a few years ago.)

• My spending has remained roughly flat as a percentage of my income.

• My debt has remained the same (debt free in 1999 and still so today)

• My house is worth a bit more than the house I had in 1999, but the value of the house has fallen in the past three years

• We're still saving a good portion of our income (roughly 40%).

• And the bottom line: my net worth is up 207%.

Yeah, I'd say I'm better off financially than I was in 1999. :-)

Of course, if your income is flat, your spending is up, you're not saving much, and you're accumulating more debt, then I can see how 10 years can be a financial drain. But if you're doing what we talk about here all the time -- growing your income, controlling your expenses, paying off debt, and saving -- then a decade will find you much, much better off at the end of it than at the beginning.

How about you? Are you better off now than you were 10 years ago?

Net Worth Update for 2009: My Best Year Ever

At least once a year I give an update on my net worth (I used to do it monthly, but there isn't really that much new news each month) and this post is my update for the year ending December 31, 2009.

The summary is that it was my best year on record. A few pieces of info:

• I ended 2009 with my highest net worth ever.

• My net worth was up 28.8% in 2009 -- the highest percentage gain since I started tracking my net worth in 1996 (second biggest gain was in 2003 at 28.3% and third best was 1998 at 22.8% increase.)

• In 2009 I also had the largest absolute dollar gain ever from one year to the next.

• My net worth was up 8.5% from where it was at the end of 2007 (my previous best year-end number.)

• With this result, the compound annual growth rate for my net worth from 1996 until 2009 is at 14.5%.

• My net worth was up 37.9% versus its recession-bottom level in February 2009.

So, in the end, it was simply a great, great year.

What drove the results? Two main factors:

1. The stock market (Wilshire 5000) was up 26.5% for the year (and up 67.6% from its bottom on March 9, 2009). Now I'm not 100% invested in US stocks (I have bonds, international stocks, real estate, bond-like investments, cash, etc. as part of my asset allocation) and there are chunks of my net worth that earn basically nothing (the value of my house, the cash I keep in our emergency fund and for upcoming large purchases, etc.), so you can't simply say I should be up at least 26.5% if the market was up that much. That said, a large part of my net worth is in the US stock market, and for the most part, my net worth goes the way the market goes. In particular, it helped BIG TIME that I was buying all the way down in the darkest days of the crash. Those purchases performed very well over the final months of 2009.

2. My savings rate. I know I harp a lot on getting income high and expenses low so you can create the largest possible gap between them, but the reason I do this is because it makes a HUGE difference in how quickly you can grow your net worth. If you work to grow your career and develop other income streams and keep a tight handle on expenses, you'll have plenty of money to make some wanted discretionary lifestyle purchases as well as grow your net worth by leaps and bounds.

Now that I've written this, I see that there's not much to learn from this post. But I guess I wanted to do two things with it:

1. I wanted to give you a report card on how I'm growing my net worth (so I'm accountable to you in part.) This update was much better than the one last year, don't you think? ;-)

2. Let you know that if you apply the principles we talk about here every day you will have financial success. I'm seeing it and you can too!

How about you? How did your net worth end 2009?

The Wealthy Aren't Who You Think They Are

I saw this picture on PostSecret not too long ago. It reads:

My friends and relatives think I'm poor or stingy because I drive a clunker and own old appliances. Ha! I've given 400G to charities, helping to restore sight to thousands. And I keep doing it!

This reminded me of a few things:

1. There's a BIG difference between those that look wealthy and those that are really wealthy (see below). As we've been discussing the past month or so, it's often those that look like they have tons of money that actually have low net worths. The "average" wealthy person doesn't have a lot of glitz and glamour in their lives.

2. If you create enough room between what you make and what you spend, you can do great things with the difference (like help those less fortunate.) You can also save up a lot for future needs, if you prefer.

3. I have some acquaintances that regular kid me for being "frugal." (They'd probably say "cheap.") But little do they know that my wife and I have given a very large amount away during our marriage -- and we continue to do so (just the amount given from FMF so far is substantial). And no, we haven't had to stop saving to do so. We've simply created a big gap between what we make and what we need/spend. The rest can be saved and given away.

Here are some more interesting thoughts on the wealthy (and many instances where they differ from those that are not-so-well-off):

• The Difference Between the Wealthy and Everyone Else 
• How to Become Wealthy
• What Makes Wealthy People Wealthy 
• Rich People Know that Things Don't Satisfy 
• Don't Look at Others' Riches -- Become Wealthy by Doing Your Own Thing 
• Money Saving Tip: Don't Dress Like You're Rich 
• Looking Poor, Being Wealthy
• Stay Low Key for Financial Success

Net Worth for the US House of Representatives

Check this out -- it's a list of the net worth of every US House Representative. Quite interesting indeed!!!

Two things to note as you look at the list:

• There's wiggle room. When members of the House file their financial disclosure, they are only required to report approximately how much they have/owe in each account. For example, in a savings account, they can report that they have between $15k-$50k, or between $50k-100k, etc. Same for their liabilities. As you can imagine, things could become skewed rather quickly. That said, these numbers at least need to be in the ballpark, right?
• The numbers used are MINIMUM net worths. So the actuals are higher -- just how much higher, we don't know.

Anyway, here are some things I found interesting about the 435 Representatives:

• 125 are millionaires (have a net worth of $1 million or more.) This is 29% of the total.
• 29 have negative net worths (less than zero). Another 38 have net worths of $20k to $1k. In all, 15% have net worths less than $20k.
• The median net worth is $380k.
• 222 (over half of the 435 Representatives) have liabilities of "$0". 26 have liabilities of $1 million or more.
• 11 have assets of "$0" and another 15 have assets of $10k or less.
• Speaker of the House Nancy Pelosi has assets of $25 million, liabilities of $13 million and a net worth of $13 million (numbers off a bit due to rounding).
• Majority Leader Steny Hoyer has assets of $148k, liabilities of $0 and a net worth of $148k.
• Minority Leader John Boehner has assets of $1.7 million, liabilities of $0 and a net worth of $1.7 million.
• The highest net worth goes to Darrell Issa (R-California) with a net worth of almost $165 million.
• The lowest net worth goes to Alcee Hastings (D-Florida) with a net worth of NEGATIVE $2 million.

It's enlightening to see what these folks are doing with their own money since it gives us some insight into how they are managing our (tax) money.

See anything that you found especially interesting?

One Thing that Sets Wealthy People Apart

Here are some interesting thoughts from Stop Acting Rich: ...And Start Living Like A Real Millionaire on one thing that sets wealthy people apart from the pack:

One of the things that set wealthy people apart from others is that they have a wide variety of interests and activities. In fact, there is a substantial correlation between the number of interests and activities that people are involved in and their level of financial wealth.

The book goes on to note that the truly wealthy often value their time as much (or more than) their money, and it often keeps them from spending on items like a vacation home, boat, etc. They think that if they had these, they would need to spend a ton of time with them in order to make it a worthwhile investment. And since they have other interests and/or don't want to spend the time in a second home or on a boat, they don't buy them.

I'm guessing that the "interests and activities" are also reasonably affordable ones. From the tone of the book as well as this section, I'm assuming that these sort of outside interests are more like "playing softball on a community team" than they are "collecting rare Russian artwork."

Part of the involvement issue is that you're so busy that you don't shop (and buy stuff you don't need.) Our usual shopping day is Saturday, where we often go out as a family and get stuff we "need." But during soccer season, my son and I are busy every single Saturday. So either my wife goes or we don't go at all. Guess what? We spend less during those two months. Add in church and volunteer activities, gardening, basketball, swimming and so on, and you can see where doing something else is not only fun and rewarding (and not very expensive) but also simply eliminates the time we have available to shop -- thus saving us money and "accidentally" growing our net worth.