Blog 3: Charting Your Financial Flight Path:
Practical Applications of the Millionaire Next Door’s Net Worth Formula
As the sun crests the horizon, Lieutenant Melissa Donovan, our KC-135 pilot, taxis her refueling plane onto the runway of the Maine Air National Guard base. The vast sky ahead reminds us that life, like Melissa’s flight path, is a journey filled with diverse experiences and varied landscapes. The same is true for our financial journey, where the net worth formula proposed by Stanley and Danko in “The Millionaire Next Door” can be our instrument panel, guiding us towards a destination of financial stability.
In the last blog, we dissected this formula and its components: age, realized pretax annual household income, and net worth. Now, let’s navigate through the practical application of this formula. Just as Melissa meticulously goes through her pre-flight checklist, let’s walk through the steps of calculating our net worth.
Step 1: Calculate your annual income
For this, you need to calculate your realized pretax annual income. This should include all income sources – salaries, business profits, rents, royalties, and profits from asset sales.
Step 2: Multiply your age by your annual income
This simple multiplication gives you an interim figure. For Melissa, at 27 years of age with an annual income of $65,000, this figure is $1,755,000.
Step 3: Divide the result by ten
This gives you the expected net worth. For Melissa, it would be $175,500.
Step 4: Calculate your actual net worth
Subtract your liabilities (debts) from your assets (what you own). Assets include cash, investments, real estate, and other valuables, while liabilities include mortgages, loans, credit card balances, and other debt. For Melissa, with assets totaling $55,000 and student loans worth $15,000, her net worth comes to $40,000.
Step 5: Compare your actual net worth with the expected net worth
If your actual net worth is less than the expected net worth, as is the case with Melissa, it shows that there is potential for improving financial health.
The most common misstep people make while using this formula is over- or underestimating their assets and liabilities. It’s crucial to be as accurate as possible in these calculations. Another common misconception is to regard this formula as a measure of success or failure. It’s not. It’s a financial tool, a compass, guiding us towards better financial health and understanding.
We’ll use this information, this financial snapshot, not as a final destination but as a waypoint on our journey. Our goal is not to judge our current position, but to learn from it and chart a course that takes us closer to our financial goals.
In the next blog, we will examine how to interpret the results of our net worth calculation and use this knowledge to inform our financial decisions. Just as Melissa interprets her in-flight instruments to reach her destination safely, we too will learn to interpret our financial indicators to guide us on our financial journey.
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 June 1, 2023. https://www.dfas.mil/militarymembers/payentitlements/Pay-Tables/.
- “How to Calculate Your Net Worth.” Investopedia. Last modified November 22, 2022. https://www.investopedia.com/articles/pf/13/net-worth.asp.
- “The Complete Guide to Calculating Your Net Worth: Understanding the Numbers.” Forbes. Last modified July 7, 2022. https://www.forbes.com/advisor/personal-finance/calculating-net-worth/.
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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