Posted by: George Christopher | July 17, 2009

An easy, 3-step wealth score


An easy, 3-step wealth score

A key ratio — net worth divided by lifetime earnings — provides a telling gauge of your financial progress, no matter how big your paycheck.

By Liz Pulliam Weston

Here’s a little financial calculation that just may change your life:

Step 1: Add up your lifetime earnings. You don’t have to go searching for your old tax returns; just use the handy summary Social Security sends you every year, a few months before your birthday. (If the Social Security and Medicare earnings columns show different amounts, use the Medicare column.)

Step 2: Calculate your net worth. This measure of wealth is basically the total of all your assets (investments and property) minus your liabilities (your debt).

Step 3: Divide your net worth by your lifetime earnings. This is what all your labor has achieved for you in terms of tangible wealth.

Rick Ulivi, a fee-only financial planner in Orange, Calif., likes to have his clients do this calculation. He wants to see the following ratios:

For young clients early in their careers, the desired ratio is somewhere between 0 and 25%.

For clients in midcareer, he wants a ratio between 25% and 100%.

By the time theyre ready for retirement, the preferred ratio is 100% to 200%.
Exceeding these ratios is great, of course — just not very common.

A no-excuses exercise

A similar calculation — but without Ulivis ratios — is a central exercise in the book Your Money or Your Life, by Joe Dominguez and Vicki Robin. The numbers are used to drive home several points about money. Among them: Youve probably made more than you think, but you may have less to show for it than you might like.

Lots of people are so focused on work and consuming that they never think about building wealth. They lock themselves into being wage slaves forever — or at least until theyre no longer able to work, at which point they retire to some level of financial subsistence.

OK, so what if your ratio falls far short of Ulivis guidelines, or of what you yourself would like to see? What if — even worse, but not uncommon — your net worth is negative?

Perhaps you believe you have good reasons for falling short. Maybe you dont make much money, or youve had some setbacks in life, or youve been burned by bad investments.

Don’t blame your paycheck

Two economics professors have already blown a hole through your theories. Steven Venti of Dartmouth and David Wise of Harvard studied the issue of income versus wealth for the National Bureau of Economic Research a few years ago, using Social Security lifetime earnings and net income assessments for 3,992 households whose heads were near retirement age. Among their conclusions:

Theres a huge variation in wealth at every income level. Many low-income families have almost nothing. But the same is true of many high-income families.

Income alone doesnt explain wealth disparities. Some of the lowest-earning households had managed to accumulate significant wealth.

In fact, income differences explain just 5% of the wealth dispersion the researchers found.

What the researchers called chance events — inheritances, medical bills, marital status, number of children — explained about 4% of the dispersion.

Investment choices explained about 8% of the variations.
In other words, the vast majority of the differences in wealth had nothing to do with income, chance events or investment choices.

What did explain most of the differences in wealth? Venti and Wise concluded it was this: How much the families chose to save. Those who made it a priority to save built wealth, regardless of their income level, individual circumstances or choice of investments.

Break your wage-slave shackles

Yes, life can be unfair and deals sometimes devastating blows. But the people who survive and thrive tend to be the ones who have a plan and who stick to it.

We hear from 23-year-olds who are buying their first homes, contributing to 401(k)s and paying off their student loans. We have other 23-year-olds being pursued by collection agencies — or who have already declared bankruptcy. Both have plenty of time ahead for life to happen to them: children, job losses, stock market booms and busts, you name it. But if you had to guess, which ones do you think are going to keep building wealth over time, and which arent?

The good news is that your past doesnt have to dictate your future. If youre tired of letting money slip through your hands, tired of being at the whim of economic or investment cycles, tired of always scrambling, you can change things starting today. Youll find plenty of information on this site and elsewhere about how to manage your money, plan for the future and get ahead. If the results of the calculation above depressed you, do something about it.

Make your own financial freedom a priority. Make it happen.

Read the original article here.


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