This formula doesn't work for people who are just starting out w/ their career. Example, 22 yr. old new grad making $55k/yr. Based on this formula, s/he should have $121k in net worth. That's impossible to have unless s/he have rich parents.
Submitted by jimmyle on November 2, 2009 - 11:04am.
I only have 1/3 of the formula. And I am an above average saver. I doubt that even 10% of the 20s and 30s crowd meet the criteria.
For example,
30 year old guy making $80K needs $240K nest egg to meet the criteria. Let say he starts working at 23, he needs to save $35K a year while paying down his $20K+ college loan. Impossible.
Unless he bought a house on 0% down in 2002 and sold it in 2006.
I only have 1/3 of the formula. And I am an above average saver. I doubt that even 10% of the 20s and 30s crowd meet the criteria.
For example,
30 year old guy making $80K needs $240K nest egg to meet the criteria. Let say he starts working at 23, he needs to save $35K a year while paying down his $20K+ college loan. Impossible.
Unless he bought a house on 0% down in 2002 and sold it in 2006.
Add on to that fact that this guy didnt start at 80k when he was 23. He prob started at ~40k, and has been working his way up. So for the first few years he would have to be saving more than his after tax income.
Maybe we should use a real life example and modify the formula so that it is multiplied by 1/3. Meaning a 30 year old making 80k a year needs to have socked away 80k. It wouldnt be easy, but that is atleast in the ballpark of doable.
Submitted by carlsbadworker on November 2, 2009 - 2:02pm.
The most important use of a net worth statement is to measure your progress toward retirement. In order to retire at age 72 and have sufficient funds to maintain your standard of living you need about twenty times your annual spending.
Take your net worth and divide by your annual take home pay. This is how many times your annual standard of living you have amassed in savings. If you are under 40, the number is probably less than five. That’s ok; it is supposed to be.
Progress toward retirement is not a linear function. To those of you wondering if the math you studied in high school is useful, the following equation was determined by quadratic regression. It estimates how much of your current net worth you should have saved given your age. This gives you a benchmark for determining if you are on track to retire by age 72.
Take your age and divide by 166. Then subtract fifteen hundredths (0.15). Finally, multiply the result by your age. The resulting number should be between zero and twenty. That number is how many times your current annual income you should be worth.
Pull out your calculator and follow an example. If you are 45 years old then forty-five divided by 166 equals 0.2711. Subtract 0.15 to get 0.1211. Then multiply by 45 again. The result is 5.45. By age forty-five you should be worth about five and a half times your annual spending. More sophisticated retirement planning includes the difference between taxable, tax deferred and Roth accounts as well as Social Security guesses and defined benefit plans, but this is a good approximation of your progress. Here is a table that shows by what age you should have saved different multiples of your annual spending.
If your net worth is a higher: Congratulations! You are on the path to retiring earlier than 72! For every 0.5 you are over, you could consider retiring about a year earlier. Conversely, for every 0.5 you are under your age’s benchmark you may have to work an additional year beyond 72.
Between the ages of 40 and 60 your net worth should increase by one unit of your annual spending every two years. That means that your current net worth divided by your take home pay should be one unit greater than it was two years ago. Alternately, if you are between 40 and 60, your net worth should have increased this year by half of your take home pay.
This is because money makes money, and by the time you are in your 40’s you should have enough investments to be earning about half of your annual spending each year. The compounded growth of your investments does the lion’s share of the work while you only need to contribute 15% of your current earnings. If you save 15% of your take home pay between age 20 and age 72 you should have sufficient savings in retirement. This is despite the fact that you will have saved less than 7 years worth of pay and many of those years will have been at a lower rate of pay. How much you save and invest is the primary determination of your financial future.
Want to retire younger? Try lowering your standard of living. In retirement, most people spend about 70% of the gross salary they earned while they were working. If you can live off 50% of your take home pay, you don’t need as much savings to maintain that lower lifestyle.
Need to catch up? Save more than the 15% of your take home pay. Determine how far you are behind and what additional percentage you can save each year. For example, at age 30 you should be worth 1.4 times your annual income. What should you do if you are only worth 1.1 times your annual income? Normally, to stay on track you need to save 15% of your income each year. In order to catch up you need an additional 0.3 times your annual income. One option would be to save an additional 10% of your income for three years. If saving 25% of your income is too much, try saving 20% (an additional 5%) for six years.
Can you tell me:
- only half of my net worth is retirement. I have a bunch in 529s and some in other non-retirment investments. Shouldn't I only divide my retirement savings by annual spending?
- About that "annual spending": this should not include any annual savings (again, 529s and non 401k monthly investments), right?
- Are you really saying that when I'm 40, my retirement investments should be yielding 50% of my annual spending?
The version of Quicken I have has a pretty good retirement calculator tool that allows you to include life's "financial events" such as kid's college education, selling your home, etc. The tool certainly is pretty comprehensive, but it's hard to know if it's correct. (I guess I'll find out a few decades from now...)
I don't remember which versions of Quicken has this tool - I think you have to get "deluxe" or something like that. If you care about when you can retire and use Quicken, it's probably worth the $30 bucks or so in additional cost. I find that it is useful to change parameters and "run scenarios" as you will learn that some factors matter much more than others.
- Are you really saying that when I'm 40, my retirement investments should be yielding 50% of my annual spending?
I read that to mean that your savings+investment returns should increase your net worth by 50% of your pay. Of course investment returns will vary year to year, but this is a good target.
too simplistic, besides in my personal opinion we are going to be hit by a massive wave of inflation and higher taxes in the years to come which will wipe out savings unless you're invested in something that will survive that.
Submitted by carlsbadworker on November 2, 2009 - 3:38pm.
Fletch:
I just copied a formula that I think makes more sense than the one from Millionaire Next Door. It still has a few shortcomings, primary one is that it does not take inflation into account. It needs tuning but could definitely serve as a good start.
To answer your questions,
1. You should only use the amount that could be coverted into retirement funds when needed. So even if you have taxable accounts, as long as you can use the money for retirement, count it as your retirement savings.
2. Yes, annual spending does not include annual savings.
3. I think the saying makes sense only in average return sense, but since an investment-grade asset always produces fluctuating returns, it makes the saying useless. I would change the rule such that using a hypothetic 6% return on your existing networths, it should yield a similar amount of savings compared with your real savings from the salary.
Fletch wrote:
Thanks for the explanation, Carlsbad.
Can you tell me:
- only half of my net worth is retirement. I have a bunch in 529s and some in other non-retirment investments. Shouldn't I only divide my retirement savings by annual spending?
- About that "annual spending": this should not include any annual savings (again, 529s and non 401k monthly investments), right?
- Are you really saying that when I'm 40, my retirement investments should be yielding 50% of my annual spending?
Submitted by carlsbadworker on November 2, 2009 - 3:45pm.
kev374 wrote:
too simplistic, besides in my personal opinion we are going to be hit by a massive wave of inflation and higher taxes in the years to come which will wipe out savings unless you're invested in something that will survive that.
That is right. If I were to design a formula, I would assuming an inflation adjusted 2% return on my networths, and walk backwards to see how much saving is needed each year from now until my retirement.
Unfortunately, that will make the formula complex. And a complex formula has its own drawbacks (hard to remember thus impossible to draw actions based on the formula).
Excellent points carlsbadworker.
Wealth accumulation is not linear with time (age). If one is saving and growing a nest egg, it should follow a growth curve.
I think that would be too complicated for the audience targets by the millionaire next door, so he uses an approximation that probably makes sense for people in the ~ 40-50 age range.
This formula doesn't work for people who are just starting out w/ their career. Example, 22 yr. old new grad making $55k/yr. Based on this formula, s/he should have $121k in net worth. That's impossible to have unless s/he have rich parents.
hey, it works for my daughter :)
3 * ($10)/10
How about $1 Million more then the SOB
who my wife ran off with :-)
PatB, They just started a thread for you over at
"I have the pu--y, I make the rules"
Bizarre. A good formula would look like:
(Age - X)*(Income - Y)*C
I only have 1/3 of the formula. And I am an above average saver. I doubt that even 10% of the 20s and 30s crowd meet the criteria.
For example,
30 year old guy making $80K needs $240K nest egg to meet the criteria. Let say he starts working at 23, he needs to save $35K a year while paying down his $20K+ college loan. Impossible.
Unless he bought a house on 0% down in 2002 and sold it in 2006.
Formula is too simplistic. Written in 1998 when netscape ruled the internet world and the S&P was up 20% a yr for almost a decade.
Try getting that return now
For example,
30 year old guy making $80K needs $240K nest egg to meet the criteria. Let say he starts working at 23, he needs to save $35K a year while paying down his $20K+ college loan. Impossible.
Unless he bought a house on 0% down in 2002 and sold it in 2006.
Add on to that fact that this guy didnt start at 80k when he was 23. He prob started at ~40k, and has been working his way up. So for the first few years he would have to be saving more than his after tax income.
Maybe we should use a real life example and modify the formula so that it is multiplied by 1/3. Meaning a 30 year old making 80k a year needs to have socked away 80k. It wouldnt be easy, but that is atleast in the ballpark of doable.
The most important use of a net worth statement is to measure your progress toward retirement. In order to retire at age 72 and have sufficient funds to maintain your standard of living you need about twenty times your annual spending.
Take your net worth and divide by your annual take home pay. This is how many times your annual standard of living you have amassed in savings. If you are under 40, the number is probably less than five. That’s ok; it is supposed to be.
Progress toward retirement is not a linear function. To those of you wondering if the math you studied in high school is useful, the following equation was determined by quadratic regression. It estimates how much of your current net worth you should have saved given your age. This gives you a benchmark for determining if you are on track to retire by age 72.
Take your age and divide by 166. Then subtract fifteen hundredths (0.15). Finally, multiply the result by your age. The resulting number should be between zero and twenty. That number is how many times your current annual income you should be worth.
Pull out your calculator and follow an example. If you are 45 years old then forty-five divided by 166 equals 0.2711. Subtract 0.15 to get 0.1211. Then multiply by 45 again. The result is 5.45. By age forty-five you should be worth about five and a half times your annual spending. More sophisticated retirement planning includes the difference between taxable, tax deferred and Roth accounts as well as Social Security guesses and defined benefit plans, but this is a good approximation of your progress. Here is a table that shows by what age you should have saved different multiples of your annual spending.
Age Annual_Spending_Saved
30 1
35 2
38 3
42 4
44 5
47 6
49 7
51 8
53 9
55 10
57 11
59 12
61 13
63 14
64 15
66 16
68 17
69 18
70 19
72 20
If your net worth is a higher: Congratulations! You are on the path to retiring earlier than 72! For every 0.5 you are over, you could consider retiring about a year earlier. Conversely, for every 0.5 you are under your age’s benchmark you may have to work an additional year beyond 72.
Between the ages of 40 and 60 your net worth should increase by one unit of your annual spending every two years. That means that your current net worth divided by your take home pay should be one unit greater than it was two years ago. Alternately, if you are between 40 and 60, your net worth should have increased this year by half of your take home pay.
This is because money makes money, and by the time you are in your 40’s you should have enough investments to be earning about half of your annual spending each year. The compounded growth of your investments does the lion’s share of the work while you only need to contribute 15% of your current earnings. If you save 15% of your take home pay between age 20 and age 72 you should have sufficient savings in retirement. This is despite the fact that you will have saved less than 7 years worth of pay and many of those years will have been at a lower rate of pay. How much you save and invest is the primary determination of your financial future.
Want to retire younger? Try lowering your standard of living. In retirement, most people spend about 70% of the gross salary they earned while they were working. If you can live off 50% of your take home pay, you don’t need as much savings to maintain that lower lifestyle.
Need to catch up? Save more than the 15% of your take home pay. Determine how far you are behind and what additional percentage you can save each year. For example, at age 30 you should be worth 1.4 times your annual income. What should you do if you are only worth 1.1 times your annual income? Normally, to stay on track you need to save 15% of your income each year. In order to catch up you need an additional 0.3 times your annual income. One option would be to save an additional 10% of your income for three years. If saving 25% of your income is too much, try saving 20% (an additional 5%) for six years.
http://www.emarotta.com/article.php?ID=165
Thanks for the explanation, Carlsbad.
Can you tell me:
- only half of my net worth is retirement. I have a bunch in 529s and some in other non-retirment investments. Shouldn't I only divide my retirement savings by annual spending?
- About that "annual spending": this should not include any annual savings (again, 529s and non 401k monthly investments), right?
- Are you really saying that when I'm 40, my retirement investments should be yielding 50% of my annual spending?
The version of Quicken I have has a pretty good retirement calculator tool that allows you to include life's "financial events" such as kid's college education, selling your home, etc. The tool certainly is pretty comprehensive, but it's hard to know if it's correct. (I guess I'll find out a few decades from now...)
I don't remember which versions of Quicken has this tool - I think you have to get "deluxe" or something like that. If you care about when you can retire and use Quicken, it's probably worth the $30 bucks or so in additional cost. I find that it is useful to change parameters and "run scenarios" as you will learn that some factors matter much more than others.
And, no, I don't work for Intuit ;-)
I read that to mean that your savings+investment returns should increase your net worth by 50% of your pay. Of course investment returns will vary year to year, but this is a good target.
too simplistic, besides in my personal opinion we are going to be hit by a massive wave of inflation and higher taxes in the years to come which will wipe out savings unless you're invested in something that will survive that.
Fletch:
I just copied a formula that I think makes more sense than the one from Millionaire Next Door. It still has a few shortcomings, primary one is that it does not take inflation into account. It needs tuning but could definitely serve as a good start.
To answer your questions,
1. You should only use the amount that could be coverted into retirement funds when needed. So even if you have taxable accounts, as long as you can use the money for retirement, count it as your retirement savings.
2. Yes, annual spending does not include annual savings.
3. I think the saying makes sense only in average return sense, but since an investment-grade asset always produces fluctuating returns, it makes the saying useless. I would change the rule such that using a hypothetic 6% return on your existing networths, it should yield a similar amount of savings compared with your real savings from the salary.
Can you tell me:
- only half of my net worth is retirement. I have a bunch in 529s and some in other non-retirment investments. Shouldn't I only divide my retirement savings by annual spending?
- About that "annual spending": this should not include any annual savings (again, 529s and non 401k monthly investments), right?
- Are you really saying that when I'm 40, my retirement investments should be yielding 50% of my annual spending?
That is right. If I were to design a formula, I would assuming an inflation adjusted 2% return on my networths, and walk backwards to see how much saving is needed each year from now until my retirement.
Unfortunately, that will make the formula complex. And a complex formula has its own drawbacks (hard to remember thus impossible to draw actions based on the formula).
Is investing in RE a good way to fight off the in coming inflation? Any other good way for us to protect our nest egg? Is cash still the king?
Excellent points carlsbadworker.
Wealth accumulation is not linear with time (age). If one is saving and growing a nest egg, it should follow a growth curve.
I think that would be too complicated for the audience targets by the millionaire next door, so he uses an approximation that probably makes sense for people in the ~ 40-50 age range.