Lifetime Wealth Ratio and Other Simple Personal Finance Formulas
While reading some of my favorite personal finance blogs this weekend I stumbled across a post from almost a year ago by J.D. over at Get Rich Slowly. J.D. outlines an awesome way that I’ve never heard of for measuring where you are wealth wise. The formula he uses is called the Lifetime Wealth Ratio.
While the Lifetime Wealth Ratio isn’t perfect, it is a great gauge of where you are currently. What it does is take your net worth and divides it by your lifetime income. You may be wondering how in the world you are going to get these numbers, especially your earnings. But I promise, it’s easy, and this exercise took me 10 minutes. Here is what the formula looks like.
Simple formula right? Now, let’s get some numbers.
The first thing you are going to need is your net worth. This is a number that every single one of you should know and should be tracked at least twice a year. Calculating your net worth is extremely easy and lucky for you I’ve already done an article on it. Check out The One Number That Makes You Rich: Net Worth. If you don’t know your net worth then you’ll never have a gauge of how you’re doing financially. You’re flying a plane with no GPS, take the time to go calculate it.
Once you have your net worth the next thing you’ll need is your lifetime income. Now, how in the world are you supposed to get this information. I’m willing to bet most of you don’t have bank statements dating back to when you started working. Hell, I don’t have any from last year. Luckily for you and I, the government has all this information (of course they do) and you can access it.
To do this you are going to need to create an account on the Social Security Administration’s website. Once you’ve done this you can see your statements for all your income that has qualified for social security withholdings. For most of you who have regular jobs, this is your only income. Here is an actual screenshot on mine:
This data goes all the way back to when I was 16 years old and working as a farm hand for minimum wage. As you can see my income goes up and then swiftly down, I’ll explain why and why this matters in a minute. But for now, the total that was eligible for withholdings was just over $150,000
We can then plug this number into our formula. While I’m not going to say what my net worth currently is we’ll just use $50,000 for the sake of this article. This turns out to be:
So what does 33% mean? Well, it’s not good but it definitely isn’t bad. It is important to remember here that this formula is just a guide, it’s not the end all be all. The general guideline is this:
- Less than 0% – You need to focus solely on eliminating debt
- 0% – 15% – We have a lot of work to do
- 15% – 50% – This is the average person, do you want to be average?
- 50% – 100% – You’re in the 1% and doing great! Keep it going
- Greater than 100% – Congrats you’re in the .01%, go ahead and add me to your will.
Why It’s Not Perfect
First off, this is just an arbitrary number, it doesn’t mean anything concrete. Instead, it should just be used as a guide and calculated once or twice a year. Obviously, you want this number to be increasing and if it isn’t you need to figure out why.
Secondly, the income in this just takes into account income that is susceptible to certain taxes like social security and Medicare. If you own a business, you’ll have to pay certain self-employment taxes. Different business structures will cause this number to fluctuate heavily. The combination of how I’m paying myself from my businesses and leaving a corporate job led to the decline of over 40% from 2015 to 2016. That topic is far too complex for this article and I’m not a certified public accountant but just know if I took in ALL my income the % we calculated earlier would be much lower.
It’s important to understand the amount of income you pay social security tax on now will affect your payout in the future as well. Personally, I’m not counting on social security payouts when I’m older. If I do receive something it will just be the cherry on top of my other retirement savings. If you want to calculate what your potential social security checks will be you can do this at the same site you got your income data from.
The last key item is that the younger you are the lower your percentage will be. For most of us when we’re young our income will be low and our expenses will be high. Hopefully, as we grow in our careers so will our income. Along with that we should be maturing more and making more educated purchases. This, in turn, will raise your net worth. Remember, this is just a guide.
One Additional Formula
If you can’t tell already I’m obsessed with formulas, especially when they tell me how I’m doing with my money. This affirmation drives me to continue good money habits and find ways to increase my overall numbers.
One more formula you can use revolves around your age, yearly gross income, and net worth. It’s even simpler then the one stated above as you don’t have to go find any historical data. Here’s how it works. For this example, we’ll use a 30-year-old, with a gross annual income of $50,000.
Multiply your gross annual income by your age – $50,000 x 30 years old = $1,500,000
Divide this number by 10 – $1,500,000 / 10 = $150,000
This number should be less than or equal to your net worth. If it’s greater than yours then just understand you may have a little work to do but don’t panic. This formula just like the one above works best for people who have established careers and are within 15 years of retirement. So take everything with a grain of salt.
Wrapping It Up
Assessing where you are financially is quite a simple exercise when you sit down and tackle it. The fear people have around money is mostly overhyped and simple formulas like this should allow keeping yourself accountable easier.
I believe there is no excuse to not track these formulas at least once a year. This along with knowing your net worth will make sure you stay on the right track.
What did your percentage come out to be? Do you know what is driving this and what you need to do to raise it higher?
Also, heads up! We’ve turned this post into a YouTube video. If you’re struggling to understand or just learn better through video then check it out below.
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