I’m re-reading The Millionaire Next Door. It is filled with great reminders of how millionaires are different from most Americans. The authors studied the wealthy and were surprised that most millionaires don’t look like millionaires.
They give numerous examples of how un-wealthy most millionaires appear. The average millionaire had not paid more than $235 for a watch or $399 for a suit. The book was published 20 years ago so these numbers would need to be increased to $361 (watch) and $614 (suit) for inflation.
They contrast the millionaires with those that make high incomes but have low wealth. The folks we think are millionaires often are not–they use the big hat, no cattle analogy. Those who look rich often aren’t, those who look poor sometimes aren’t.
They provide seven traits or habits that are common amongst people who successfully build wealth. I can summarize them for you–they work hard, work smart and live well below their means. They often work in fields that don’t require them to look prosperous by living in fancy homes, driving fancy cars or dressing in fancy clothes.
The authors provide a calculation to determine if you are wealthy:
Age / 10 X pretax annual household income
So a 50 year old with $100,000 household income would have the following calculation:
5 x $100,000 = $500,000
If this 50 year old’s net worth less any inherited wealth exceeds $500,000 she is considered wealthy, if her net worth is less than this she is not considered wealthy.
Once achieving this “wealthy” level, your net worth must increase by 10% of your income each year to stay there. If your household income increases 3% per year with inflation, a 13% savings rate would keep you in that category.
But a much higher savings rate would be necessary to get to this level since there is typically not much wealth accumulated before age 25.
This seems like a high bar to set for wealth but when I compare this calculation to what it takes to retire, I find that it isn’t enough.
Let’s take a typical retiree. A 65 year old with household income of $100,000. A net worth of 650,000 would put this person in the “wealthy” category (6.5 x 100,000) according to the authors. But even if no portion of that wealth was home equity, a 4% withdrawal rate in retirement would support only $26,000 of spending.
The 4% rule is based on the trinity study and shows that you can withdraw 4% of your invested assets in the first year of retirement then increase that amount each year based on inflation. 96% of the time, you will end with more money than you started with. Here’s the best article I’ve read on the 4% rule.
In my example, pension, social security or other income sources would be needed to duplicate the pre-retirement standard of living.
If the goal is retirement, wealth accumulation needs to be closer to three times the level described as wealthy by the authors.
Age / 3.33 X pretax annual household income
A 65 year old with $100,000 household income would have the following calculation:
19.5 x $100,000 = $1,950,000
$1,950,000 of invested assets should support spending of $78,000 increased by inflation in perpetuity following the Trinity Study’s 4% withdrawal rate. This total could be reduced if other income sources are available.
For US residents, we should be able to count on Social Security providing a portion of our retirement income needs. At my age (almost 52) I expect the payments will be similar to payments made to current retirees. This is one benefit of being “old”! I’m pretty conservative so I only included about 70% of this in my long term plan.
I would expect my younger readers will receive payments of at least 70% of current retirees. The beauty of social security is that it provides income increasing with inflation forever. Currently the average social security payment is $15,700 annually. This is equivalent to having almost $400,000 invested at a 4% withdrawal rate.
As you approach retirement, go on SSA.gov to get an estimate of your social security benefits. You can then adjust the invested assets required to support your income needs in retirement.
If retirement is your goal, work on living like the millionaires mentioned in The Millionaire Next Door–work hard and smart and whatever you do, don’t look like a millionaire!