How rich should you be?
When Ed Koch was mayor of New York City, he almost always greeted his constituents with the same question: How’m I doin’?
People rarely ask themselves this question when it comes to their financial lives, but it’s a good one. Given your age, your income and your spending habits, are you rich enough?

One way to answer that question was spelled out in a best-selling book by researchers Thomas J. Stanley and William D. Danko, called The Millionaire Next Door. It’s a simple little formula, really. It says that your net worth (i.e. the value of all your assets minus the value of all your debts) should equal your age times your annual income, divided by 10.

*If you’re 30 and make $50,000, for example, your net worth should be $150,000.
*If you’re 45 and make $75,000, your net worth should be $337,500.
*If you’re 50 and make $150,000, your net worth should be $750,000.
People with half or less than the expected net worth were deemed "Under Accumulators of Wealth" or UAWs. Those whose holdings totaled twice or more the benchmark were deemed "Prodigious Accumulators of Wealth" or PAWs. The rest are just AAWs -- "Average Accumulators of Wealth".

The real measure of financial success.
Over the years, this formula has popped up on Web sites and in discussion boards as a way people can take their own financial temperatures. Like most financial rules of thumb, however, the Stanley-Danko formula has limited usefulness and the potential to cause some harm. Here’s why:

· The formula focuses on income, rather than spending.
· The formula ignores individual goals in favor of a one-size-fits-all approach.
· The formula overestimates wealth goals for many young people and underestimates them for many older folks.

What really determines success in meeting financial goals, planners say, is not necessarily how much you make, but how much of it goes out the door. Not only will that govern the amount you’re able to save during your working years, but it dictates how big a kitty you’ll need to sustain you after retirement.

Measuring up to the formula -- or not. "I’ve seen people with less than $1 million (in assets) but who spend quite modestly, so that’s enough," said Seattle financial planner Karen Ramsey, author of "Everything You Know About Money Is Wrong." "I also see people with $3 million to $4 million who don’t have enough because they spend like crazy."

Worse, the formula could discourage some folks who are actually doing fine financially, but who don’t measure up to the level Stanley and Danko consider "average."

A 35-year-old with a $50,000 income and a $130,000 net worth, for example, would be considered a bit of an underachiever by this formula. Yet according to the Federal Reserve’s latest Survey of Consumer Finances, however, she would be in the top 25% of her age group in terms of accumulated wealth.

"If a goal looks unrealistic, it might discourage people," said Gary Foreman, a former Certified Financial Planner who publishes The Dollar Stretcher, a newsletter and Web site for the frugal called (See link at left.) "Instead of doing what they can to meet their goals, they freeze and don’t do anything."

Goals of saving for retirement and slashing debt. Foreman actually liked "Millionaire" quite a bit, because the book emphasized that most millionaires got that way by living well below their means and valuing financial independence over status symbols. But he believes people can help themselves more by planning and saving for retirement, and striving to get out of debt, than by setting an artificial wealth goal for themselves.

"If they wanted to set goals, the goal really should be to be mortgage-free by the time they’re 50 or 55," Foreman said. "If they’re able to pay off that mortgage (before retirement), they’d be doing really well."

The final problem with the Stanley-Danko formula is that it really falls apart when applied to the young and to the old.

Stanley and Danko wrote that the formula applied to "most people in America with realized annual incomes of $50,000 or more" who were between 25 and 65. The younger or older you are, however, the less helpful the formula seems to be.

The two ends of the spectrum. Imagine you were a 25-year-old lucky enough to nab a job paying $50,000 a year. By the formula’s reckoning, you should have $125,000 accumulated -- and this just four years out of college. That would require saving about 60% of your gross income, which is not a feat most of us are likely to pull off.

Consider the other end of the spectrum, as well. A 65-year-old who makes $100,000 should be fine with $650,000 in assets -- at least according to the formula.

This might be true if he has a generous pension. But otherwise that amount of savings likely wouldn’t be enough to get him through a 20-year retirement, let alone anything longer, unless he’s willing to cut his spending to something under $40,000 a year. The T. Rowe Price retirement income calculator, which uses probability analysis, says that our man would most likely outlive his funds unless he withdrew just $3,185 a month from a diversified portfolio.

So when is this formula useful? The book’s authors hoped it would prod people to realize that a good income doesn’t mean much if you’re not growing your wealth through saving and investing. The formula also underscores that your net worth should be growing over time -- at least until you hit retirement age. If your net worth is slipping -- thanks to lower investment returns, for example -- you may need to save more to reach financial independence.

Mostly, however, the formula is too general to be of much help to most people. Planners suggest the following as better ways to determine if you’re on track financially:

Are you saving at least 10% of your income? Consistently saving 10% to 20% of your income is the best way to make sure you don’t come up short later in life, planners said. If you got a late start, you may need to put away even more. Saving helps in two ways -- by building your assets and by getting you accustomed to living on less, which can help you make your retirement assets last longer.

Are you staying out of debt? Net worth consists of two parts: assets and liabilities. Running up credit-card debt, tapping your home equity or borrowing against your retirement funds whittles away the wealth you can accumulate for tomorrow. Again, paying off debt helps in two ways -- by removing the liability and freeing up the money that used to go for interest payments.

Do you have a plan? Financial success comes from setting goals, making choices and taking action. Someone who wants to retire at 50 will need to make different choices than someone who’s comfortable working longer. Likewise, those who have expensive hobbies -- travel, for example -- will probably need to save more than homebodies.

Personal-finance software such as Quicken 2002 and Money 2002 also have planners that can help you integrate multiple goals, such as saving for college, buying a new home and investing for retirement. A good financial adviser can guide you through this task as well.

So forget formulas and benchmarks -- set your own course, then judge your financial success by the progress you’re making toward those goals.

-Liz Pulliam Weston
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