Blog 2: Fueling Your Financial Journey:
The Elements of the Millionaire Next Door’s Formula
Let’s return to the tarmac with our Maine Air National Guard pilot, Lieutenant Melissa Donovan. She pilots the KC-135 Stratotanker, a military refueling aircraft that’s a marvel of modern aviation. Every switch, dial, and instrument in her cockpit serves a purpose, giving her vital information to execute her missions successfully. If we liken the wealth formula from “The Millionaire Next Door” to Melissa’s cockpit, each component of the formula is akin to an instrument, providing necessary information to guide our financial journey.
Just as Melissa needs to understand the function of every control and gauge in her aircraft, we too must familiarize ourselves with the individual components of the wealth formula – age, realized pretax annual household income, and net worth.
Age: This might seem straightforward at first glance. After all, age is just a number, isn’t it? In the context of Stanley and Danko’s formula, age represents more than the passage of time. It reflects years of earning potential and opportunities to save and invest. As Melissa ages, her income and hence her expected net worth should proportionally increase, assuming constant saving and investing habits.
Realized Pretax Annual Household Income: This is the gross income one earns in a year before taxes. For Melissa, it’s her salary from the Air National Guard combined with her part-time income as a tutor. It’s worth noting that this doesn’t include unrealized income from assets such as stocks and property unless they’re sold and the income is realized.
Net Worth: Net worth is the difference between your assets (what you own) and your liabilities (what you owe). Assets include savings, investments, property, and any other valuable possessions. Liabilities include debt, such as student loans, mortgages, credit card balances, and other financial obligations. For Melissa, her assets include her savings account balance, her growing investment portfolio, and her grandmother’s inheritance, while her student loan debt constitutes her main liability.
Now, let’s turn the formula into action. As a 27-year-old with a combined pretax income of $65,000, according to the formula (27*65,000/10), Melissa’s expected net worth should be approximately $175,500. However, with assets totaling $55,000 (savings, inheritance, investments) and a remaining student loan balance of $15,000, her actual net worth is $40,000.
There’s a clear discrepancy between Melissa’s actual net worth and the figure suggested by Stanley and Danko’s formula. Is it cause for concern? Or is it merely a signpost on her financial journey, indicating areas for growth and improvement?
In our next installment, Charting Your Financial Flight Path: Practical Applications of The Millionaire Next Door’s Net Worth Formula, we’ll learn how to apply the formula in our lives and the significance of the results it yields. Just like Melissa, who continually learns and refines her flight skills, we’ll see that understanding and applying this formula is an ongoing process, not a one-time calculation. So stay tuned as we navigate this financial flight path together.
References
- Stanley, Thomas J., and William D. Danko. The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. New York: Simon & Schuster, 1996.
- “Military Pay Charts.” Defense Finance and Accounting Service (DFAS). Accessed May 31, 2023. https://www.dfas.mil/militarymembers/payentitlements/Pay-Tables/.
- “What is Net Worth?” Investopedia. Last modified December 13, 2022. https://www.investopedia.com/terms/n/networth.asp
Avery Rock Financial, LLC is a registered investment adviser. The information in this material is for educational purposes only, is not intended to predict or guarantee future market performance, and is not intended to act as individualized tax, legal, financial, or investment advice. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Please consult a qualified attorney or tax professional for individualized legal or tax advice. Please contact a financial advisor for specific information regarding your individualized financial and investment planning needs.
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