Struggling with your electric bill? Get an energy assist from SDG&E and SAFE. You may qualify for an 18% discount. Visit sdge.com/fera to find out more. - Welcome to Radical Personal Finance, the show dedicated to providing you with the knowledge, skills, insight, and consistent daily encouragement you need to live a rich and meaningful life now while building and working on your plan for financial freedom in 10 years or less, fighting the sniffles today.

So today's show is going to be extremely short and to the point, but I wanna talk with you about the Millionaire Wealth Index. I'm drawing this from the well-known book, "The Millionaire Next Door" by Tom Stanley and William Danko. This seminal work was published about 20 years ago. In fact, I just realized that they published a 20th anniversary edition, which I have not yet gotten, which I need to look up and get a copy of the 20th anniversary edition to see how they've updated that since the passing of Dr.

Tom Stanley back in 2015. Interested to see how they've updated the research, interested to see if there have been any changes that have occurred since then. In the beginning of "The Millionaire Next Door," the authors talk about how to define the wealthy. After all, they're writing a book about the wealthy.

The subtitle of the book is called "The Surprising Secrets of America's Wealthy," and they talk about some different ways to discuss and to categorize wealth. This is not actually an easy question to answer. Words have meanings depending on where we are. We ascribe the meaning to a word based upon our own personal experience, our own personal knowledge, and our own personal use of the word.

I do this every day. In my little intro there that you just heard where I said, "Show dedicated to helping you "to live a rich life now "while building a plan for financial freedom "in 10 years or less," depending on how you're stumbling into that slogan, you'll interpret that differently.

For example, I personally live a very rich life now, and I want you to live a rich life now. But some people define that term rich in the context of driving a luxury automobile. I place a lot more emphasis on having an intellectually rich life than I do on driving a luxury automobile.

I place a lot more emphasis on having freedom and control over my time than I do on having a luxury timepiece on my wrist. Of course, your mileage may vary, but that's the definition that I've chosen for living a rich life now. Similar things with financial freedom. When I talk about financial freedom, as I've made clear in previous shows, that word can be applied in various ways.

I consider somebody who is not overwhelmed with debt, who has more income than they do expenses to be financially free. I also consider somebody who's financially independent, meaning able to live on the income from their investment portfolio, to be financially free. Some people can be financially free on $20,000 a year, and some people cannot be financially free on $200,000 a year.

And so we face the same problem with the word wealth. Different people define wealth, or the state of being wealthy, differently. Some people think about having a lot of stuff, a lot of material possessions, and having a lot of luxury items. However, that definition can be misleading. And in the book "The Millionaire Next Door," the authors don't talk about wealth or affluence in terms of material possessions.

One major reason for this is sometimes there can be a positive relationship between wealth and material possessions. Somebody who has a lot of material possessions, especially even including luxury material possessions, might indeed be extremely wealthy. But sometimes there can also be an inverse, negative relationship between wealth and material possessions.

After all, it's possible that somebody has spent all their money buying material possessions, and thus they don't have any other forms or sources of wealth. So how do you get a little closer? Net worth should certainly be a factor. Net worth, meaning the value of somebody's assets, minus their liabilities, that number could be high or could be low.

And you could have a high net worth and a lot of material possessions, or you could have a high net worth without a lot of material possessions. So net worth is useful. And generally, in Tom Stanley's research in "The Millionaire Next Door," they discussed net worth in the context of usually most of their profiles and research respondents had a net worth an average of between one and $10 million.

Of course, these numbers were published in 1998. And in 1998, if you had a net worth of a million dollars, although it wasn't worth as much as it was in 1978, in today's dollars, in 2017, as I record this, you would have to accumulate $1,496,788. So let's just call that $1.5 million among friends to have the same amount of buying power as you had in 1998.

So here we are coming up on the 20th anniversary of this book, and we would need to adjust this. The respondent who was worth a million dollars would need to be worth now in today's dollars, $1.5 million. That is a useful consideration. The actual nominal or stated dollar value is valuable and is worth considering.

But that doesn't take into account two important characteristics or two important pieces of data, namely, how long have you had to build wealth? We would define that in age or possibly number of years working and accumulating money. And how much income have you had to work with? Somebody who has turned a $50,000 annual income into a $1 million net worth has been a much better saver, investor, and manager of wealth than somebody who has turned a $500,000 income into a $1 million net worth, given similar amounts of time.

In order to factor all these things together, the authors came up with a simple formula to calculate how much wealth they said you should have. And I think this is a very valuable formula. I don't know whether it's particularly valuable still in the context of calculating anything across populations.

I don't know the usefulness of this. But I do think it's a useful consideration for us to know for ourselves. And I also think it's valuable to look at the factors that are involved in this wealth index. Here's the formula. The authors say that the formula is to multiply your age times your realized pre-tax annual household income from all sources except inheritances and divide by 10.

This, less any inherited wealth, is what your net worth should be. Now, let me simplify that to make it a little bit more easily grasped in an audio format. Take your age, multiply it by your income, divide by 10, and that's what your net worth should be. So if you are 40 years old and you have an annual income of $50,000 per year, multiply those together and you come up with a number of $2 million.

Divide that number by 10 and you wind up with a number of $200,000. And your net worth should be about $200,000 if you're about normal or average. And by that I mean normal or average as a wealth builder. I don't know, again, any comparison here to the average population.

But you're listening to Radical Personal Finance, you're not the average population, and averages don't particularly matter. They might be useful for sociologists to study or economists to study, but they don't make much of a difference in your life or in my life. It's a funny anecdote, but I always think of this when I think of averages.

Somebody made the quip somewhere that if you take one bucket of water and you fill it up with boiling water, and you take another bucket of water and you fill it up with ice water, on the whole, on the average, you'll be pretty miserable. And the point was, yes, if you put the hot water and the cold water together, on average, the temperature should be comfortable, but in your case, you're miserable, depending on where you are and which foot you happen to have in which bucket.

So I don't know what that means. I just think it's always funny that averages are useful to be aware of, but they're not useful for running your life. In order to think about the next category, which the authors, and before I go on, I encourage you, take a moment, and you can do this in your own mind.

Take your current age, measured in years, multiply it by your current income. Just round it off. So age times income, and think what that number is. And then divide by 10, and the simplest way to do that is just move your decimal point one place to the left. So again, 40 years old, $100,000 of income.

In that situation, you would have, the number would be $4 million. Move the decimal point one place to the left, and you would now have an expected net worth of $400,000. Now, from here, though, we should add a little bit of texture. The authors use two categories in "The Millionaire Next Door." One is a PAW, which is an acronym for prodigious accumulator of wealth.

A PAW is a prodigious accumulator of wealth. Also, a UAW, or an under accumulator of wealth. And of course, if you desire to be profiled as being wealthy, then you would want to be in the PAW, the prodigious accumulator of wealth category. In order to be well-positioned as, and characterized as a PAW, the authors state that you should be worth twice the level of wealth expected.

If you are 40 years old, earning $100,000 per year, and you want to know, am I doing really well? Am I in the top quartile? Am I a prodigious accumulator of wealth? Well, in that case, your expected net worth of $400,000, you would like to be able to see that about double, $800,000.

So these numbers might be able to give you a sense of how you're doing. If you're younger, for example, if you're 30 years old, and you have an annual income of $50,000, and you apply this formula, well, your expected level of wealth is $150,000. If you've accumulated half a million dollars in savings, or $300,000, and 150 in your 401k, and $100,000 of equity in your house, and $50,000 of savings, you're doing really, really well.

You're on track. And so there are a few reasons I want to profile this formula for you. Number one, I want to encourage you that either you're on track, or you might want to adjust things a little bit. The reason it's important to recognize you're on track is you have to go with, you have to look and compare yourself to people who are in a similar situation as you.

And this is why I want to break this down. The two big factors are your age and your income. Don't, if you're 30 years old, don't compare yourself and your level of wealth to somebody who is 50 years old. Compare yourself to other 30 year olds, because in general, you're going to have started working at a different time than they did, and you've got to compare yourself to a similar category.

Likewise, if you're earning a very high income, don't compare yourself to people who are earning a low income and think, oh, look, I'm doing great. Compare yourself to people who are also earning a high income, who are good producers of income. Compare yourself to these peers. In order to do that, you're going to have to find some kind of formula, because it's going to be hard for you to find similar peers who are at similar amounts of age and similar income.

I think the use of something like a wealth index is a valuable and useful way for you to get a sense of how you're doing. Couple of caveats. If you are very young, don't look to this as a source of authority. Whether you're very young because you are very young in terms of your actual age, if you're 20 years old or 25 years old or 30 years old, or if you're very young in terms of the amount of the number of years that you have been working, you cannot look to a formula like this.

The most extreme example would be somebody like a recent doctor, a recent graduate from medical school, or some highly trained, highly specialized occupation. A recent graduate from a medical school may be half a million dollars in the hole. Their net worth may be minus $500,000, and they have gotten out of school in their early or going on mid 30s, and they have no wealth accumulated yet.

That doesn't mean that you are, that doesn't mean that you're necessarily inefficient. Stanley, in one of his blog posts on this topic, later wrote and recommended to his readers that they adjust their age and pull out all the years that they've been in school as a way of adjusting the formula.

You will be extremely wealthy, and this formula will be very helpful for you when you reach about, say, 45 or 50 years old. But when you're just getting out of school, or if you're very young, these results, the results of this wealth index are not particularly useful to you.

One other point on this topic that I want to emphasize of how you can game the formula. It's always good to look at something and see, how could I manipulate this if I were going to manipulate it? And I want to point out the huge possible point of manipulation in this formula, which is something that you should manipulate because, as is written later in the book, this is what the wealthy manipulate.

I read verbatim. Multiply your age times your realized pre-tax annual household income from all sources except inheritances. Divide by 10. This less any inherited wealth is what your net worth should be. Do you catch one of the biggest factors that you can manipulate? You can't manipulate your age. But what can you manipulate?

I read again with emphasis. Multiply your age times your realized pre-tax annual household income from all sources except inheritances. The key way to game a formula like this, and in this context, gaming is a good thing because it means you're going to be a much more efficient accumulator of wealth, is to play with that word realized.

Now, in tax lingo, what realized means is money that you've actually received. You would talk about this in the context of real income. Real income is money that you've actually received as compared to phantom income, which is income that you pay tax on, but you don't actually receive. Examples of phantom income would be things like zero coupon bonds, where you are accruing interest, but you're not, which you're paying tax on the interest, but you're not actually receiving any money because you'll receive the interest that's being assigned to you when you actually sell the bond.

Or another example of phantom income would be when you have a debt that is forgiven by a creditor. If you have a creditor that forgives you a $10,000 loan, you are going to incur $10,000 of income, and you're gonna owe the tax on it so you could save your effective tax rate, or 20%.

You would owe $2,000 of taxes on that money, which the IRS will collect on, but you never actually realized any income. That's called phantom income. So that's what realized and unrealized income is. The other word that is important is recognized income, meaning when do you actually recognize a gain or a loss?

Sometimes with certain types of income or certain types of losses, you can choose to recognize them at different times. The point is the lower your realized income, the lower your expected net worth. And so what the wealthy people generally will want to do is to lower their realized income and to keep the money efficiently invested.

Because if you can lower your realized income, you have the opportunity to keep it invested if you control the source of that income. If you're just simply offered two job options, job A pays you 50 grand a year, and job B pays you 100 grand a year, and you have no equity stake whatsoever, then in that circumstance, you better take the $100,000 a year.

But if you own the company and you have the choice to either take a job paying $50,000 a year or to take a job paying $100,000 a year, and you're 100% shareholder of the company, it's in your best interest, probably, as long as the company is doing well, to keep that realized income number as low as possible.

Yes, that games the formula, but as you read later in the book, it's one of the best ways to game the formula because it allows you to keep the money because it allows you to continue investing the money without it getting out into the wild and wooly world of taxed dollars.

Calculate that formula for yourself. Use it as a useful rule of thumb. Don't put too much stock in it, but don't ignore it. Think about what you learn from it. Multiply your age times your realized pre-tax annual household income and all sources except inheritances, divide by 10. That, less any inherited wealth, is what your net worth should be.

This show is part of the Radical Life Media Network of podcasts and resources. Find out more at radicallifemedia.com. - Struggling with your electric bill? Get an energy assist from SDG&E and SAFE. You may qualify for an 18% discount. Visit SDG&E.com/FERA to find out more.