No. of Recommendations: 9

I liked “The Millionaire Next Door” (TMND).
I like the lessons it had to offer. I
especially appreciate the equation it gives
as a way of benchmarking how effectively
I am accumulating my wealth. I think it's
important to chart your progress over
time. I see this as no different between
measuring your return against the return
of the S&P 500, or charting the progress
of the lowering your blood pressure. Things
need to get measured. I must agree with
Felbi http://boards.fool.com/Message.asp?mid=17816502
however that the equation that TMND door offers,
Age / 10 x Income = Average Accumulator of Wealth (AAW),
is flawed in that it does not give enough weight to
age. For equation to be useful, it must somehow
come close to telling where we should be in reality.
Like Felbi, I've also played around with a few
equations to try and come up with something that will
be more useful. I wanted the equation to approximate
the net worth of the average person of median income
in a particular age group.
According to the June (or July) 2002 issue of “Money” magazine
http://money.cnn.com/2002/07/30/pf/millionaire/rp_millionaire_networth/index.htm
median income and net worth by age looks like the
following
Age Income (approx) Net Worth (approx)
---- -------------- ------------------
<25 25,000 2,000
25-34 40,000 22,000
35-44 54,000 100,000
45-54 62,000 165,000
55-64 53,000 210,000
>65 25,000 185,000
In order to be sure I checked some other sources
as well. On Scott Burns' website
http://www.dallasnews.com/business/scottburns/alsoonline/score.html
median net worth by age looks like the following
Age Net Worth (approx)
---- ------------------
20-29 5,000
30-39 35,000
40-49 86,000
50-59 121,000
60-69 156,000
70-79 141,000
So with these figures in mind I tried to create an
equation that would give similar results based on
age and income.
**[(Age * Age) / (22 * (100 – Age))] * Income**
The equation seems a little kooky at first but there
was some thought put into it. I thought of the
“Age squared” piece so that the equation would have an
exponential component. In the denominator you can think
of the “22” in the equation as the age when you begin
working. I assume it could be 18 or 25 but 22 seems
about right. Further you can think of the “100 – Age”
component as the number of years you have left to
accumulate. Over time the numerator goes up and the
denominator goes down. This has the affect of giving
your age more and more weight as you get older.
I must admit however that the equation was created
through trial and error but it seems to work well as
an approximate gauge of median net worth (in TMND terms,
AAW status). That's all we want. If we plug some
numbers into the equation we get the following
Age Income My formula NW
---- -------- -----------------
22 25,000 7,051
30 40,000 23,377
40 54,000 65,455
50 62,000 140,909
60 53,000 216,818
70 25,000 185,606
If you compare these figures to the ones I got from
“Money” and the Scott Burns website, my results are
pretty darn close.
The equation above gives us the expected (or median)
net worth based on current income and age. This gives
us the AAW status of an individual. What we truly want
is an equation that will also give us the PAW status.
In TMND that equation is
Age / 10 x Income x *2* = Prodigious Accumulator of Wealth (PAW)
The “2” in the equation above can be viewed as the
PAW multiplier. We need one for our equation. Again,
through trial and error I came up with a PAW multiplier
of
**Age / 15**
Here's the test. According to TMND, the typical
millionaire is 57 years old and has a median income
of $131,000 or about 3.5x the median income of the
typical household. The median net worth of millionaire
households is $1.6 million. If we plug the age and
income of the typical millionaire into the TMND
equation and into my equation we get
Age Income TMND My Formula
---- -------- -------- --------
57 131,000 746,700 449,914
Different figures but I believe mine more closely
represents what the median would be. If we plug in
the PAW multiplier for each we'd get
Age Income TMND (2) My Formula (Age/15)
---- -------- -------- ----------------
57 131,000 1,493,400 1,709,675
Both figures are pretty close to the $1.6 million net
worth that TMND says a PAW would have. There you have it.
What do ya'll think?
LF