Updated on 09.16.07

# What Should Your Net Worth Be? Why “The Millionaire Next Door” Equation Falls Short – And What A Better Thumbnail Calculation Might Look Like

Recently, I was reminded of the first book I ever reviewed on The Simple Dollar, The Millionaire Next Door. I really liked the book, even though there was one big flaw in it: a rather large age bias. The book was written for people over forty, from top to bottom.

This was most obvious when the book offered up a formula for calculating what your net worth should be:

Target Net Worth = Age X Annual Pre-Tax Income / 10

So, let’s say I’m a 23 year old, fresh out of college. I am carrying \$25,000 in student loan debt and my only asset is my car, but I get a job paying \$30,000 a year. According to this formula, this is my net worth:

Target Net Worth = 23 X \$30,000 / 10 = \$69,000

I don’t know very many fresh college graduates with a net worth that high – most are saddled with a lot of student loan debt and simply haven’t been in the workplace long enough to build any assets.

What can we do to change that? The big question is really how old should a person be when their net worth switches over to positive? For the average college graduate, that’s going to be at least a few years after graduation, no matter what. So let’s try this instead:

Target Net Worth = (Age – 27) X Annual Pre-Tax Income / 10

That gets a more realistic number for young people – our straw man above would have a target net worth of -\$12,000, which is pretty realistic – and even if a person chooses graduate school, the number isn’t too far off.

The problem pops up later on in life. At age 40, with an annual salary of \$40,000, a person would have the following target net worth:

Target Net Worth = (40 – 27) X \$40,000 / 10 = \$52,000

A person who has been earning \$30K to \$40K over fifteen years or so should definitely have a higher net worth than that. The culprit, I think, is that number on the bottom – 10. It assumes that a person’s net worth should only grow 10% in a given year. What will actually happen is once the net worth starts going positive and growing well, it will grow by more than 10% each year. My net worth, for example, will probably grow somewhere around 30% this year.

So let’s say we think a financially healthy person, once they’ve paid down some of their debts, should see their net worth grow by significantly more than 10%. Let’s try making that number on the bottom 5 instead of 10.

Target Net Worth = (Age – 27) X Annual Pre-Tax Income / 5

For our straw man, at age 23 with an income of \$30,000, his target net worth would be

Target Net Worth = (23 – 27) X \$30,000 / 5 = -\$24,000

This is probably a pretty good estimate, considering he graduates with \$25,000 in student loan debt and owning only his beat-up car. The new equation is far more realistic for people in their twenties and thirties than the old one. What about the 40 year old with an income of \$40,000?

Old Target Net Worth = 40 X \$40,000 / 10 = \$160,000
New Target Net Worth = (40 – 27) X \$40,000 / 5 = \$104,000

Even at age 40, the new equation points at a lower target net worth. But what about a 60 year old with an income of \$60,000?

Old Target Net Worth = 60 X \$60,000 / 10 = \$360,000
New Target Net Worth = (60 – 27) X \$60,000 / 5 = \$396,000

Late in life, the modified equation actually points at a higher net worth than before. I think this is a much more realistic model because of the power of compounding – compounding is going to be much more powerful for you later in life as you’ve been building up your retirement and such.

So, instead of using the equation found in The Millionaire Next Door to figure your net worth, try this one instead:

Target Net Worth = (Age – 27) X Annual Pre-Tax Income / 5

It creates a much more realistic view of a person’s financial state throughout their life than the original, particularly for younger people. No single thumbnail formula like this is perfect – I’m just seeking one that matches better than the one in the book.

I recommend using this number as a target throughout your life, much as The Millionaire Next Door suggests: make it a goal to try to double the target or better, but know that if you’re matching the number, you’re doing all right.

1. Alexis says:

What factors do you take into consideration when calculating net worth? What about the balace of a 401(k) or an IRA? What about a car – clearly this represents debt, but if it is paid off – or at least is not upside down, do you count the value?

2. Anna says:

@Alexis: Someone can correct me if I’m wrong, but I believe “net worth” means EVERYTHING to your name. So the worth of your car is an asset, but the amount you owe on it is a debt, and the balances of any savings, whether it’s a 401(k), and IRA, or your emergency fund, should be counted as assets.

3. Minimum Wage says:

I think it should more properly be a function of disposable income, not gross income. Your formula says the net worth of someone earning \$15K should be half that of someone the same age earning \$30K and I don’t think that’s realistic.

4. r says:

@Minimum Wage – Interesting point. So, while I can appreciate your argument from the perspective of what it seems likely people will be able to achieve, another way to think about this number might be what someone needs to be putting away in order to be able to maintain a reasonable version of their lifestyle in retirement. And actually, unfortunately for the person making 15k, this doesn’t scale with disposable income – rather, it would be a steeper curve the other direction, such that the person with the lower disposable income has *less* room to not quite meet this goal. Thoughts?

5. Minimum Wage says:

As soon as I posted that, I realized I got it wrong, since I was going by the book’s formula rather than Trent’s formula.

But your point is correct, and the point I was trying to make: a low earner can’t realistically be expected to have a certain net worth based on gross income, as their low disposable income doesn’t afford them the average or expected savings or investment..

6. Susan says:

Don’t include your car since in

7. Trent says:

That’s a good point. It would be a good idea to include some sort of “minimum living expense” in there, subtracting that from the salary. I’ll have to puzzle over that and write an update to this article sometime soon.

8. echo says:

Trent: How do you propose couples should use this formula. Particularly if there is a significant age differce (10 years) Do we split our joint assets in two or is there a formula that a couple should use to look at family income and total net worth.

9. Michel says:

I really don’t see the point of all this math.
It doesn’t even consider changes in income. Let’s say someone gets a promotion at 42, how can this calculation make any sense for the previous years when he earned 20% less, for instance?
What income should s/he consider?

Did I get anything (everything?) wrong?

10. dong says:

While I think it’s good to have rules of thumb for general guideline, I never liked the one in the Millionaire Next Door. It’s designed for one class of individual, but it doesn’t tell us who that class is. Is it the person who gets a job straight out of High School? There many ways to improve it but then it’s not so basic, and at that point most people would be better served my a real model with many different inputs.

I agree with Minimum Wage that the equations should probably use disposable income. The reason is that the tax brackets are pretty different between a person earning \$30000 a year and \$100000 a year. Paying a lot of taxes affects what you can save. When you use a linear equation on the gross income when the tax rates aren’t exactly equal then the savings goals don’t make much sense. I agree that it’s slightly better than the formula in the book.

12. Miguel says:

I agree that there is an age bias in the book, but… 27 is too high a number to subtract from the age. One of the main points of the book was that prodigious wealth accumulators started making money, and saving early on in life. Some as early as 18. The book also made it very clear that graduate school, caused people to begin their earning years later in life, causing a lower net worth. As for me, your equation seems a little low. I am worth several times what I should be then :)

13. Tippy says:

Everything about personal finance is new to me, why is knowing your net worth is so important?

14. jtimberman says:

Generally speaking, cars are not counted as assets by many financial people because they depreciate at a very rapid pace.

Some financial people would go as far to say that you shouldn’t be concerned with the actual net worth amount as long as you’re debt free and saving at least 15% of your take home pay for retirement.

Statistically speaking, if you’re saving 1% you’re beating MOST of a America because the average savings rate is -2% because of all the consumer debt our country racks up. Becoming and staying debt free is one of the biggest keys to financial freedom and building wealth because you open up your greatest wealth building tool: YOUR INCOME.

15. Minimum Wage says:

Okay, I earn my state minimum wage and am paying \$300 a month (forced) toward debt reduction. How much should I be saving?

16. Cheryl says:

Well, I feel a LOT better after using that formula. Apparently, I’m more than \$50k ahead of where I should be. How?

(20 (my age) – 27) X 48,000 / 5 = -67,200

And with my student loans and everything, my net worth is -\$15932.76

If this formula is for real, I’m doing excellent!!

– Cheryl

17. Ryan says:

One thing that I’ve heard is that your should have 2 times your salary saved (not net worth, but actual savings in accounts) before your 40th birthday to be on track to have 15 times your salary saved before you retire. I’m on track to have 3 times my salary saved before I’m 35, so I guess that is ok. Buying a house before the run-up though sure was a bonus.

18. mitchell says:

trent,

consider this formula?

Net Worth = ((e^(Age/8))/((e^(Age/22))*1.75))-5) * 20000

its adjustible and considers someone to be pretty solidly in the hole in college and slower to come out of it, but once capital is obtained and saved, it builds faster.

19. vh says:

What do we mean by “what your net worth _should_ be”?

“Should be” for what purpose? If the Millionaire formula is age-biased, the bias is pretty bizarre. Sixty-nine grand would be off the charts for a 23-year-old fresh out of college. But for an old bat like moi, the formula’s result makes no sense: at 62, I should have a net worth of \$378,200??? And in retirement, I’m supposed to live on…what?

My net worth (assets minus liabiities) is more than twice that, but unless ISocial Security bases my SS payments on my ex-husband’s earnings instead of mine, my post-retirement lifestyle will be much crimped. In either event, I will have to depend on Social Security to maintain my present distinctly frugal but still (modestly) middle-class lifestyle.

Your target should be to have no debt and enough dollars in savings that a 5% return on savings will provide you an after-tax income of your present net, absent Social Security. Where net retirement income is concerned, your net worth is less relevant than how much savings you have and whether you’re carrying any debt.

For a single person, I’d take \$1 million dollars (giving you a gross passive income of \$50,000, which would probably leave you with an adequate after-tax net unless you live like the Queen of Sheba) as a target for the age at which you hope to retire. Then subtract about 7% for each year of your age before that (since a balanced portfolio should grow at about 8% over time, this should give you approximately the amount of capital you need, at any given age, to achieve your goal by retirement). So, say you want to retire at 50. At 45, you should have \$705,688 in savings. And so on, in reverse compound interest mode. This exercise seems to skew the target-age savings upwards as you move toward younger years, & it doesn’t add in your regular contributions to your savings plan. But that could be seen as accounting for inflation, since the the target figure and the figures that result are in today’s dollars. Someone who knows calculus could no doubt design a better reverse-compound-interest formula.

Those of us who are old enough to know for sure that Social Security will be around for the rest of our lives should regard SS only as inflation protection; those who are under about 45 or 50 should figure it won’t be there, unless we get some much smarter elected representatives than we’ve seen of late.

20. Dave says:

Trent,
Unless you’re Warren Buffett, you can’t realistically expect to compound at 20-30% too far into the future. I mean, sure, when your IRA is \$4000, you can put in another \$4000 and see a 100% return that year… but what about when it’s \$400,000? Can you commit to saving \$40,000 that year to earn 10% on top of the markets usual 10%?
Realistically, there’s no real equation that will work for everyone. You can make it more and more complicated, but it still won’t work for everyone… so why bother?
I think people should set a goal for retirement and aim for that… if you want to retire at 30 with \$2,000,000, you’re going to be doing things differently than someone who wants to retire at 65 with \$800,000.

21. Mitch says:

VH, the problem with actually doing more realistic (non-linear) calculations as you are is that you are going to end up with some messy exponents (powers and roots)–more accurate but not as back-of-the-envelope (what I believe Trent means by “thumbnail”). I would recommend your idea, though, and suggest setting it up in a spreadsheet or calculator program, or using an online calculator.

(This is also probably why the “e” shows up in Mitchell’s approximation, though I have not looked at it carefully; we don’t have pretty-print here.)

22. Duane says:

The formula in the MND wasn’t provided as a guideline for other people. The authors kept being asked if there was any particular formula that expressed the habits of the wealthy. They worked their way backward to a fairly predictive formula to describe the 40+ crowd they interviewed.

Once you see the context it makes a lot of sense. For the younger people (which I’m among) you can take comfort if you are saving 10% or more and have decent earning prospects.

23. Rich says:

Congrats on the newborn!

I enjoy your posts; you have such good content that is a model for my near-term blogging efforts.

My main point was that perhaps you want to share how you gain %30 year-to-year on your net worth? That’s worth some serious money.

24. Maura says:

I think the assumption of 30% increase on his net worth includes additions to savings. He is not assuming his investments will earn 30% every year!

When someone is older and has a larger amount saved, say \$500,000, if the account earned 7% (\$35,000), he would have to have \$115,000 in new savings to increase his net worth by 30% that year!

I prefer to calculate my retirement needs with an excel spreadsheet using the following factors:

(a)current savings/retirement plans
(b)% of my salary I can save each year (I am putting the maximum into a retirement plan
(c)number of years until retirement
(d) assumed rate of earnings- 8% to 9% for a mix of stock funds and bond funds (See his recent review on Lazy Investing)

That gives me the retirement savings I plan to have at retirement

(e)amount I would need in today’s dollars to live (my house will be paid off, but there is still property taxes, insurance, & repairs, and I am planning on higher medical costs)then add 3% to 4% expected inflation per year

to be conservative I plan on taking no more than 4% of my savings out each year to live on. If the results of (e) are less than 4% of the balance of my savings at retirement, then I am saving enough.

25. I fear that some posters are missing the point.

This isn’t completely about retirement needs.

That’s a separate calculation/equation altogether.

This net worth equation is just a benchmark of sorts to see how you are doing, based on your age (while I agree it’s age-biased, it’s good enough of a general factor to use as a calculation).

The whole point is to provide a simple calculation, not a complex one. Something simple that ordinary, normal non-math-oriented people (like myself) can use in a pinch to quickly calculate what their net worth is SUPPOSED to be, and kick their butts into gear to save/pay down debt and accumulate a higher net worth.

For example, reading the millionaire next door, I was supposed to have a networth over \$100k!! But I had just graduated from university, and with student debt, that was not possible (not counting car or my clothes/shoes/electronics as assets. Just pure hard cash and investments and gross income).

With Trent’s formula, my net worth should be -\$39,000, which sounds more reasonable/realistic. At least I have a sort of benchmark to use to say: Okay, I’m at least keeping at the curve/mark/target net worth as I should be, considering my age (not taking into account my gender, background, the city I live in, and cost of living).

It’s not a magic number to use to calculate anything else, but just a benchmark to assess how you’re doing.

Just my 2 cents…

26. Bill says:

I’d consider the demographic in “The Millionaire Next Door” to be 50+, not 40.

The conclusion from that book is that having your own business is the way to wealth.

However, a successful small business is not necessarily very liquid.

Having a chain of small dry cleaners worth \$5 million is very different from having \$5 million in a diversified stock portfolio.

You probably want to think about liquid net worth.

27. vh says:

Right on, Bill.

When I remarked above that my net worth is more than twice the net worth this calculation thinks I should have, that includes the value of my house (about \$350,000). Unless I sell and move someplace cheaper or take in a renter, that money does nothing to put dinner on the table. Well…except in the sense that not having a mortgage payment leaves more disposable income from SS and income off investments. Since 350 grand is pretty cheap where I live, downscaling will entail a significant cut in safety and lifestyle, or else I’ll have to move to Sun City, where acceptable housing is cheaper…because most baby boomers don’t want to live there. Similarly, the \$10,000 value of my seven-year-old car does not help maintain my house, pay my taxes, or feed me. The inefficient local public transportation is used mostly by people who have had their driver’s licenses rescinded and as rolling shelters for the homeless mentally ill (recently I tried taking the bus to work: the 30-minute drive morphed into a grueling odyssey of 2 hours and 10 minutes!). So, sell the car, bank the proceeds, and use the \$40/week in gasoline costs to support my eating habit? Not likely.

If you regard the car as an asset (questionable), my net worth is over a million dollars. But if you get real and calculate retirement income from liquid net worth, then you get a gross annual income of about \$28,000, based on a 5% drawdown; at a more conservative 4%, that would be \$22,400. Add Social Security of \$10,320 p.a., and you come nowhere near replacing my \$61,000 annual income.

28. Margo says:

I’ve got my target set for retirement based on my 65th birthday, and certain assumptions about inflation, expenses, etc. Rather than use a % of income approach – since I’m fairly young, and income will go up but possibly fluctuate over time – I set a line in the sand: Enough cash in the Retirement Funds, to yield an inflation-adjusted \$40,000 income, from 4% of assets in the initial year.

My goal, for 2047, is about \$3-3.5mil liquid Retirement Funds.

I have a two-part Excel workbook to track my progress toward goals and to project, at a point in time, where I will be relative to those goals.

The progress tab shows how much is in an account, the start/end timeframe for achieving the goal, expected interest, etc. It then calculates the monthly savings amount needed to hit the target in that timeframe. For the nearer-term goals, like a house, it helps that it shows the percent time elapsed vs. percent of goal amount saved – e.g., I’m ahead on my Emergency Fund but behind on my Down Payment Account, so any new income can be directed appropriately.

On the other tab, I have linked those same actual saving amounts, timeframes and expected interest, only here I include actual monthly savings amounts – and it projects where I will end up, at the “end date”, if I do nothing but remain consistent. So I know that in my house fund, from the “progress” tab, that I need \$216/mo to get to my goal of \$20K on time…but if I continue at \$86/mo I end up with only \$11K.

It definitely helps motivate me to “save more today”

If anyone’s interested, I could send it to Trent to post online and you can pick apart my methodology, or just use it as is.