Without looking online, how would you define wealth?
We all have a general idea of what wealth is, but I’ll bet that if you were to ask the average person on the street their definition would come close to Webster’s:
Wealth: abundance of valuable material possessions or resources.
It’s not that easy.
I’m going to say that if you were to ask me five or six years ago I might have agreed. Now though, I’m not so sure. To me, possessions just means stuff. So would a person who drives a $150,000 car and lives in a million dollar house on the water be considered wealthy? What if they were in debt to the tune of 1.5 million dollars and had a negative value? They’d still have an “abundance of material possessions”, but to me they’d seem to be in a pretty precarious position.
Definition from The Millionaire Next Door
Thomas J. Stanley, Ph.D and William D. Danko, Ph.D made me question the original definition of wealth in The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. Since you’re on a personal finance blog, I’m going to assume that you read it. And if not, what are you waiting for? There’s a good chance that your local library has a copy waiting for you right at this very moment. It’s one of the books that caused a paradigm shift in the way I thought about my money and what makes the rich different from the rest of us.
The basic premise of wealth in The Millionaire Next Door is that wealth is based on age, income, and the net worth of your appreciable assets minus any inheritance. I’m guessing that you want to know if you’d be considered wealthy by these terms. Well it’s not too hard, just:
- Take your annual pre-tax household income, minus any inheritance and multiply it by your age.
- Divide that number by 10.
- Subtract any inherited wealth. The number remaining is the amount of money your net worth should be without any inheritance.
To put this definition into perspective let’s take Richard and Bill.
Richard is 60 and earns a very nice salary of $500,000 per year. However, even with such a nice income, Richard tends to spend it faster than it can come in. Still, he’s managed to accumulate a net worth of $1.2 million. Not bad right? Well, not so fast. See, according to The Millionaire Next Door, Richard should have a net worth of at least $3 million to be considered wealthy.
Bill’s financial situation is much different from Richard’s. Bill is 35 and makes $45,000. Bill has managed to save $200,000 without ever inheriting a dime. I wouldn’t mind having a net worth of $200,000 at 35, but that can’t really be considered wealthy right? Bill hasn’t even reached the million dollar mark. However, based on his income and age, Bill is considered to be wealthy. He’s actually quite a bit ahead of the game because his wealth number would be $157,500.
Wealth is Relative
According to the traditional definition of wealth, Richard would be quite a bit wealthier than Bill. But I think that the definition presented in The Millionaire Next Door paints a much clearer picture of what true wealth really is. If both men were to lose their jobs tomorrow, Bill’s wealth would be able to carry him much longer than Richard’s would.
Bill’s net worth is actually a tad bit over four times his annual income. Whereas Richard’s is just a bit over twice as much. If you add in the fact that Richard is twice Bill’s age, then you can see that Bill actually could live longer than four years, because he saves so much income and lives under his means. Richard on the other hand spends a large portion of his income which is shown by the fact that his net worth is much lower.
How would I define Wealth?
My current views on wealth was actually formed a few years ago when I watched an episode of the Cosby Show. One of the girls was getting picked on at school because her family had money. Her father is a physician and mother is a lawyer, so why not. Anyways, she ran to her mother to explain what was bothering her. Her mother said that they were not wealthy. She said you’re wealthy when your money starts to make more than you do. I liked that definition of wealth and it stuck with me, because once you’ve hit that point you have pretty much achieved financial independence.
How do you define wealth? Do you agree or disagree with any of these definitions?