2 men who studied millionaires for over 20 years developed a formula that classifies Americans in 3 different categories of wealth
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- Wealth can be defined by one's expected level of net worth.
- That's according to the authors of "The Millionaire Next Door," who devised a formula to determine whether you're wealthy - or at least, as wealthy as you should be.
- "Prodigious accumulators of wealth" - America's richest people - have a net worth twice their expected level.
Wealth is relative.
According to Thomas J. Stanley and William D. Danko, authors of the classic "The Millionaire Next Door," a simple formula can determine whether you're wealthy - or at least, as wealthy as you should be.
After spending more than 20 years studying American millionaires, they defined wealthy not in terms of material possessions, but by net worth - your assets, including cash and home equity, minus your liabilities, or your debt.
That's where Stanley and Danko's formula comes in:
[Your age] x [pre-tax annual household income from all sources, except inheritances] / 10 = your "expected" net worth
From there, you're categorized in one of three ways:
1. Under accumulators of wealth (UAWs) are those whose real net worth is less than one-half of their expected net worth.
2. Average accumulators of wealth (AAW) are on par with their expected net worth.
3. Prodigious accumulators of wealth (PAWs) have a net worth twice their expected level.
The latter group is what Stanley and Danko call "builders of wealth."
For example, if a woman named Anne earns $150,000 a year and has investments that return $15,000 for a total annual income of $165,000. Multiplied by 50 (her age) that's $8.25 million. Divided by 10, her net worth should be $825,000.
Anne has diligently built her net worth to $1.65 million - she's a prodigious accumulator of wealth.
James, on the other hand, is 30 with a total annual realized income of $95,000. Multiplied, that's $2.85 million. Divided by 10, his net worth should be $285,000. But he's only worth $140,000 - he's an under accumulator of wealth.
Anne could have built her wealth with resilience and perseverance - two qualities it takes to get rich, according to Stanley's daughter, Sarah Stanley Fallaw, coauthor of the follow-up book "The Next Millionaire Next Door: Enduring Strategies for Building Wealth" and the director of research for the Affluent Market Institute.
These qualities can help one stick to their goals and avoid "lifestyle creep" - the tendency to spend more whenever one earns more. By not succumbing to this pressure, Anne was able to live below her means, a key practice of many millionaires, according to Stanley Fallaw's research.
"Spending above your means, spending instead of saving for retirement, spending in anticipation of becoming wealthy makes you a slave to the paycheck, even with a stellar level of income," she wrote.
Prodigious accumulators of wealth, like Anne, ultimately follow a three-step strategy to build wealth: Earn good money, save it, and invest it.