Saw this article on MSN Money today: The answer to this question will tell you if you're wealthy.
Excerpt from the article:
To qualify as upper class in the U.S., a family of four needs to earn an annual income of at least $144,251. To place in the top 1 percent of Americans, they would need to bring in at least $389,436.
But do either of these comparative distinctions make you wealthy? It depends on how you define wealth.
For Derek Sall, a personal finance blogger and financial analyst who paid off $116,000 in seven years, it's not about how much money you bring in each month but how much you're able to save.
He says you need to ask yourself only one simple question to determine whether you're wealthy: If you lost your job tomorrow, how long could you survive?
It's easy to judge wealth as a function of what you own, but as Sall points out, material possessions mean nothing about the real state of your finances.
"Heck, you could drive a $40,000 BMW and live in a $500,000 home, but if you're $600,000 in debt, then you're actually worth less than a 7-year-old child," he writes.
To answer his own question, Sall developed a scale for quantifying wealth. Here's how well off you are depending on how long you could last without a source of income:
- Less than a month: Broke
- One to three months: Teetering
- Three to six months: Satisfactory
- Six months to two years: Well off
- Two to five years: Wealthy
- Five or more years: Ultra-wealthy
The author makes some good points. Often times people are presumed to be wealthy because they live in a big house or drive a fancy car, but I would argue that alone usually doesn't tell you how well the person is really doing financially. In fact, I've personally known people who live in a big house and drive a nice car and they wouldn't be able to pay their bills for a single month if their income suddenly stopped.
The one thing I would probably disagree with the author on is what seems like his interchangeable use of the questions "How long could you last if you lost your job" and "How long could you last without a source of income". I'm sure to most of us on BP, these mean different things. For example, if you lost your job tomorrow but still had your passive income from rentals, you may be able to survive much longer - perhaps indefinitely. The point is, a job is just one source of income, not the only source. (Or at least it shouldn't be.)
I'm curious what others interested in personal finance think about the author's definition of wealthy? How about you Scott Trench....would being able to survive for five or more years without a job be considered Set for Life?
Interesting article I agree with the muddy waters of income and job that the author points out. I think it is a loaded question though I have seen surveys in the past where far too many people claim to be in the middle class both on the high and low end.
We on BiggerPockets I believe are not satisfied with these levels. Three to six months of living expenses accumulated in net worth? How is that possibly satisfactory for folks on this site that aspire to early financial freedom?
Here's a first stab at a list for those of us that aspire to be competent and confident in the realm of personal finance:
- Less than a month: Emergency - one bad day from homelessness
- One to three months: Urgent - a moderate amount of bad luck from homelessness
- Three to six months: Whew - The baseline of being able to sleep soundly at night, still in all-out hustle mode
- Six months to two years: Satisfactory - no longer afraid continuing to support one's self/family if job/business is lost
- Two to five years: Well-off, Investments are just starting to produce meaningful amounts of supplemental income
- Five or more years: Confident - Investment income may be even more than most people's salaries
- 25 Years or more: Financially Independent - even with the conservative 4% Safe Withdrawal Rate
- $100,000 more passive income than one spends to support their lifestyle: Wealthy
- $500,000 or more in passive income above and beyond what's needed to support one's lifestyle: Ultra Wealthy
I will say that this is a really good article. Thank you for sharing! I really enjoyed it and am impressed with Derek!
Another aspect you’re not considering is age. If I’m 40 and make 100k (as a household) I’m probably middle class or maybe slightly above middle class.
If I’m 25 and making 100k (and it’s just me and not a family), I would probably consider that a lot wealthier (assuming saving rate was still high).
Income is just one factor of wealth, ofcourse once you have a high income saving becomes much easier.
Technically speaking I will likely (assuming I reach my projected goals) become “financially free” in my late 20s but that would assume I don’t have kids etc. So in reality I’ll probably keep working, assuming I enjoy what I do.
But how does that account for people in their 50's with 2 million dollars in their 401k. Technically if they lost their job, they might only have 3 mos of reserves to cover it. But ultimately, they're what I would consider wealthy.
In addition, most real estate investors (buy and hold anyway) would appear to be wealthy on paper but in reality they have a small percentage of the net worth that shows up on paper.
Example: If you have 10 150k houses and owe 100k on each one, it looks like you are worth 500k. Sounds like you could live off that for 5 years. In reality, if you go to sell those houses, you have to figure 6 mos of vacancy, plus some make ready costs of 5 to 7k to make them retail ready, plus closing costs/realtor fees. You might be spending 20k a house to sell them. So are you really worth 500k? Or does 250k sound a little more reasonable?
I equate wealth to net worth. And I equate being rich to income. I think this article is equating more to being rich and income and the replacement thereof should you lose your job. So I guess I would say you could be wealthy yet still not be rich. :-)
btw: I don't know that I would think someone that could cover their living expenses for 6 mos as well off. Two years, maybe. But not six months. :-)
Caleb is right. Age is entirely missed in the article. Is someone that is 65 and can survive 5 years Ultra-Wealthy? I would argue they are "teetering" at best!
I have found that it is hard to make have financial rules and laws (as far as advice) because so much is situational. It also takes clearly defining concepts that different people could interpret differently.
I think even with Scott's classifications, age matters. Also, Asset Composition really matters. Are we talking earnings or cash flow? The big thing is whether you are required to consume capital when hard times hit or are you able to consume earnings only (or ratio between the two). If an income source (Job or active vs passive) goes away how much adjustment in life style do you have to make? (If I started consuming capital instead of earnings and income, I could make it a lot longer because I would adjust my lifestyle down).
Another big thing is perspective. If you are Wealthy, you might think someone that is satisfactory is broke and if you are broke you might think someone that is confident is utltra-wealthy (Thus why everything is so political these days).
Personal Finance is just that....very personal.
I think it's all perspective.
I have heard that true wealth isn't measured in how many years you can live with your money but how many generations the money you have made can help others.
Another way one of my friends put it... "I don't want to live off the interest my money makes... I want to live off the interest FROM the interest"
I have a wife that loves me unconditionally
I have two beautiful and healthy children that are very happy.
EVERYTHING else is immaterial... I AM a very VERY wealthy man!
In my mind wealth is different than this article describes.
To me income is a huge factor. $10,000,000 in the bank with no additional income from that money will decrease until its gone. A steady stream of income from working, investing, and owning businesses will help you continue to maintain/grow your wealth.
Scenario 1 - Live Sub Standard / Ultra-Wealthy
Let's say you live in a Van by a brook and depend on that brook for your hygiene but you are satisfied with it and your living expenses is maybe $200 per week for food/Gas/etc?
Let's say you have several Investments that pays you $800 a week.
Technically, by the definition of that chart, you are ULTRA-Wealthy because you can live forever this way.
Scenario 2 - Live like a King / Broke
NOW.... let's say you have $10 million in the bank but make ZERO Income and all you do is live on that cash. You are 50 years old and believe you will live for another 50 years to 100 years old. So you divide the $10 million by 50 years and you get $200k a year to live on without working.
If we look at the chart, we have a problem.
No one would say the person in Scenario 1 would be classified as Ultra-Wealthy though he meets the definition.
In Scenario 2, no one would say this person is in an EMERGENCY situation which is below broke.
Each one of these has to have a STANDARD of LIVING in which we can calculate the Value of it.
So if Scenario 1, we calculated the Standard of Living in the area where this person lived to be $2k per month, he is obviously living financially free, but way below the normal standard of living.
In Scenario 2, if we also agree that he spends $200k / 12 = $16,667 per month but has not discernible income, he is still living WAY above the $2k per month income.
In my opinion, the Value of the Standard of Living has to be taken into account. The Chart is too simplistic.
@Mike H. your points on TRUE equity in rental property is a VERY GOOD ONE.. I know as someone who has sold off their portfolio over the last few years.. exiting rental properties in most markets is not easy and its costly.
5 to 6% sales costs... and if your going to retail them to a homeowner like I did 5 to 20k per house to get them ready to sell.
If your going to sell them as cash flow the VALUE in MOST markets is purely based on rental income and backing into the 1% rule or there abouts in some markets or low value assets 2% is where you may need to price it.. so I think your correct if you think you have 20 or 25% equity because your mortgaged to the max your really only have 5 to 10% of TRUE equity if you had to convert to cash.. does not mean you might have more as mortgages paydown over the years and its nice that your tenants are paying them down.. mine I bought brand new 10 to 12 years ago and the mortgage paydown was the only reason I got any money out of them at all.. most I lost money selling by the time you pay back your positive cash flow to get the house ready to sell.
I think your truly wealthy in the landlord game when your debt is far less than 50% and better yet when you have no debt. then your in the drivers seat.. you need monthly income just sell on terms.. you need cash you have ton A ROOM to move because your have 100% equity..
For me I look at paid for house to live in ( which I have ) and my and my wife's SSI here in a few years will be in the 4k a month range.. we have it made :)
Wow what a great post and diverse discussion we have going on. That’s the great thing about REI is we ALL have different definitions of wealthy and many different reasons of WHY we invest, from money lasting generations, to I am already happy with a great spouse and healthy children.
I would say we are all correct in some way or another because your own definition of wealthy should be what makes you happy or comfortable. The goal for me, I would like to replace my and my wife’s income (perpetually) so we can both pursue other interests/hobbies and always be there for our children.
@Ben Freiman one of the absolute best perpetual income generators I have seen hands down is TIMBER..
I see so many of the older larger private timber owners in the North west.. they log enough for the year replant..
next year thin some more replant some more and just move in rotations.. it will go on as long as there is a demand for wood products... Very passive and very profitable if done right.. tree's just get fatter fatter tree's are more valuable.. :)
then in up years like now when building is strong prices really go up.. mid 90's when Japan was on fire what was historically a 400 to 600 dollar MBF log market became a 1200 dollar log market for about 4 years.. it was not uncommon for us to make 500k NET on one 40 acre patch.. OH those were the days :)
Yes Jay I have heard wonderful things about timber! Very natural too. Love it. Unfortunately I don’t know much about it so I have much research to do. Thank you!
@Ben Freiman there are REITS that buy timber holdings and companies.. Plum Creek being one.
largest timber owners in America are
1. John Hancock
2. Harvard endowment
3. Werehouser and Harvard and Hancock finance a bunch of it for the bigger operators.
but I am talking about private holdings in the 500 to 2000 acre range.. strategically planted and harvested then replanted these are just like any other farm enough to live on that revenue alone.. unlike farming though.. you don't have to work the land.. you can pre commercial thin you can do a Little fertilizing but not necessary.. when you log you just hire a contract logger... some of the bigger mills will manage the sites if they get the wood.. but you don't get top dollar like if you hire your own loggers .. GYPO's they are called.. No need to own any equipment.. plus you can hunt and ride your quads.
on one of are tree farms it was 700 acres we got it approved for a zip line park.. Never came to fruition but I got it approved at the county level.. would have been way cool.. !!!
I agree with @Caleb Heimsoth point. One thing I have always hated about the way average income statistics are given is that they are given as a per household number. What if I am not part of a household? I assume this is done for a reason, does anyone know why?
A wealthy life is a lot deeper than finances.
BUT if we're talking finances I agree more with @Scott Trench and his definitions of wealth.
I define wealthy as such: with a reasonable standard of living (I'm not talking about living in a tent), meaning a decent house, utilities, enough to eat, catastrophic insurance coverage (home, medical, car), something to drive, and a little "sauce" for an occasional vacation or night on the town - if you woke up tomorrow and decided "Hey, I don't think I'm going to work any more" - could you continue that standard of living, indefinitely, barring some catastrophic event that cannot be reasonably guarded against (a meteor hitting the earth, for example)?
If you can continue your standard of living without ever working another day in your life, if you so chose, you are wealthy. Kind of the definition of "financial freedom", the idea that you go to work because you want to, not because you have to.
Originally posted by @Scott Trench :
- $100,000 more passive income than one spends to support their lifestyle: Wealthy
- $500,000 or more in passive income above and beyond what's needed to support one's lifestyle: Ultra Wealthy
Ugh. This is depressing.
I'm 53, retired, and I guess I'm wealthy.
No way I am interested in doing the work necessary to become Ultra Wealthy.
I think I need to move to Florida.
According to that metric, I would be well off. But I do feel like that "wealth" is all self-defined. I personally do not feel like I am well off. I feel like real wealth doesn't begin until someone isn't worried about being able to afford their investments or their wants.
Sorry, I'm not interested in what someone makes. Tell me what you keep. After expenses, after taxes, what's left at the end of the year?
A lot of us have 'til death wealth and never have to punch a time clock again thanks to RE. I like the idea of getting into next generation, changing your family tree kind of wealth as 'wealthy'. My sons having ROTHs and mutual funds and ownership in 2 apt bldgs as a teen and tween. Plans to let my grandkids someday inherit my entire ROTH and a 4-plex or two, at least. That sounds more 'wealthy' to me. $10s of millions by the time they are at retirement age in 75 years or whatever.
Ultra wealthy to me is like Murdock selling 20th cent fox for $50B. He's not a real happy guy and still fights with his brother at 87, but he is 'ultra wealthy'.
Good post and article. We could use more of this teaching in our schools and households.
Below is a good podcast on the milestones of financial independence. It does not matter as much on the term we use for each milestone as it matters that we track it and are intentional about our savings and investing.
If this post proves one old adage about who is wealthy, the answer is "it depends...."
Even though @Scott Trench improved the post with more levels of variation and clarity (and taking age into account), now we can find other areas left out: such as cost of living. $100,000 in Cali buys a lot less than $100K in my home town in SW Missouri. Yes, I get it that we've already covered housing because the phrase is "making $100K above living expenses (which includes housing)," but there are still other expenses that are higher. Individual taste must also be taken into account. As others have said, you can "cover" you cost of living by living very cheaply. The guy in the van down by the river vs. the guy who wants to live in Beverly Hills. The guy who takes the city bus or bicycles vs. the guy who wants a Beamer or Lambo.
Wealth is a very personal thing. Some view it as purely financial numbers and balance sheets. Others view it as having the time and freedom to do what you want when you want. Others see it as having health and family. Some--like me--see it as all of the above and more.
The original article shows a very high-level, unsophisticated approach to defining wealth. It's fine for a newbie to get them thinking without burying them in lots of details, but as we all know becoming wealthy and staying that way is a life-long process. I don't think most people realize that. It's why you get these insane ideas that someone "making" $144K per year is in the upper class. As compared with whom? Sam Walton's heirs? Hardly! Compared to the average paycheck to paycheck American? Definitely! Also this is why a lot of folks vote to raise taxes on "the rich" when they define anyone with an income of $200,000 per year as being rich...in SW MO (median family household income $34,000/year), that's a pretty decent income. In Cali's best neighborhoods it's barely getting by. But I digress.
The question is, "Are you wealthy?" Yes, I am, by my definition. I earn considerably more money than I consume in income. I could lose my job tomorrow and be okay on investments alone. I live in a house that will be fully paid off next year, at which point we'll be debt free. I have a loving spouse, 3 wonderful kids, no health problems, a vibrant spiritual life as a Christian, a positive attitude, and we give generously to several charities that touch our lives. Would a Hollywood star agree with me? Probably not. And you know what? I really don't care what a Hollywood star thinks.
To me being "wealthy" isn't a dollar amount, or a level of savings in the bank. Rather, it's how an individual makes their money. In my eyes anyone that relies on earned income is not wealthy. Regardless of how high their income is.
A brain surgeon making $300,000 a year is not wealthy because they have to keep their foot on the accelerator to keep the money flowing. But a person making $50,000 a year passively is wealthy. This is just how I personally define wealth.
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