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Thursday, August 5, 2010

Are You a Wealth Accumulator?

There is this book called The Millionaire Next Door by Thomas J. Stanley and William D. Danko regarding the process of every one to accumulate great wealth. Don't get me wrong, this book is not giving the tips on how to get rich in 5 minutes, but rather the slow and steady process of successfully accumulating wealth.

According to the book, there is a formula to calculate or benchmark whether a person has successfully accumulate wealth according to their age and income and it summarizes into the following:-

Multiply your age by your gross annual income from all sources except inheritances. Divide this by ten. This, less any inherited wealth is what your net worth (excluding home equity) should be.

There are few classification of wealth accumulator and is as follow:-
  • A prodigious accumulator of wealth (called a PAW throughout the book) has a net worth twice as high as this formula.
  • An under accumulator of wealth (UAW) has a net worth under half of this.
  • An average accumulator of wealth (AAW) who has the net worth between half the formula and twice the formula.

The formula actually quite make sense because a doctor might be making a whole lot more money than a janitor, yet because the doctor spend excessively, he or she is actually a UAW while the janitor might be AAW or UAW because of his or her habit of accumulating wealth. Age also comes into play in determining whether a person is a wealth accumulator or not because the older you get, you will eventually have higher net worth.

Let's look at the following scenario:-
A and B is earning 50K and 100K respectively and both of them are of same age at 30 years old.

According to the formula,
A = 50, 000 x 30 / 10 = 150, 000
B = 100, 000 x 30 / 10 = 300, 000

Both A and B are AAW if both of them have 150K and 300K in net worth respectively. But should A has net worth the same as an AAW B which is 300K, then A is a PAW. On the other hand, should B manage to accumulate net worth as an AAW A which is 150K, then he or she is UAW.

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