Saturday, June 18, 2011

How good are you at accumulating wealth?

I'm currently reading a book titled "The millionaire next door". From the few chapters that I gathered, the book is about the characteristics of wealthy people. As I read it, I am keenly aware that while wealthy people have certain characteristics that make them wealthy, it's not true that by following such characteristics, I'll be wealthy too. This logical flaw is similar to this: It is found that all cancer patients drink water, so drinking water will cause cancer. Basically, it's a mistake on causation and correlation. Correlation does not imply causation. I think it's important to have this principle in mind so that when I'm reading this book, I won't be unduly swayed by these characteristics and start to follow them, thinking that it'll lead me to wealth.



There is, however, one thing that I found quite interesting as I was reading the book. It's a heading about how to determine if you're wealthy. As described in the book, you can determine this by this rule of thumb:


Multiply your age by your realised pretax annual household income from all sources except inheritance. Divide by ten. This, less any inherited wealth, is what your net worth should be.


Let's say a 30 yr old person earning 50k a year and having an investment return of 10k a year, will have a calculated net worth of 180k. If that person has a networth of less than 180k, he is a UAW (under accumulator of wealth). If he has a networth of 180k, he is a AAW (average accumulator of wealth). If he has a networth of twice the calculated amount, that is 360k, he is a PAW (prodigious accumulator of wealth).






I found this idea rather interesting. Based on the rule of thumb, I'm considered a AAW because my networth is around that value calculated. For computation of networth, I included all my cash, cash equivalent and investments (marked to market), cpf and the cash value of whole life insurance. I did not include my house since I treat the asset value of the house at cost and that will be balanced by the liability of the loan in my balance sheet. I guess the reason why I'm not a PAW is because my investments are not returning a fantastic return to me. That is something that I would have to do about in the future.



You'll realised that you cannot just pluck the numbers and key into the formula straight away. You'll need to find out how much you earn per year (that is usually easy for salaried workers). You'll also need to know your assets and liabilities and calculate your actual net worth so that you can have something to compare with. I think by doing this little rule of thumb exercise, you can get to know more about your own financial status.



So go on, try it and tell me if you're a PAW, AAW or UAW.


*This article is contributed to IM$avvy financial portal, which is managed by Central Provident Fund Board and supported by MoneySense. This site has a noble aim of promoting financial literacy to the general population.

19 comments :

Musicwhiz said...

I did the "simple" computation and concluded that I am an under-accumulator of wealth. Oh well. Darn.

Cheers,
Musicwhiz

la papillion said...

Hi mw,

Well, don't take it too seriously, haha! There's a lot of things that are not represented in this rule of thumbs that I'm sure you are aware of :)

Temperament said...

Hi,
Don't be discouraged, just believe you have to save and invest and of course at times spend and enjoy also.. Treat it as your life time hobby and by the time you realise it, you will be a one of the millionaire next door or at least richer than your next door neighbours.i "guaranteed" if you treat it as one of your hobby for life.
Shalom!

Temperament said...

Hi LP,

"The Millionaire Next Door" is one of my favorite books. Recently survey after survey stated that Singapore has the highest number of millionaires per population. Is this a joke or something funny? On the other hand it may be the truth. We know we have many $million dollar paid ministers, civil servants, Company's CEOs .... etc. That's why a 800 sq ft private condominium sell for more than $1.xx million dollars.
Are you one of "The millionaire Next Door"

Anonymous said...

you can download from below link
http://www.mediafire.com/?u2z1s6psfaxpx54

Createwealth8888 said...

That formula 'chun bo'?

Based on 2010 earned and investment income and net worth excluding home, CPF SA and MA and at last Friday market closing.

Paiseh. I am PAW but can be demoted by Big Bear to higher AAW if he comes.So I will need to defend this PAW position against the future Bear.

I think after spending many years of time and efforts in educating myself in the local stock market it really help.

:-)

AK71 said...

Hi LP,

My maths is really poor and I got somewhat lost. Maybe you could come up with an app where people can just key in some numbers and, voila, they would have the result! Yes, I am lazy. I know. ;)

Anonymous said...

Not sure how relevant this is to S'pore as housing cost more than in other countries. So, if you do not factor in your home, you'll definitely be U or A.

hydrogenperoxide said...

I'm a super under accumulator according to that formula.. :(
But I must say this formula should have included some age element to make it a bit non linear.. for now it's linear, which I think make it easier for older people to beat it?

la papillion said...

Hi Temperament,

I received your many comments, haha :) Do you have problems posting? I think it's because it's too long, sorry! I'll put it up later on your behalf :)

You should jio me to read your favourite books :)

Hi bro8888,

Haha, why am I not surprised that you are a PAW? Congrats bro8888, you deserve it!

Hi AK,

I can help you do it, but you still need to know your networth figures to compare against this computed one. So if you're curious how well you do in this rule of thumb, you can't be lazy, haha :)

la papillion said...

Hi anonymous,

Why so sure that you'll be U or A if you don't factor in your house? I think unless you plan to sell off your house, it's not important to put it as your networth. It might be the kind of dead weight in your balance sheet, serving no real purpose other than to make it appear that you're well off, networth-wise :)

Hi H2O2,

You're still young :) If you've just started working, it's quite hard to hit the ground running. Well, at least you know where you should be aiming at :)

Temperament said...

Hi LP,
Ya, sorry. Each time i posted the "book review section, it just disappear. so i try more than one time till i gave up.
Very sorry neh!

la papillion said...

From temperament:
---------------------------
LP pardon me i borrow your blog's space now to share one of book review from the "WWW".

The authors write:

In the course of our investigations, we discovered seven common denominators among those who successfully build wealth.
Those characteristics are:

1.They live well below their means. In general, millionaires are frugal. Not only do they self-identify as frugal, they actually live the life. They take extraordinary steps to save money. They don’t live lavish lifestyles. They’re willing to pay for quality, but not for image.
2.They allocate their time, energy, and money efficiently, in ways conducive to building wealth. Millionaires budget. They also plan their investments. They begin earning and investing early in life. The authors note that “there is an inverse relationship between the time spent purchasing luxury items such as cars and clothes and the time spent planning one’s financial future”. In other words, the more time someone spends buying things that look good, the less time they spend on personal finance.
3.They believe that financial independence is more important than displaying high social status. The authors spend far too much time beating home this point: usually millionaires don’t have fancy cars. They drive mundane domestic models, and they keep them for years. (There’s an entire 31-page chapter devoted to how millionaires shop for cars. It’s tedious. It may be the worst chapter I’ve ever read in any personal finance book. And the authors go on ad nauseum about the average price per pound of various vehicles. There’s even an appendix showing the average price-per-pound for the most popular models.)
4.Their parents did not provide economic outpatient care. That is, most millionaires were not financially supported by their parents. The authors’ research indicates that “the more dollars adult children receive [from their parents], the fewer they accumulate, while those who are given fewer dollars accumulate more”.
5.Their adult children are economically self-sufficient. This chapter is fascinating. The authors clearly believe that giving money to adult children damages their ability to succeed.
6.They are proficient in targeting market opportunities. “Very often those who supply the affluent become wealthy themselves.” The authors discuss how one of the best ways to make money is to sell products or services to those who already have money. They list a number of occupations they feel have long-term potential in this area.
7.They chose the right occupation. “Self-employed people are four times more likely to be millionaires than those who work for others.” There is no magic list of businesses from which wealth is derived — people can be successful with any type of business. In fact, most millionaire business owners make their money in “dull-normal” industries. They build cabinets. They sell shoes. They’re dentists. They own bowling alleys. They make boxes. There’s no magic bullet.
Thank you.

NB:
“Self-employed people are four times more likely to be millionaires"

Ha! Ha!
LP i got you,congratulations. i agree wholeheartedly.
Shalom.

financialray said...

Hi LP,

Shouldn't it be personal income rather than household income? Nowadays a lot of wives are working and getting considerable income compared to men too.

Createwealth8888 said...

Why most employees are harder to become millionaires?

Most companies will pay enough to keep the employees from leaving and most employees will work enough not to get fired.

PanzerGrenadier said...

Hi LP

I've read the book and yes one of the flaws by its critics is that the author is merely documenting the characteristics of millionnaires.

The key point that living within your means and saving and investing are the keys to being a millionnaire. But then, being a millionnaire by itself shouldn't be the end result, it's the process that we live by that's important.

What I got from that book was not to indulge in too much conspicuous consumption but focus on the principles of financial freedom.

But I balance that by living more of life. Recently, my elder sibling had a health scare but fortunately turned out to be treatable. Also, more common to hear of people in 30s-40s passing away from accident or disease.

Be well and prosper.

Temperament said...

Hi CW8888,
"Why most employees are harder to become millionaires"?
It is because Chinese believes 工 字 不 出 头。(i like to think most other races have the same belief too).By the time 工 字 出 了 头,time to say bye! bye! from this world.
Ha! Ha! Chinese words very "powderful".

la papillion said...

Hi financial ray,

Well, I'm not the one who came up with the formula. I did, however, use personal income instead of household income.

Hi PG,

Yup, you're right. No point reaching attaining a number without significance. It's always the why that matters.

how to accumulate wealth said...

Thanks for this post about on how to accumulate wealth. The book is also good, I read it many times and I would recommend to people who really want change in their financial life.