People often wonder what their net worth should be. Some compare themselves to the average, while others have a magic number in their head. Once they hit that number, they know they are financially set. The best net worth formula is courtesy of the Millionaire Next Door.
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The Millionaire Next Door is a groundbreaking book which revealed that the pop culture view of millionaires is false, they actually live a simple life. By limiting their spending and saving well, they build a great net worth over time.
The Millionaire Next Door Formula
The Millionaire Next Door offered a formula to calculate your ideal net worth:
Target Net Worth = Age x Annual Pre-Tax Income / 10
Suppose you’re 30 years old, making $100k per year. According to the net worth formula, your target net worth should be $300k.
Flaws with the Formula
While this formula is a great rule of thumb, it doesn’t work for people who just started their careers. For example, suppose you are 22 and recently graduated college. The average student loan borrower has $37k when they graduate college, and their average salary is around $50k.
Based off of those assumptions, the 22 year old has a net worth of -$37k. According to the formula, their ideal net worth should be $110k. Therefore, their net work is $147k lower than it should be.
Did this 22 year old make a mistake going to college? Since the average net worth of college graduates is 4x high school graduates, they probably didn’t. So what’s the deal?
Many disregard this formula entirely due to this flaw. We agree that the formula doesn’t make sense until they are 35, and until then believe that this is a formula they should strive for.
Net Worth Formula – The Bottom Line
The Millionaire Next Door offers a great rule of thumb on your ideal net worth. With that said, this formula works better after you’re 35.
Many will say to skip the book until you’re forty because of this. While the formula doesn’t immediately apply to younger people, the habits in this book need to be learned as soon as possible.
As you build your nest egg, strive for to exceed that formula. If you are later in your career and above this target, you are doing it right.