Measuring Wealth: How Do You Compare?

Measuring your net worth is a relatively straight forward matter. All you do is total all your assets (home, car, investments, pensions, etc) and deduct your liabilities (mortgage, credit card debts, loans, etc). What you are left with is a figure (hopefully not a single figure or one that starts with a minus sign). But how do we interpret that figure? Is it good or bad? Are you on the right track? Do you need to try harder?

To help answer these questions I decided to look on the internet at some ways of interpreting your net worth figures:

Millionaire Next Door Method

In the bestselling book The Millionaire Next Door, authors Stanley and Danko put forward a suggestion to gauge what your net worth should be at any given age. They proposed the following formula:

(Age X Pretax Income)/10

So for me this would be:

(37 X $32,417)/10 = $119,942

Last month my net worth was $117,438 so I’m about $2,500 below target. Pretty much spot on. However I have a few gripes about this simple method. Mainly, it’s a bit too linear. It assumes that if I was earning double or triple my current income I would still be saving at the same rate. Currently I save 35%+ of my income. If I was earning $100,000-a-year I think I could easily save 50%+. Similarly if I was earning $15,000-a-year I would struggle to save 5% or 10% of my income. I guess as a quick and easy rule of thumb it has a place. It also skews its estimates against people at the beginning of their careers (e.g. a 25 year old earning $40,000-a-year would be expected to have a $100,000 net worth), although this could be a good thing as it may incentivise them to save more.

Compared to the Average Joe

The US Census publishes data on net worth of Americans and this is a rich source for comparing yourself to others. I’m not American but it seems a fair group to compare myself with. The average (mean) net worth in America is $264,437 according to US Census data for 2013. This might seem high, and it is, as people in the top 1% or top 5% skew these figures forcing the average up. A better and more realistic measure is probably the median. The median is simply the middle person’s net worth. If a hundred people lined up in a room in order from richest to poorest the median would be person number 50. In the USA this person has a net worth of $80,039 (you’ll notice this is a lot less than the mean of $264,437 mentioned above, obviously the people in the top 1% or 5% have a disproportionate amount of the wealth).

This data is also broken down by age group:

Under 35: $6,936 (yes, less than $7,000!)

35-44: $45,740

45-54: $100,404

55-64: $164,498

By this measure I am doing well, 162% above the average Joe in my age range. Maybe the Americans need to save more.

Percentile Comparisons

We often hear about the top 1% having x amount of wealth. From the above I know I’m in the top 50% as I am above the median. But where exactly (or roughly) am I? Top 20%? Top 30%?

The US Census also have data on key points of net worth ($500,000; $250,000; $100,000; etc). I’ve created the table below to summarise the information:

The table gives cumulative values, so if you are under 35 and have a net worth of over $250,000 you are in the top 7% for your age bracket, if you are 56 and have a net worth of $50,000 for are in the top 68% (or bottom 32%) of your age bracket. By this metric I am in the top 39% of my age bracket. At $117,000 I’m probably top 36% or 37%.

Percentage of Financial Independence

The final method is sometimes referred to as %FI and is based on the calculation of the amount of passive income you require to quit your day job. You need a bit of data to work this out but it’s generally straight forward and probably one of the best real measures of wealth for an individual’s circumstances as you are not comparing yourself to others and is based solely on your lifestyle.

To calculate it you need to know your expenses or your target retirement income and then find the amount of net worth you would need to safely produce that level of income. Many suggest a figure of 4% which is sometimes called the Safe Withdrawal Rate or SWR and sometimes called income draw-down. If I take my annual expenses which at present are $10,560 then I would need a net worth of $264,000 at 4% to generate this. Dividing my current net worth by this figure gives me my %FI, which is 44% ($117,000/$264,000). When this figure hits 100% you can retire.

The figure can vary greatly depending on your level of expenses and the rate of SWR you choose. Many conservative savers choose SWRs between 3%-3.75% which will increase your target net worth. Your age at retirement also makes a difference. If you are 75 then using a higher SWR is less risky as your life expectancy is lower than someone retiring at 50.

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