Bummer, I’m An Under-Accumulator Of Wealth…

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I just found my old copy of The Millionaire Next Door, a book which found that, contrary to popular belief, most millionaires actively live in modest neighborhoods and drive common cars like the Ford F-150 truck. Flipping through it, I remembered that it also provided a target as to what your net worth “should” be:

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

If you don’t have any significant inheritances, this boils down to:


If you are near this target, you are an average accumulator of wealth (AAW).

If you are less than half your target, you are an under-accumulator of wealth (UAW).

If you have more than double this target, you are an prodigious accumulator of wealth (PAW).

I’ve never liked this formula. The main problem I see with this rule of thumb is that it is linear with respect to age. This makes it pretty harsh on younger people, especially those who are just starting out.

Someone who is 25 and makes $40,000 a year is supposed to have a net worth of $100,000. If you got a job at 21, you’d need to have both graduated with zero student loan debt and saved up $25,000 each of the last 4 years. That’s barely even possible after taxes. But if you went to say, law school, and just graduated at 25 making $90,000 a year, you’re supposed to have $225,000 saved up right out of the gate?

Let’s do our target, roughly: 29 x 200,000 / 10 = $580,000. Whew, we are serious under-accumulators!

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  1. Boston Gal (aka Jane Dough) says

    Actually what you find wrong with the calculation is a central point of the book. If you really want to know the secret to how these “Average-John-Doe-Next-Door” are doing so much better than others then you need to focus on how much worth you can accumulate on your income considering your own age.

    Your example of the 25 year old making $40,000 who needs $100,000 to be considered an AAW is a bit misleading. That is the target sweet spot, but the calculation allows for a range. So really, you would be considered an AAW if your Net Worth was $50,000 or greater ($50,000 – $200,000 is the AAW range for those parameters).

    For your personal example your AAW range would be $290,000 – $1,160,000 with the sweet spot of $580,000. Given your current Net Worth of $161,400 you are about 28% of where you should be for the AAW sweet spot but 56% of where you should be to get into the AAW range. Given your young age, newly combined household status, and relatively recent jump in earning capacity – you are doing well.

    But, as the book points out, if you had married earlier (so got the bump of the combined household earnings sooner), if you had purchased a home immediately when starting your adult working life, if you had created your own business instead of working for someone else, if you had decided to invest in a well paid trade (such as plumber) which costs little to train compared to high cost training (such as lawyer)… On and on the book documents that all of these decisions impact who is considered a “Millionaire Next Door” and who is not. It is not as easy as just buying a certain type of car – it is long term decisions made throughout life.

  2. As you mentioned for younger people, this formula does not give much time to accumulate net worth, or allow for payback of student loans or other debt. But their investments may not yet show much return.

    The reason it might work for older folks a little better is because compound interest on their investments will hopefully have increased their net worth enough to come close to the formula. It takes awhile to see good returns on compound interest.

  3. You’ve made a good point. It’s easy to be UAW as a younger person because of the age bias.

    I have seen this discussed on my own blog (I link to it from my name). There is an article by Liz Pulliam that discussed the same age bias.

  4. The problem I have with this calculation is that if you make a major career move and receive a large increase in pay, you can suddenly go from PAW to UAW without an actual change in your financial standing. In my case, I changed jobs and received a 45% raise. So one day I was doing fine, and the next day I was way behind the curve. And yet, I was *way* better off after the job change than before. So tell me… How realistic is that?

  5. Boston Gal (aka Jane Dough) says

    fivecentnickel.com – Did you project out your calculation to see how many years at your new salary and your higher saving and investing capacity (hopefully you are saving and investing a huge portion of that 45% bump?) will get you back into the AAW range?

    Again, the main point of the calculation is to illustrate how much you are accumulating given your income. If you suddenly bump up into a different income level then yes, you should have a different amount accumulated – Will it take a couple of years to adjust – likely. Is that reasonable – of course. Does the calculation account for that – no. But it is a quick and simple formula. For your situation you are asking for something far more complex. If you had to account for all of the variables in the calculation it would take a math genius just to figure out a value.

    The point of the book was to communicate and illustrate simple principles which when applied consistantly over long periods of time result in prodigious wealth accumulation.

    While the calculation may be far more accurate for folks further along in their working and accumulating years (45 – 55) – it also makes it much more difficult for those folks who find themselves pegged as UAW to change and become PAW. But for the 25 – 35 year old doing the calculation and getting a UAW result they may still be able to achieve the PAW if drastic action is taken.

    • Not even drastic action is needed. There are many valid criticisms, but it doesn’t make the PAW calculation useless. We saved a higher percentage of our income when we were younger, actually… but have steadily progressed from UAW to AAW to now PAW in our early 50’s. I think the formula is more backwards looking than it is prescriptive. Still, it’s very useful in target setting. Anyone who makes PAW is going to be OK in the long run, for the most part.

  6. Jonathan,

    I assume you’ll include the value of your house in your total net worth, when you do buy.

    How do you plan to incorporate that into the monthly tabulations?? (i.e. Will you simply use equity – loan amount?? Will you value the house at the original purchase price or change it as comps sell in the neighborhood, etc.)

  7. As with any “instant calculation” methods, it’s just a rough number. More importantly, I think it makes us think and review our “wealth” and whether we are indeed saving enough for retirement.

    Unfortunately, most people out there (this audience obviously excluded) do not think about money or the need to save for retirement. They think that Social Security is going to bail them out – but that’s a whole different discussion.

    I always liked these rough calculation methods as it forces me to review my budget and makes me think twice before I drop $$$ on expensive/luxury items!

  8. Maybe a better solution is to average out your past 3 or 5 years of pretax income. However, Boston Gal is right – it’s just a basic guide. Afterall, your income can vary so widely – you could lose your current job and get hired at walmart, moving way up the chart.

  9. Net Worth always overstates the value of one’s home vis a vis retirement savings. Using the formula, I’m fine. My net worth is just where it ought to be. But the truth is, at age 58, with $160,000 in retirement savings, I’m not fine. It’s the value of my real estate that is the bulk of my net worth–but unless I’m willing to liquidate my housing (and assuming I could live elsewhere for less, which is NOT a valid assumption), the net worth calculation is not a good measure of how I’m doing.

  10. You are correct. This formula doesn’t work for hard working young people like myself. I’m at less than half my target.

  11. Perhaps the thing to focus on is the thinly-veiled principal: you should save 10% of your pretax income every year. After all, that’s how much the formula will expect your net worth to grow by next year (all else being the same).

    That’s not a particularly profound idea. You’ll find the same idea in The Richest Man in Babylon and a slew of other books.

    Personally, I’m a pretty good saver in my mid 30s and I didn’t live up to the target set in the book either. I do however generally save more than 10% of my pre-tax income each year, and, given a reasonable return on my investments, I can expect to make headway against that target and eventually surpass it.

  12. doesnt make sense. My salary for past 5 years has been $50K and now its $100K. So using current salary gives a false pretext that i should have saved $320K by now.

  13. To me, this is a silly formula if it doesnt work half the time and need to make exceptions or excuses.

    It almost like saying there are 100 cents in a dollar only if the u have 50 pennies and 2 quarters.

  14. I don’t see much use in this equation. What is it actually trying to tell me. A young person or someone who has recently had a significant change in pay as everyone has pointed out has a very difficult time living up to the “average.” In fact if I am 25 and make 40,000 a year having worked since I was 21, as Johnathan points out should be at $100,000.00, this is possible but requires a savings rate of 62.5% of pretax dollars! After tax assuming taxes of 25% I would have $5,000.00 to live off of. And it is impossible for this person to achieve the PAW category as even if I were to save 100% of my salary I would still only have $160,000.00, $40,000.00 away from the $200,000.00 target.

    So young peoples Net worth is seriously exagerated by the equation but older people’s net worth appears to be under-valued where it should be. For example, let’s say I am 50 years old, and make $100,000.00/yr. I should have a network of about $500,000.00 if I am an average wealth accumulator. Furthermore lets say that my income keeps track with inflation of 3% a year. This would mean that by age 65 I would be making about $155,000.00 and I should have a net worth of about $1,000,000.00. This would allow me only to sustain about 25% of my original income which would not allow me to maintain my current standard of living.

    All in all this equation seems to get it wrong for all age groups so I am not really sure what knowledge I can gather from it. If I am young it is unlikely that I will live up to their standards. If I am old then it is unlikely I will be able to maintain my lifestyle with their average wealth accumulation projections.

    Wealth accumulation is not a linear equation. It should be logarithmic.

  15. As has been said here, the calculator, like all personal finance calculator should not be used as a simple pass/fail tool. It’s purpose is to let you know if you need to act differently and then for you to figure out what different means.

  16. This calculation isn’t relevant to the real world, especially if the average net worth in this country is NEGATIVE.

  17. Boston Gal: Yes, we are saving a ton of our income (we were actually doing so before the raise — now it’s more both in actual dollars and proportionally). No, I didn’t calculate project this out because I think it’s an artificial and inaccurate value.

    Rather, I chart our net investable assets as well as progress toward our “magic number” (self-determined using a variety of calculations).

  18. Yeah, the formula is clearly BS. It demonstrates nothing of value.

    It fails to answer the question “am I saving enough”. It’s no good for retirement b/c it can’t account for estimated retirement age, starting age of work of partial retirement. The formula doesn’t account for changes, it doesn’t account for the endpoints or unproductive years, it doesn’t account for debted “investments” like University.

    Clearly, the “Criteria” should be # of years worked and not age. And the second criteria should clearly be “average income” or “average income in the last X years”.

    So Jonathan, I wouldn’t worry about “failing” this test, it’s a bad test.

  19. Why not just say, are you saving 10% of your gross income each year, or not? I’d even bump it up to 15 or 20%. Seems much easier.

    • Terry Pratt says

      Formula works poorly at poverty level; I don’t know anyone making $12K who saves 10 percent of their income – let alone 15 or 20 percent. Heck, I pay more than half my income to rent a room. Not much ‘room’ in my budget to save there.

      • Not even drastic action is needed. There are many valid criticisms, but it doesn’t make the PAW calculation useless. We saved a higher percentage of our income when we were younger, actually… but have steadily progressed from UAW to AAW to now PAW in our early 50’s. I think the formula is more backwards looking than it is prescriptive. Still, it’s very useful in target setting. Anyone who makes PAW is going to be OK in the long run, for the most part.

  20. I prefer using (Age – Years in Education)

  21. Ryan: I’m 36 and I’ve had 20 years of education. Does that mean I should have $16? 😉

  22. This formula is like BMI (Body Mass Index) or any other simplified measure for something complicated. To me it makes more sense closer to retirement. The book mostly interviews people who have been around a while and not people starting out. These are people who have saved their money (not inherited) and are considered wealthy by the authors. They did not achieve this in their 20s. Like other simple measures it can give silly answers. For example, the year after college when someone starts working you’d have to have 4 times pay saved to be a prodigious saver. That’s just laughable. However, having 13 times pay at 65 could buy an immediate annuity equal to pay and having 26 times pay at 65 will could also buy inflation protection on that annuity. So there is some argument that could be made in favor of the reasonableness of the number close to retirement. There isn’t a perfect measure, so keeping it simple helps people frame their situation and hopefully they’ll put some plan together based on some analysis. The future is unknown, I can’t imagine there is any formula (simple or complicated) that could measure the exact point at which you’ve got enough.

  23. I am quite skeptical as to how helpful this formula truly is. The formula doesn’t work nearly as well for a younger person as it does for someone middle aged or older.

  24. Whew, I’m only $190,000 off pace. I should be able to scrape that together in short order. Gonna sell some stuff on ebay.

  25. This seems like one of those things not necessarily relevant until you’re a bit older. As a recent graduate myself it’s nearly impossible to fit this formula!

  26. Kevin Spring says

    Quit your job and get one at McDonalds. You should be a PAW then if you only make $15,000 a year.

  27. Not to defend the author’s oversimplification, but wouldn’t it be a little more fair to at least say that your “annual” salary is what you actually made in the last 12 months and not what you are making after a recent raise? Heck, SS and most pensions are determined by the last X years’ average. Jonathan’s number won’t be as far off after 1yr or more of actually making $200K. Also, remember that your age is the same for an entire year. Since we all don’t miraculously save all of the year’s money on one day, our net worth will change dramatically during the course of that year. Yes I am aware that using fractionals would make it worse, but just trying to give a different interpretation of the formula. If the author gets readers to save more than they did before then I’d say his methods, while questionable, are at least worthy of a more favorable description than “BS”.

    I’m sure we’d all like to consider ourselves PAWs, and don’t like being labeled otherwise. However, if you think you are saving as much as you can and investing it as best as you can, you wouldn’t be here looking for ideas…

  28. it’s a simple formula and it generally works for those in the age range of 30-50, i’d say. it even adjusts for inflation. i also think it doesnt really apply to the current generation.
    when i picture the people those portrayed in this book, i picture a couple that got married at 20, started having kids at 21, owning their own small business like contractors of some sort, etc. these previous generations are very different than what is out there today imho

  29. This is the dumbest calculation I have ever seen. My wife and I save more than HALF our income. We are 27. And yet we are just barely at the AAW level… hilarious!

    Quick example of how flawed this formula is:

    1 year out of college with Engineering degree:
    Age 23: $60k salary*23/10=$138k NW. Good luck at that when you have only been out of school for one year. Most people probably have a negative NW one year out with student loans.

  30. I think some folks are nitpicking and missing the point that this is supposed to be a simple rule-of-thumb calculator. I’m guessing the target person is substantially less sophisticated than the readers of PF blogs. Of course a more accurate model that takes more into account could be created, but it would probably be more complex to calculate, too.

    That said, it would be nice to see a more complex version for those who want it. How does one count variable income? If you include it, the formula above “expects” you to have it every year. Also, if average HHI increases substantially exceed inflation and/or investment returns, you will fall further and further behind.

    The simplest way to handle these kinds of issues is to do some kind of running average of income over the past X years.

  31. OK guys, here’s a simple “rule-of-thumb” calculator.

    (#of years since you’ve been working) * (average pre-tax income over the last 5 years) / 10

    This accomplishes the same thing but it’s way more accurate at both ends of the curve. The 5 year average actually accounts for income shifts and some interest-based growth. It still has tons of exceptions, but it’s trivially more complicated and significantly more accurate.

    My formula is by no means “good”, it’s just way better at accomplishing what he set out to do (are you saving and growing 10% of your money?) The average person is already bad enough at math, let’s not complicate the matter by giving them bad formulas.

  32. My opinion is that net worth goals should be a function of spending and the number of years in the workforce.

    It should not be a function of gross income and the number of years since birth.

    The MND formula expects too much of young people, and too little of older people whose net worth should be growing from investment returns alone. It also expects too much of someone who just got a promotion and salary increase.

  33. I think this formula is pretty useless for many individuals. Incomes vary way too much. Any consideration of wealth accumulation should be function of total income earned. My income has jumped a number of times, and I know many individuals who have gone from low 5 figures to medium 6 figures back down to high 5 figures in a couple a years. The type of saver they are hasn’t changed…

  34. That’s a horrible formula. anything linear would be poor when you consider that compound interest is (for most people) the most important tool for accumulating wealth. And obviously, its not a linear progression.

  35. Mike The Fighter says

    What a f***ing bull**** test, it is skewed against young people. I took it earning $65K as a 30yr old and failed, even though I save 17.5% into my retirement account (I am NOT under USA laws, so sorry for no comparison to yours) plus regular 10% of my paycheck.

    What a load of bollocks, for a guy with a PhD, he knows jack-all mate.

  36. I am 29 with 720K saved up and my average income is 1.2 million it is saying I should have 3.48 million. This calculator and the rich man next door theory is a hoax.

    This is liquid after tax dollars. You explain to me with 52% taxes (self employed) you can even logically come up with that number? That means that I would have had to make 2.4 million dollars a year for 4 years and save almost every penny to save that money.

    Let’s take a simpler analogy, someone who makes 40K a year with a 22% tax bracket who is 39 years old would need to spend less then 19830 dollars a year after taxes if employed.

    Even with accumulating interest, this calculation is almost impossible to reach unless you are 50 years old with compounding interest of the mid 90’s.

    I can think of 2 other ways to get a much better calculation in order for the compounding interest to the final goal and what he is trying to preach.

    Another guy writing a book on how to get rich, but he accumulated real wealth after writing the book.

    Millionaires aren’t rich people, 25+ million is rich.

  37. American Fool says

    There are a variety of tools for measuring what your Net Worth should be at a given age, and they all have substantial weaknesses. I think the MND wealth formula works best for 40-60 year olds with relatively stable income. I think I’m a PAW if I compare net worth to my income of 5 years ago, but high AAW with today’s income, so that’s a decent place to be. I like to use the income based gauge below to target based on age – it’s the combination of inputs from a few sources, and I consider it a base target: the minimum necessary for a comfortable retirement w/ SS replacing 20-30% of your income (assumes some adjustments to payouts in the coming decades). Just multiply Income x the ratio for your age. It’s a somewhat better fit, but also suffers when your income rises quickly – tough to get around that. Optimal would be to do about 67% better than this (i.e. ~8.5 at 50 years old) which would theoretically provide an annual retirement income equal to your pay before retirement without relying on social security… but I consider that a very difficult goal to reach. I do better than the ratios below, but not 67% better.
    25 years old — CIR: 0.1
    30 years old — CIR: 0.6
    35 years old — CIR: 1.4
    40 years old — CIR: 2.4
    45 years old — CIR: 3.7
    50 years old — CIR: 5.2
    55 years old — CIR: 7.1
    60 years old — CIR: 9.4
    65 years old — CIR: 12.0

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