Calculating Net worth & Concepts of Wealth Building

Scope

• Determine the efficiency of accumulating wealth by calculate your net worth based on your income and age.
• Benchmark yourself to singapore median net worth
• Concept of wealth building

Net Worth

How much should my net worth be? Where am i compared to my peer? These may be some of the questions that is running through your mind during your financial journey.

In the book, "The Millionaire Next Door", there is a formula that calculate your net worth by your age and income. The 3 level of wealth accumulators are identified in the book:

• Average Accumlator of Wealth (AAW)
• Under Accumulator of Wealth (UAW)
• Prodigious Accumulator of Wealth (PAW)

This provide a goal for you to achieve every year. You may be a UAW when you just started but as you continue to build wealth you may become a PAW in a few years, because it is a compounding effect of your decisions and actions.

Example

Joe Annual salary =$50k @ 29 years old. According to the formula, his net worth should be $145k to be a AAW. If his net worth is less than $72.5k then he is UAW. If his net worth is more than $290k, then he is a PAW.

Assets & liabilities

In order to calculate your net worth, it is required to know your assests and liabilities. "The Rich dad, Poor dad" has a simple defination:

Assets = Anything that put money in to your pocket.

Liabilities = Anything that take money out of your pocket.

Assets will include you savings, emergency fund, investment, insurance & *CPF

* FIRE people may exclude CPF as net worth, but let assume for people who retire at 65.

Some liabilities that are unavoidable like mortgage, student loan these are ok. However, racking up credit card debt, buying car before building up a strong financial foundation is actually doing a disservice to yourself.

Benchmark Singaporean Median Net worth by age

Based on the Singaporean median income, we are able to derive the median net worth of Singaporean for different type of wealth accumulator.

Wealth Building

There are few concepts that i think is important during the wealth building journey:

Time value of money

$1 in your 20s and 30s actually have different value. Assumed you invested $1 in S&P500 with 10% p.a. returns at 20 years old (retiring @65) it will compound into $72. As you grow older, the value of $1 reduces, in order to achieve the same value @40 years old you need to invest $6.73. Time is the most important multiplier.

To put it into perspective, if your goal is to achieve $1 million by 65 years old, if you invested in S&P500 the contribution per month will be different if you start at different age:

• 20 years old- $105.4 per month
• 30 years old- $279.52 per month
• 40 years old- $770.31 per month
• 50 years old- $2384.38 per month

• 60 years old- $12408.9 per month

There is often a saying "Taking more risk, when you young." However, by taking more risk, the chance of lossing money is higher. Example: if you investing horizon is 20 years, if you just lose 10% in the 10th years, the final value of you portfolio will down ~18%. Risk management is key for long term returns vs chasing gain.

Having a Financial Roadmap

It is important to draft out your financial roadmap, including all the big ticket items & budget, on a piece of paper. So you will be clear with the time horizon you have between each milestones. I would suggest to plan until 100 years old, so you will not run out of money during your retirement phase, as living until 100 years old is highly unlikely.

Example:

Budgeting & Emergency fund

While some will follow the general 50-20-30 budget rules as it is easy to implement. However, in my opinon, because it is so simple and general, it does not work, as everybody have different needs and goal. Budgeting should be based on your financial roadmap.

Everybody should have 3 buckets. Where savings are the money for the emergency fund and big ticket items and investment bucket is the money you should never touch. However, how to distribute the income to the other buckets is the question.

Example:

Joe is 25 and plan to marry and buy a house at 30, he needs $45k. Joe must be able save more than the amount, so after he pay for all the items he would still have leftovers for the Emergency fund. Again, in general emergency fund, should be 6 month of your monthly expenses.

As a general guide, i will use a formula below as a guide, so Joe have to save $1125 per month. Joe is a median income earner with a salary of $3500 per month (take home $2800) assume monthly expense =$1000, savings $1125, he will left with $675 to invest. With $675 invested per month @ 25, Joe will still be able to achieve more than $1 million @65 years old.

Increase your Income should always be the main focus

While statistically, a median income for a 25 years old is $3.5k/mth. There are also people earning $2.3k/mth ($1.8 take home after CPF) or lower. It will be extremely difficult to have additional money to invest without proper budgeting. It will be nearly impossible to save and invest after you started a family for a low income earner as expenses increases and inflation. Stuck in a job, living paycheck to paycheck and a viscous cycle begin. You have to increase your income instead of taking unnecessary risk in the stock market.

Way to increase your income:

• Further study - A long term solution is to get a better qualification, get a higher better job. With the same amount of time you are reward with more money. Con: you have to take up student loan, make adjustment your roadmap and not everybody is the study type.

• Dividend Stocks - Some month when your "hands are tight", the addition cashflow, although not life changing, may help to pay off some of the bill, and you do not need to sell your investment. Con: extremely boring, will miss out of market gain if portfolio consists fully of dividend stock, this can be overcome by diversify into some US stocks/ETF. But focus more on building cashflow.

• Renting out extra bedrooms- The amount can help to subsidise your monthly expenses. If you are paying the instalment using your CPF. You are basically "cashing out" your CPF. Con: no privacy, you need to be living in at least a 3 bedroom HDB before you have addition room to rent out.

• Having a side hustle- in my opinon is the most effective of generating extra monthly cashflow. Example: if today having a take home salary of $2k after expenses you will be left with $500, your annual savings will be $6k. Today if you have a side hustle that generate $1.5k of income, while you maintain your lifestyle, you would have 4x your savings, risk free.

Conclusions

What to focus on at different age?

20s- Not to rack up debt, learn new skills, budget, saves, build your emergency fund and invest. Your $1 is the most valuable now and do not have much commitment. While you still studying, you will have lot of free time compared to adults, get some part time job.

30s- You have a family. You are not alone anymore. Having an emergency fund is a MUST! Also think of scenario if you are not around, how will your family deal with the finance. Get an insurance coverage. As the expenses increases there is a temptation to cut down on your saving/invest, try not to, look for addition income to supplement. In addition, avoid lifestyle inflation.

40s- if you are doing things all right in your 20s - 30s. You should see your net worth in the AAW - PAW level and you will be on track of your goals. However, if you have just financially awaken, dont give up, this is the last chance. There is still some juice in your $1, you can still 10x.

50s- By this age, if you have done everythings right, congratulations. Is time to enjoy the fruits.

Time is the most valuable asset that you cant buy with money, so cherish it.