Hi there! It's Nik, excited to share a neat little formula with you today...
In the movie Wall Street 2, Shia LaBeouf plays a rising star in the cut-throat world of stock traders. At one point, he asks his mortal enemy about his "number" — "the amount of money you would need to just walk away from it and live."
LaBeouf claims everybody in finance has such a number, and that it's usually an exact one. "So, what is yours?" he asks. His nemesis, played by Josh Brolin, just smiles and replies: "More."
More. When it comes to money, most of us think we need more, but we rarely think about exactly how much, do we?
"If I had an extra $100,000, I could buy the house I want," we might say, but we tend to tie exact milestones only to specific goals — the next vacation, the next investment, the next big desire we want to fulfill.
How much money do you ever want to have? What's the sum you'd need to live your best life, for your whole life? It's a hard question. There are so many variables!
What's more, most people have a poor grasp of money once sums exceed a certain size. How much more is $10 million compared to one? What about $100 million compared to ten? Sure, on paper it's just another zero, but how does it affect a human life for a lifetime?
Then, there's the fickle human mind. "More." Even if you had an exact number, you'd probably replace it with a bigger one as soon as you got close. I've caught myself many times, plotting how I might reach 10x this goal or that, often long before I'd achieved half of my initial target.
A better approach to the question "How much?" is to ask it relative to time: "How much when?" Money is a function of age because, usually, we earn more as we get older. We also spend more, especially when starting families, and our healthcare expenses tend to be highest in our last two or three decades.
Therefore, instead of asking, "What's my number?" you might want to ask, "How rich should I expect myself to be at what age?"
This, too, is a question quickly fraught with bias. We'll factor our family background into our estimate, look at how much money our friends make, google average salaries in our industry, and quickly conclude that, yes, as usual, we are behind.
According to Thomas Stanley and William Danko, authors of The Millionaire Next Door, there's an easier, faster, more accurate way to estimate your expected net worth. They call it "the wealth equation," and it works like this: Take your pretax annual income, and multiply it by your age. Then, divide by 10.
For example, if a doctor aged 40 makes $100,000 before taxes, the total value of her assets should be $100,000 x 40/10 = $400,000. This is the "average expected net worth," given her age and income.
Stanley and Danko also offer another simple rule of thumb to see if you're in the top or bottom 25% of your age group: Simply double (or halve) the result, and you'll see what it takes to be above or below average. If our doctor had $800,000 in assets, she'd be very well-positioned.
The good thing about this formula is that it accounts for a larger population than just your immediate network. It also considers the dynamics of age, expenses, and income over time. A 50-year-old may have benefitted from compounding interest for 20 or 30 years. That's an advantage no 30-year-old can have, so it's normal to have less when you're younger.
The wealth equation is a good indicator to see where you should be relative to where you are. If nothing else, it's a much better answer to "What's your number?" than "More."
Happy reading,
-Nik
PS: I'm spotting a pattern here. It seems this excerpt from The 4 Minute Millionaire shares yet another idea from an all-time classic finance book.
I wonder if the book is just a collection of the best ideas from the best finance books...🤔 Let me know if you find out more! 😋
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