Your Total Measure of Wealth: Age and Net Worth
Author: Nick
Category: Money
Topics: investing, savings, wealth
Now that we’ve established that net worth is inadequate for wealth determination and have come up with a suitable list of alternative wealth measures, it’s time to start looking at each of the criteria and put together a new formula for deriving one’s Total Measure of Wealth™. (Seriously, where’s that book deal??? Don’t make me trademark more stuff.)
Today we’ll start covering the easy stuff–the keys to your Total Measure of Wealth that already have established, standard metrics associated with them.
Age
Description
For those who haven’t touched a calculator since grade school, we’ll start off easy. Your age is how old you are. It’s the number of years between today and the day you were born. I could say more about this, but a long paragraph here might confuse you into thinking this is more complicated than it really is. Oops, too late.
How to Calculate It
If you don’t know your age, ask somebody who does. Or just assume that you’re 37.
How to Use This Number
Despite its extreme simplicity, age is perhaps the most important factor in determining your Total Measure of Worth. That’s because age is the factor over which you have the least control. In fact, you have no control over your age until you build a time machine, and I just don’t see you doing that anytime soon.
Age can mean the difference between a bright financial future and a hopeless financial meltdown. $100,000 does a lot more for a 20-year-old who has a lifetime to invest it than a 65-year-old retiree who must spend it to survive. Age won’t tell you too much about your wealth picture alone, but you’ll see shortly that it can have a big impact on the other measures of wealth.
Net Worth
Description
Net worth has long been the de facto standard of wealth determination. If my net worth is higher than yours, then I am richer and you are poorer. But how can we say that a starving orphan with a net worth of zero is richer than a person with a home, a job, and a promising outlook but who currently has a negative net worth due to a few thousand dollars in student loan debt?
While net worth can’t demonstrate wealth on its own, it is still suitable as a snapshot of your current financial status. It is even more useful when compared to your historical net worth calculations; a rising net worth may suggest smart financial decisions, while a plummeting net worth could indicate out-of-control debt or rapidly depreciating assets.
How to Calculate It
There are really two parts to any net worth calculation: instantaneous net worth and historical net worth growth. Computing your instantaneous net worth is simply a matter of tallying up all of your assets and subtracting all of your liabilities:
Historical net worth growth is a little trickier to compute because you must decide over what span of time you would like to calculate your net worth’s change. On the one hand, we’d like to look at data over a long period to see how your finances have progressed over the years (and maybe decades). On the other hand, long-term data might not place enough emphasis on more recent smart (or stupid) financial transactions.
Let’s start with a look at your long-term net worth change. How far back should we look? That depends on how old you are. Older people have more financial history and should look back further than younger people. For now, we’ll set up a rule of thumb stating that long-term net worth is over the course of the last one-third of your life. So simply take your age, divide it by three, and compare your net worth from that many years ago to your net worth today. (If you don’t have exact figures from that long ago, just estimate.)
For example, since I’m 24, my beginning date would be:
Once we have our dates set, we determine our rate of change:
Now we need a short-term net worth change formula. Let’s say that the short term is fixed for everyone and just looks at your net worth growth over the last year.
How to Use These Numbers
You should view your instantaneous net worth merely as an indicator of where you are financially today. Without the change rates, there is no way to tell based on this number what you should start doing differently, if anything, with your money. Then again, if your net worth is a few million dollars or more, you could try writing me a check.
The long-term and short-term net worth growth figures are much more useful to us. The long-term change provides a summary of how you have handled your finances over the years and indicates what sort of net worth goals you should set for yourself in the next stages of your life. The short-term change lets you know if you’ve made any dumb mistakes lately.
You can also annualize your long-term change rate and use it as a starting point for setting future net worth goals. Simply divide your long-term net worth growth by that age-divided-by-three number to get your annualized long-term net worth growth rate.
So if you’re 24 and your net worth tripled (i.e. increased by 200%) over the last 8 years, your annualized long-term net worth growth rate is a healthy 25%.
While some may argue that maintaining a steady long-term growth rate is a smart goal, I’d like to see my rate increase every year. Comparing your short-term net worth growth to your annualized long-term growth rate will tell you if you’re hitting your target of meeting or beating your growth rate each year.
Tomorrow we’ll look at the other three “easy” wealth indicators: income, savings rate, and rate of return.
Loading ...
39 Responses »
1.
eh
March 15th, 2007 at 7:31 am
interesting & worth reading (as least so far….)
2.
HouseWealthy
March 16th, 2007 at 6:34 pm
These are interesting equations. How about the argument that one should not include the equity of their primary residence (if they own a home) in their net worth calculations? I have hear this and am not sure if I agree. How do you compensate for people who do not own a home? Just a thought.
3.
Nick
March 17th, 2007 at 5:28 pm
Good question, HouseWealthy. You’ll notice that Housing Status is one of the parts to the wealth measurement, and I’ll be covering it in an upcoming article. I’ll talk extensively about how one should include a house (and how/if equity should be included) in wealth calculations.
Once we cover Housing Status, I may need to come back here and add a few notes to the net worth calculations. But all of this is a work in progress, so some parts may change as others are completed.
4.
Michael
March 19th, 2007 at 12:30 pm
You’re, like, asking us to do math and dividing and stuff.
That would be so not cool if we didn’t have spreadsheets.
5.
broknowrchlatr
March 21st, 2007 at 9:48 pm
Great article. I’ve never really looked at my results like this yet. Three things:
1) When going back 1/3 of your life, you shouldn’t look past the point where you started working at your current education level. It doen’t help for me to compare vs when I was 17 years old and my net worth was about $1000.
2) Your annualized grrowth calculation is a bit off. Try this: [annualized long term growth]=[long term net worth growth+ 100%] ^(1/[age-3])
In your exacmple 3^(1/8)= 1.147 (14.7%)
3) Use caution when using the annualized long term growth in forward projections. Due to savings rates decreasing as a portion of net worth, declining income increases, and other factors, it is inevitable that annual growth rates will decline.
6.
Nick
March 21st, 2007 at 10:43 pm
broknowrchlatr (heh, nice name),
1. I would still include those periods when you were still in college or otherwise not yet employed at your current level because those years will have a more dramatic impact on your net worth the more recent they are. For example, since I’m 24, I will look back to my first year of college. Since I’m still pretty young and I’ve only been professionally employed for about three years, I wouldn’t be expected to have as high of a long-term net worth growth rate as when I’m 30 looking back at ages 20-29. When I’m 30, those college years will have less impact on my growth calculation, but the fact that two of the years are still included reflects that I’m still relatively young.
2. Your formula seems to reflect a compounding annualized growth rate. Mine just divides the growth evenly across the years. We figure in the effects of compounding later on in your rate of return. (Plus if I had put exponents in this early, I’d have scared off a lot of folks!
)
3. Even in the slower years of the economy, it’s not a bad idea to try to maintain the same net worth growth rate. I mean, I totally understand if the stock market crashes and your net worth takes a bit of a hit as a result; but just because the S&P grew only 10% instead of 15%, I don’t see that as enough of an excuse for why my net worth only grew by 10% instead of 15%. Looking at it another way, I wouldn’t want to fall into the trap of using external factors as an excuse for my net worth performance.
But I see what you’re saying, and I agree that there are definitely cases where your net worth will fluctuate from year to year. That’s why looking at your long-term growth is so important: it takes care of those “bad years” by also including the “good” ones in your calculations.
7.
Myself
October 30th, 2007 at 2:53 pm
Personally, I perceive Net Worth as an ongoing analysis on one’s financial status.
Net worth is always an snapshot of one moment in time.
If your networth is going up over time, then you are financially better off. If it is going down or almost non-changing, then you are just spinning your wheels.
This is one reason why a 15 year mortgage (or even shorter if possible) is quite beneficial to you, in comparison to a 30 year (or gasp 40 year) mortgage. But don’t forget that the rate of change for either one of these will have a tendency to go up, as long as the mortgage is paid when it is due. Please don’t think that getting a 30 year mortgage means that you’re an idiot either. You have to examine how the monthly payments affect your cash flow.
I kind of equate the concept of cash flow with net worth. Why? Because they both change over time. In order to increase your net worth, you usually (but not always) have to increase your cash flow – as long as it is a positive cash flow of course.
8.
donnie
July 17th, 2009 at 12:08 pm
Check out cash flow note investing . Not trying to sell anything just an honest discussion.
9.
Gina M.
November 13th, 2009 at 3:37 pm
It’s nice to discuss growth as a continuous yet gradual process. I wonder how you would tie into this formula one-time sources of cash that make a big difference such as receiving the inheritance or cashing on your term life insurance policy?
10.
alomda
November 9th, 2010 at 7:30 am
I enjoy reading your article
العاب بنات
11.
Sohbetci
November 17th, 2010 at 5:09 am
thanks for admin.nice sharing.very nice.
12.
دردشة
November 30th, 2010 at 11:14 am
Merci pour le bénéfice article utile et merveilleux Vhaknahnak
13.
توبيكات
December 21st, 2010 at 12:47 pm
I would like to offer you a lot of appreciation and commendation for outstanding effort
14.
zara
March 25th, 2011 at 10:02 pm
http://www.vibramfivefingershoes2011.com/
15.
haiying
April 12th, 2011 at 3:13 am
http://www.mylouisvuittonoutlet-sale.com/
16.
xx
April 27th, 2011 at 2:42 am
http://www.coachpursestores.com/
17.
zara
May 14th, 2011 at 3:12 am
http://www.burberrybags-store.com/
18.
male toys
May 24th, 2011 at 4:01 pm
thanks for you views that was most intruging.
girls sex toys
19.
louis vuitton for sale
July 25th, 2011 at 10:29 pm
louis vuitton handbags outlet
20.
burberry outlet
July 29th, 2011 at 1:57 am
thank you for sharing,this information is useful to me.good quality
21.
شات صوتي
August 2nd, 2011 at 7:26 pm
qe http://www.q8motor.com/
22.
Property marbella
August 19th, 2011 at 4:29 am
You can also annualize your long-term change rate and use it as a starting point for setting future net worth goals. Property Marbella
23.
Dubai Jobs
August 22nd, 2011 at 12:43 pm
You are right Punny! Really it is the fact that net worth is inadequate for wealth determination and have come up with a suitable list of alternative wealth measures.
24.
دردشة
September 14th, 2011 at 8:14 pm
mcryh mcryhا
25.
скачать соундтреки
September 16th, 2011 at 10:36 am
самые новые и популярные мелодии, треки из фильмов, песни скачать аниме осты на высокой скорости бесплатно
26.
poker just
October 12th, 2011 at 5:13 am
Thanks a lot for providing the great info is visible in this blog that to using the great services in this blog
27.
HOLLYWOODS CASINO
October 12th, 2011 at 5:14 am
. I am very much satisfied by the great services in this blog.
28.
online gambling just
October 12th, 2011 at 5:20 am
This is very much impressed with the great services in this blog that to using the great technology in this blog
29.
bingo info guide
October 12th, 2011 at 5:21 am
This is very much impressed with the great technology is visible in this blog that to sharing the great services in this blog.
30.
live casino info guide
October 12th, 2011 at 5:22 am
This is very much enjoyed for the great services in this website. I am very much happy for providing the great technology
31.
ماليزيا
October 26th, 2011 at 2:43 am
thank you for sharing,this information is useful to me.good quality
32.
christian louboutins on sale
November 14th, 2011 at 2:45 am
Why did the ancients to wear high heels? christian louboutins on sale There must have aesthetic considerations, but I think more should be for the health meter.
33.
sdidgju
November 29th, 2011 at 9:55 pm
Merci pour le bénéfice article utile et merveilleux Vhaknahnak
34.
معهد
December 9th, 2011 at 8:24 pm
I have a presentation that I am presently working on – and I have been looking for such information.
35.
دردشة عراق الرومانسية
December 24th, 2011 at 8:06 am
thank you a lot’s bro
36.
replica jewelry
January 25th, 2012 at 11:28 pm
Nice hosting! It’s my first time to read like this article.rxdctf
37.
شات
January 28th, 2012 at 8:10 am
good man this topic very good
Leave a comment
Line and paragraph breaks automatic, e-mail address never displayed, HTML allowed:
<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>Trackbacks & Pingbacks
[...] Your Total Measure of Wealth: Age and Net Worth [Punny Money] [...]
Pingback by Finance Findings For Monday, March 19, 2007 — March 19, 2007 @ 2:19 am
[...] already reviewed the two easiest parts of your Total Measure of Wealth: age and net worth. Today we’ll cover three more simple components that belong in your wealth [...]
Pingback by Your Total Measure of Wealth: Income, Personal Savings Rate, and Rate of Return | Punny Money — March 20, 2007 @ 9:51 pm