This is Part 1 in a short series exploring the concept of lifetime earnings vs. net worth. It’s pretty heady stuff so I’m breaking it up into a couple of linked posts.
What is your Lifetime Wealth Ratio? How good are you at converting earned income into net worth? I first read about the wealth to lifetime earnings ratio on a Lifehacker post that was quoting Budgets Are Sexy. It’s a very powerful way to look at your personal finances.
Back up a second. What is net worth? Net worth is defined by accountants as assets less liabilities. For normal folk that means, all the stuff (investments, house, cars, etc.) you own minus what you owe to others (student loans, mortgage, credit cards, etc.).
So, let’s get started. Total up your assets (hypothetical values taken from here):
- House: $800,000
- Retirement accounts: $45,000
- Cars: $30,000
- Company Stock: $20,000
- Mutual Funds: $5,000
- Total assets: $900,000
Next, total up your liabilities:
- Mortgage: $250,000
- Car Loans: $40,000
- Credit Card Debt: $10,000
- Total Liabilities: $300,000
Subtracting total debts (liabilities) from total assets ($900,000 − $300,000 = $600,000), and we can see that this household would have a net worth of $600,000! That sure sounds like oodles of cash piled in a giant vault somewhere, doesn’t it? Using US census data from 2011, we can get a rough idea of where this household falls within the US population. Note that this is all US households (not adjusted for things like head of household age, location, etc.), and this example would fall within the top 13%.
And that’s why I think net worth is so interesting. Earned income (aka salaries or Benjamins) is great, kind of like sugar. But unless you convert it into something useful, it will be gone. And you will be left with nothing but the need to fill up again with a quick hit on payday.
It’s tough to really get a good view of the what people are really worth. The census buckets above are really coarse, and there’s no link to earned income. However, there is a pretty cool view (yes I said that about a census table) of the different types of assets that wealthy vs. poorer households own.
Keep in mind that the upper part of the graph is all median values for the category. Nevertheless, seeing the total dollars visually displayed threw me for a loop, especially when you think that 45% of the US population has less than $50,000 to their name. The goal for me was to see how rich folks allocate their dollars. My key take away: diversify your assets.
I was floored by how many folks in the upper brackets have rental real estate in their portfolios and yet how small of a proportion of their asset base it remains. I’m also shocked at how little is saved in retirement accounts vs. how much equity we have in our homes. Finally, the amount Americans have “invested” in their automobiles is
There is of course a chicken and egg problem here. We cannot say which came first: income producing assets or earned income. The results are pretty clear: wealthy folk have a much larger share of their wealth in wealth-producing assets. So, I’m happy to expand on that theme and put my (biased) interpretation on the data.
1) Buy fewer Maserati’s and more stocks/bonds.
2) Fully fund your retirement accounts (plural!)
3) Own your own (modest) home
4) Buy one or more positive cash-flowing rental unit(s)
5) Consider alternative investment strategies once you have covered the basics
6) Diversify your income sources
Next up: Lifetime Earnings. Followed by the actual Lifetime Wealth Ratio. Stay tuned!
Are you surprised by the asset category differences? Where does your household fall on the net worth distribution? What strategies are you using to grow your net worth?