Do You Have What It Takes to Be Wealthy? Defining Wealth Beyond High Earnings.

What do you think of when you envision wealthy people? Do you picture individuals with an abundance of material possessions and a high-consumption lifestyle? Think again.

Many people who live in expensive homes and drive luxury cars have little or no investments, appreciable assets, income-producing assets, common stocks, bonds, private businesses, oil/gas rights, or timber land.

Conversely, many truly wealthy individuals do not live in upscale neighborhoods. They derive more satisfaction from owning substantial amounts of appreciable assets than from displaying a high-consumption lifestyle.

Wealth is more often the result of a lifestyle of hard work, perseverance, planning, and, most of all, self-discipline. Okay, enough with the preaching and let's talk about something actionable.

First, how do people build wealth? Answer: they spend much less than they earn and invest at least 20% of their pretax income into appreciable assets. Easy? No, super hard. Because the key is consistency. This strategy needs to be executed over extended periods of time. Imagine 30 years or more. No get-rich-quick schemes here.

Second, and what this article is about. How do you know whether you are wealthy or not? The Millionaire Next Door offers a practical approach to determine if you are wealthy. According to the book, you are wealthy if you can sustain yourself for more than 10 years without working. Here’s a simple rule of thumb to determine your wealth status:

Step 1. Determine your expected level of net worth (a person's assets minus their liabilities) which is largely governed by your age and income.

Step 2. Given your age and income, compare how your net worth matches up with that of others in your demographic. Are you a:

• Prodigious Accumulator of Wealth (PAW)

• Average Accumulator of Wealth (AAW)

• Under Accumulator of Wealth (UAW)

Step 3. Consider yourself wealthy if you are a Prodigious Accumulator of Wealth (PAW). Congratulations. Now continue living the life that got you here.

Now in further detail.

STEP 1. Determine your Expected Net Worth Based on Age and Income.

The book, The Millionaire Next Door, offers a formula to determine the expected net worth for an individual, taking into account their age and income:

This formula excludes any inherited wealth and considers all sources of income except inheritances.

Examples of Expected Net Worth:

Wealth is not the same as income. Earning a high income and spending it all does not make you wealthier; it simply means you are living a luxurious lifestyle. True wealth is measured by what you save and accumulate, not by what you spend.

STEP 2. Put Yourself in the Following Categories of Wealth Accumulators:

• Prodigious Accumulator of Wealth (PAW): Whose net worth is twice the expected level or more. Example: If the expected net worth is $635,500, a PAW would have a net worth of $1,271,000 or more.

• Average Accumulator of Wealth (AAW): Whose net worth is around the expected level.

• Under Accumulator of Wealth (UAW): Whose net worth is half the expected level or less.Example: If the expected net worth is $635,500, a UAW would have a net worth of $317,750 or less.

STEP 3. You are wealthy if you are a Prodigious Accumulator of Wealth (PAW). Congratulations.

For example, Charles Bobbins, a 41-year-old fireman, and his secretary wife, with a combined income of $55,000 and a net worth of $460,000 will be considered wealthy because they have a much higher net worth than the expected net worth ($225,500 based on the expected net worth formula above) for their age and income category. They likely have a low-consumption lifestyle that allows them to save and invest significantly, making them wealthy within their cohort. Given their lifestyle, the Bobbins could sustain themselves for more than ten years without working.

In contrast, Dr. John Ashton, who earns $560,000 annually and has a net worth of $1.1 million, is not considered wealthy. Given his age and income, his net worth should be over $3 million. His high-consumption lifestyle means he could only sustain his family for two to three years without employment, highlighting that true wealth involves accumulating assets and maintaining financial sustainability.

In summary, wealth is not about living a high-consumption lifestyle, but about accumulating appreciable assets and living within or below your means to build substantial net worth. Assessing your wealth based on expected net worth can provide a more accurate picture of your financial health and guide you towards better wealth management.

Of course none of this counts for sh*t if you have a monthly burn rate (how much you spend every month) so high that your accumulated wealth cannot support you for 10+ years if you stopped working tomorrow.

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Resources

1. The Millionaire Next Door free pdf - Link.