The Millionaire Next Door by Thomas J. Stanley, Ph. D. and William D. Danko, Ph. D. have a formula to determine if you are wealthy.  This formula is simply:

This is an interesting way to look at wealth, because it controls for age and the amount of income a high wage earner makes.  For example, a family, whose primary income earner is 50 and makes 50,000 a year, should have a net worth of $250,000.  If they have more than this amount, then according to this formula, they would be considered wealthy.  In another example, a family, whose primary income earner is 45 and makes 750,000 a year, should have a net worth of $3,375,000.

It’s interesting to me that this definition does not simply rely on an arbitrary number – say one million dollars.  The more money you make equates to the more money you would need to have accumulated in order to be considered wealthy.  Of course, this makes sense when you consider highly paid sports stars that end their career with hardly anything to show for it.  Wealth isn’t determined by the size of your paycheck, it’s determined by your net worth.

The next question that may naturally come up is, how wealthy should I be, which is sometimes incorrectly tied to how much money do I need in order to retire.

If we go back to the example of the first family that makes $50,000 a year and find their net worth to be $750,000 (the same amount that Family 2 makes in a single year), we would determine that they are “wealthy” according to this formula.  But are they really wealthy?

It turns out, that if, in retirement, they maintained the same lifestyle they are currently accustomed to, they could live off their net worth for (at least) 15 years. Of course, this assumes no additional interest on the principle amount and doesn’t take into account financial strategies to prolong (think annuities) or grow (invest) it. This simplistic formula also doesn’t account for inflation over time.

Of course, this formula is not perfect.  It’s simply another indicator you can use.

The first major criticism is that it tends to align best with mid-career people.  The formula overstates the amount of savings that young people have and understates the financial position of people who were older.  Thomas Stanley stated as much in a blog post where he revealed the Wealth Equation was developed on surveys of households with incomes of $80,000 or more and the main breadwinner was 57 (or late 50’s).  He says in the post that “Those who are significantly younger than 57 should be aware of the fact that the Wealth Equation overstates what they should actually be worth.”

There are other criticisms about the formula and the book in general.  Instead of rehashing them here, I will link to a website that seems to go justice in discussing both sides. See Defending “Millionaire Next Door” Theory: What Stanley’s Critics Got Wrong – (evergreensmallbusiness.com)