Wednesday, September 30, 2009

Estimating Your Needs for the Future: The Millionair Next Door Formula

The following is the wealth building theory posed in the book Millionaire Next Door by Thomas Stanley and William Danko.

Your Age ˟ Your Gross Annual Household Income ÷ 10 = Your Net Worth Goal

This is a super quick way to estimate what your current net worth should be. It’s not an estimate for your future wealth goal. This rule does not consider inflation, taxes and varying interest rates. It does provide a useful estimate of your retirement savings goal. The formula is a good way to assess your current savings. Are you on track? or ahead? It can be eye opening.
So if you are 35 and earn $75,000/year your goal would be: 35 ˟ $75,000 ÷ 10 = $262,500
At 45 earning $75,000 your goal would be: 45 ˟ $75,000 ÷ 10 = $337,500
At 60 earning the same: 60 ˟ $75,000 ÷ 10 = $450,000
Liz Pulliam Weston of MSN Money had this to say about the Millionaire Next Door theory: “…this formula is problematic, at best. It requires substantial savings of people in their 20s and 30s, and it understates what people in their 60s will probably need.”

Note that the formula does not intend for you to include unexpected income from inheritance or other means. It should just be straight savings and investments. I have, however, known people who include the equity of their home in their personal net worth. In my opinion, it’s risky to consider your home equity as part of your net worth.

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