What does it mean to be wealthy?

7million7years live tomorrow (!) and 7million7years in the press:

Two of my favorite sites are TickerHound (the Investment Q&A Community) and the Tycoon Report (Daily Investing Newsletter); and, they’re both free! 

Also, 7million7years got two mentions when these sites got together here 🙂

Now for today’s post …

Trent at the Simple Dollar rekindled this debate  by asking “How Much Money Is ‘Walk Away From It All’ Money?”

I’ll let you read Trent’s post yourself, but, what often interests me most are some of the questions and comments left by readers to my posts and those on other blogs.

For example, I am often asked what my definition of wealth is; I can tell you what it ISN’T:

I DON’T like the simple numerical definitions of wealth that researchers and academics like to trot out e.g. $170,000 income per year; or $1,000,000 in assets not including primary residence; or even the often quoted Millionaire Next Door formula:

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.

To me, these are just meaningless numbers.

Then there are the passive-income-covers-current-income approaches to wealth [AJC: you may recall that Robert Kiyosaki  claimed $100k p.a. passive income as = wealth for him in Rich Dad, Poor Dad]; “KC” left this example in her comment to Trent’s post:

I’ve always said “wealthy” people are folks who don’t have to work and can live off their savings, pension, social security check, dividends, and any other non-work related payments. That is an age dependant term. My 90 year old grandmother is wealthy by those standards – but I’d hardly call her style of living wealthy – but she is able to live comfortably off her savings cause her budget is so small – no car, paid for house, minimal food & utility needs.

I disagree with this definition of wealth, because of exactly that scenario: the ‘cash poor’ person who accepts a certain level of lifestyle because that is what they can afford. They have one benefit: they can maintain this lifestyle WITHOUT WORKING therefore some would consider them wealthy. But, to me, they are still just getting by …

… which is interesting, because KC then when on to show the contrast:

My in-laws are wealthy – they both have pensions and health benefits, but retired early (55’ish) due to a sizable inheritance and wisely saving money when they were younger despite knowing they’d come into an inheritance. I would describe their lifestyle as wealthy – European travel, upscale cars, very nice paid-for home.

 This lifestyle has all the trappings of wealth … but, to me ‘trappings’ do NOT equal wealth. So, KC what would I consider wealthy?

Simple, it’s the definition that you provided, with an additional – but critical- twist:

It’s having the regular passive income to cover your ideal lifestyle not just your current lifestyle!

Your ideal lifestyle is the one that you measure by what you DO not what you HAVE …

… the DO part is about legacy: what, if anything, do you want to be remembered for?

The financial part of this is then simple. Just ask yourself: how much will it COST (time and/or money) and by WHEN do you need it?

When KC did the numbers she came up with the following:

But for me (a 35 yr old) to be wealthy by the no work standard would easily take 3 million. I arrived at that number by saying what amount times 8% would allow me to maintain my lifestyle on the principal generated? I chose $3 million cause in a few years I’d need that extra money due to inflation. At $3 million I could very easily pay off my home and live VERY comfortably off the 8% interest. That would make me and my husband independently wealthy. Oh well, I’m only about 2.8 million away from my goal – sigh…

Firstly, good on KC for ‘getting’ that you need a hell of a lot more than $3,000,000 AND for figuring inflation into the equation. But, here are some things that she needs to correct:

1. Firstly, she needs to work out her annual passive income requirements – it looks like she’s counting on $3 Million LESS ‘inflation allowance’ LESS Paying off current home.

2. I’m guessing that amounts to something like $150,000 a year that she’s aiming at – a healthy income, but nowhere near ‘reasonably rich’ (that would take about $350,000 – $500,000 a year income: big house, First Class flights, 5 Star Hotels, a couple of fancy cars, private schools). But, let’s assume that she has modest retirement spending requirements: she doesn’t say WHY she needs it, or HOW much … but, we do know that she needs to replace 100% of her time with money as she doesn’t intend to work at all.

3. Before retirement, KC may be able to count on a 12%+ annual compound return (over a 20 – 30 year period) on her ACTIVE investments (forget 401k’s, managed funds, index funds, etc. … to get 12+% she’ll need real-estate and direct investments in stocks), but in retirement, she will want to wind that back to, say 8% on her PASSIVE investments (now she can buy those Index Funds, if she likes).

Why 8%: because that’s the largest return that the stock market has ‘guaranteed’ over any 30 year period, in the last 100 years (the figure drops to just 4% over any 20 year period, and 0% over any 10 year period). And, then we really should deduct mutual fund and middle-man fees …

4. But, to counter for inflation and up/down market swings, KC will need to wind back her withdrawals to somewhere between 2.5% and 5% of her portfolio … 8% is right out of the question! Why? You have to reinvest at least the expected amount of inflation; KC will need a payrise if she wants to keep up with rising prices …

5. That means somewhere between $3 Mill. and $6 Mill. is the ‘Number’ for KC, or she’ll have to be content with taking ‘just’ $75,000 a year in retirement (at least, it will be indexed for inflation) … just remember, if she takes 20 years to get to that $3 Mill. it will be just like retiring on $35,000 a year today. Whilst $75k seems like a lot to most, it ain’t ‘rich’.

Maybe KC was a little optimistic in saying: “At $3 million I could very easily pay off my home and live VERY comfortably off the 8% interest”?

Do you need to shift your financial goalposts a little, as well?

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9 thoughts on “What does it mean to be wealthy?

  1. Good analysis. I reached pretty much the same conclusion – that wealth is a measure of ability to fund a chosen lifestyle: http://aprivateportfolio.blogspot.com/2008/02/what-does-it-mean-to-be-wealthy-2.html

    The problem with this definition is lifetyle creep. There are surveys which show that whatever level of wealth people have (at least until you get to the level of the seriously rich), they always set a higher number as being the level at which they would consider themselves to be wealthy. Richistan covers this phenomina quite well.

  2. @ Trainee – I like your definition of wealth:

    “wealthy: have or can afford substantial assets well beyond what is needed to sustain your chosen lifestyle.”

    For me, the key word is ‘chosen’ … AJC.

  3. I hate that Millionaire Next Door formula. If you’ve ever looked at my NetworthIQ page, it’s pretty evident I’m way behind according to that formula. It wasn’t too long ago that I realized that I needed steady passive income stream that would cover all my expenses + luxuries + (inflation, market flux, etc.) They should teach this stuff in school :p

    So here is my personal definition of wealth (forgive me for using a few of your words):

    Having enough regular passive income to cover my ideal lifestyle, be comfortable with market fluctuations, and not have inflation or withdraws significantly impact the security of my ideal lifestyle.

    (And to have enough money to build hidden lasers into watches)


  4. @ Q – Finally somebody with a goal worth aiming for! You should apply for my 7 Millionaires … In Training! Project ( http://7m7y.com/about/ ) – soon you’ll be able to open your Laser Watch Factory and online store 😉

  5. Not sure how you’re getting $75k. Using the 4% rule, $3 million generates a sustainable income of $120,000 p.a. which at 3% inflation is in 35 years time $60,000 in today’s money. Which is OK. We live on about that now and are doing fine. We don’t have a wealthy lifestyle at all, but we are very comfortable. $150,000 would be a luxury lifestyle from our perspective. There’s no conceivable need for more for just lifestyle purposes.

  6. SP – is it possible to enable e-mailing of follow up comments to commenters on the blog who sign up for it?

  7. @ Moom – One day I wasn’t a blogger, next day I had a site up … unfortunately no ‘e-mail’ option that I can see (wordpress.com); but, if anybody knows how … ?

    Also, I used 5% ‘sustainable’ withdrawal rate … 4% is better … 3.5% even better … and, I actually use 2.5% in my personal planning.

    You’re an Aussie, right … travel … and, if you think ‘economy / coach’ you ain’t planning far enough ahead … there goes $50k p.a.!

    Peter Spann (you know who he is?) says that Aussies need closer to AUD$500k p.a. to be considered ‘rich’ these days.

  8. You make a very good point. I have always assumed that I want enough passive income s that I do not have to work. But of course if I moved back in with my parents I could probably live on a very small income! I do need to start thinking about what sort of life I want to aspire to and how much I will need in order to get me there.

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