We're here for the same reason - we want to be wealthy. We want the power to live our lives independently and in control. For us, money is more than a social symbol - it's just one more way of taking control of our own future! I've discussed the three rules to acquiring wealth and the misconceptions surrounding income and riches, but even if you're applying everything I've talked about, you still have to wonder, "How will I know when I'm wealthy?"
If you aren't there yet, it might seem daunting to change your lifestyle to one more appropriate with attaining wealth, especially when it isn't really clear how long it will take to achieve that desired wealth - or if it's even worth it! My goal in today's post is to shed some light on the mystery surrounding the time it takes to attain wealth. Using the lessons learned from The Millionaire Next Door, I've devised my own series of equations to understand the formula to wealth and determine how long it will take you to attain it!
When I say "wealth", I'm referring to a state where you have significantly more savings, assets, and value (as determined by your net worth) than the peers surrounding you in your relative lifestyle! The Millionaire Next Door uses the equation (Age)*(Taxable Income)/10 to determine the borderline for wealth. To me, this equation seems accurate with the exception of people who have just begun making money (or who have gone through a significant pay raise). So "wealth" refers to any financial situation at this borderline or higher.
Using this equation as a frame of reference, we can apply other factors (such as interest rates and compounding interest) to calculate the time it will take to reach that borderline!
Calculating ETUW - Formula To Wealth
Estimated Time Until Wealth (ETUW - pronounced 'Ee-two') has to take a couple of features into account. By incorporating spending, savings, expected interest returns, and compounding interest into a time-relative number, we can calculate the expected time until we surpass the wealth borderline! (On the flip-side, we can also calculate how long until one with wealth and exuberant spending falls UNDER the borderline!)
I've already mentioned the equation for determining your own Current Borderline. That's...
Current Borderline = (Age * Taxable Income)/10
Next, calculate your Liquid Net Worth...
Liquid Net Worth = Assets (Stocks, Bonds, REITs, etc.) + Real Estate Value + Car Value (what it could be sold for right now) - Liabilities (Loans, Mortgages, Alimony, etc.)
By subtracting your liquid net worth from Current Borderline, we see the Deficit...
Deficit = Current Borderline - Liquid Net Worth
By dividing the Deficit by the yearly contribution you invest, we see the Unadjusted Time Until Wealth - how many years it will take to fill the difference between your current Liquid Net Worth and the Current Borderline... if you never aged! But we have to consider that because we are aging, the Current Borderline will also respond by increasing every year!
Unadjusted Time Until Wealth - Deficit/Yearly Savings Contribution
Now we have to adjust that number. With every year, your Current Borderline will continue to increase by 10% of your taxable income. Let's call this Borderline Growth.
Border Growth = Taxable Income * 0.10
Adjusting Borderline = Current Borderline * (Years Projected * Border Growth)
This is also the time to take into account the amount of growth on your investments! Assuming an average of 7% market growth (what seems to be about average for the past 10 years), we can estimate that our money will continue to grow, on average, at that rate. We'll leave the appreciation/depreciation on any real estate or automobile out of this consideration for simplicity's sake. Our Asset Growth will be reinvested so that it can benefit from compounding interest, of course!
Asset Growth = (Assets * .07) + Yearly Savings
NOTE: Notice that this is only the first year of savings. If we look a two years ahead, we see our Projected Assets grow exponentially demonstrating the power of compounding interest!
Projected Assets = (Current Assets * (1.07 Years Projected) + Yearly Savings Years Projected(1.07)-(Years Projected - 1)(1.07) + Yearly Savings
Project Asset Growth = (Current Assets * (1.07 Years Projected - 1)) + (Yearly Savings Years Projected(1.07)-(Years Projected - 1)(1.07) - 1)
NOW we can finally start to calculate how fast we're approaching the adjusting borderline! This we'll call the Borderline Approach Gains!
Borderline Approach Gains = Projected Asset Growth - Borderline Growth
If Borderline Approach Gains is positive then you're moving towards wealth!
If we solve for time when using the equation Projected Assets + Real Estate Value + Car Value - Projected Liabilities = Adjusting Borderline we have our ETUW!
This is a pretty complicated process and while you can do it by hand, I'm in the process of creating a tool to do all the calculations for you and give you the ETUW based on your contributions, income, and current wealth! (Link coming soon!)
Attaining wealth is certainly a milestone in anyone's life! For some, it may signify a time where budgets can loosen and frivolous spending can increase. For others, it could mean early retirement and the pursuit of something they love. Regardless of how you choose to live your life post-wealth, you have to make sure you maintain the fruits of your labor! We've all heard the stories of the guy who 'makes it' only to lose it all. If hitting wealth changes your lifestyle, you have to make sure that the changes won't break your bank!
Using the ETUW calculation can help you to ensure that you continue to get wealthier, as well as to not progress in the wrong direction!
Readers, what are your expectations as to when you'll attain wealth?