Do you ever wonder how your net worth compares to others in your age group? Do you ever wonder if you are ahead or behind? Do you also ever wonder how to build wealth?
Well I recently obtained a table that shows the average and median net worth by age. The table was compiled using data from the Federal Reserve survey of consumer finances.
Let's describe what some of those terms mean,
In statistics, the median is the middle number in a sorted list of numbers. It represents the point where half of the values are above and half are below. Essentially, it's the midpoint of a dataset.
"Average" typically refers to the arithmetic mean, which is calculated by adding all the numbers in a set and then dividing that sum by the total number of values in the set.
The fun part is that an average can be pulled up by outliers. For example, if I am a 94 year old with a net worth of $0 and I am joined by Warren Buffett, whose net worth is $152 Billion, the average net worth is going to be $76 Billion between the two of us.
If Buffett is joined by several folks in their 90s however, the mid point is going to be $293,322. This means that half of those in their 90s will have a net worth below $293,322, while the other half will have a net worth above $293,322.
The fascinating part is how a few wealthy folks (the outliers) can really pull the average net worth numbers up. However it is somewhat saddening that the median net worth figures are so low for the US population.
Most folks in the US simply do not have a high net worth to begin with.
This is due to a combination of low income, high cost of living and emergencies that could sink finances in an instant.
On the other hand, many folks in their 70s, 80s, 90s have pension and/or Social Security income, which has a "value" but is not really reflective in this statement of net worth.
For younger folks, it is understandable that their net worth would be low in their 20s or even 30s. That's when you are starting in your careers, and building out your worth from a low point. For many, they also have to overcome the negative burden of student loans as well.
I will be honest with you, when I read this table, I see it as an inspiration to build wealth.
I see it as an inspiration to convert a portion of paycheck on a regular basis into a portfolio of dividend growth stocks.
The initial grind is hard, as you need to invest in your human capital first, and then start to monetize that with your first job after college.
As a younger person, your biggest asset is time.
Assuming a 7% real total return annualized, a dollar invested in your 20s would turn to almost $30 in 50 years.
But that same dollar would only turn to almost $2 in a decade.
It would turn to almost $4 in two decades.
It would turn to $7.50 in three decades.
It would turn to almost $15 in four decades.
Remember those are "real" dollars, as in "inflation adjusted".
As for taxes, there are handy retirement accounts to defer or eliminate them (Roth IRA).
If you manage income and expenses well, you can probably afford to have a decent savings rate right off the bat. If you can live like a college student, even after your first job for a few years at least, you can soak up a lot in savings. Those can be a nice emergency fund to fall back on in case things happen. It can also be a nice nest egg that would compound for a long period of time for you too.
As a general rule, the earlier you start investing, the more time you have to compound those investments.
The latter you start investing ,the less time you have to compound those investments.
So it's important to start early, as this story demonstrates.
Your savings rate matters a lot. To get to it one needs to manage BOTH income AND expenses. A high income alone won't help you if you spend all of it. Being super frugal alone on a low income also won't help you because you have less to work with, and certain fixed costs are unavoidable. Hence you need to manage BOTH. Your savings rate matters.
The best game in town is to generate a good salary/income in a lower cost of living area. For example, making $250,000 in New York City or Silicon Valley may sound great, until you pay half of it on rent. On the other hand, while earning $100,000 in Saint Louis may sound like a lower income than the coasts, you may be able to save more as your rent/housing may be lower too. The major expense categories include housing, food, transportation + taxes as well.
Getting to your first $100,000 is the hardest, as it requires being smart with your money.
A higher savings rate can help you reach your goals and objectives faster. A lower savings rate can mean that it takes you longer to reach your goals and objectives. The math behind early retirement is simple.
If you save 70% of your income, invest in dividend paying companies yielding 3% and growing earnings, dividends and share prices at a real rate of 4% per year, you will be able to retire in approximately 10 years.
If you only save 50% of income, you will be able to retire in 17 years.
At a 40% savings rate, it takes 21 - 22 years to reach the dividend crossover point. The dividend crossover point is the point at which your dividends exceed expenses.
If you only manage to save 30% per year, you will be able to retire in 27 years.
This chart shows how long it would take for the investment income to exceed the amount of spending, given the return, the dividend growth, dividend reinvestment and savings assumptions.
For example if you earn $10,000/month, and you spend $5,000/month, you would be able to save and invest $5,000/month. This is a 50% savings rate. At the conservative return assumptions above, you would be able to retire in about 17 years. That’s when the portfolio would be generating $5,000/month in dividends.
The savings rate is very important. Getting to the right savings rate means focusing on managing BOTH spending AND income. That’s the fuel before we even discuss the investment strategy.
You can view the spreadsheet behind the calculations from this link. You can download it, and play with your own assumptions.
I assume a “real salary” that does merely keep up with inflation, and investment returns that are also “real” and therefore are after inflation. I also am ignoring the effect of taxes on investment income, since everyone’s taxes are different, and I didn’t want to complicate too much this simple truth. More complications are probably going to confuse people, rather than make it clear for them. I am also assuming that this investment income is the only income to provide the essentials for a basic retirement income. In most situations, a person would have pension income and social security income or even some part time job income to rely upon, when they retire. For those who strive to retire early, it is quite possible that they will exclusively rely on the income produced from their investments.
Also note that as with other models, there is linearity assumed in terms of savings rate each month, investment returns each month etc. In reality, real life does tend to be lumpier. While a model has its limitations, it still tends to showcase and illustrate a mental model rather well.
Accumulating income generating assets takes time. But once you reach a certain inflection point, the power of compounding starts doing the heavy lifting for you.
The power of compounding is fascinating. The human mind cannot really comprehend it easily. But if you did the right thing early on, and accumulated wealth wisely, your future self would be happy for it. Your family would be taken care of too.
Today we learned about the key ingredients that would help you build wealth. It is a simple function of how much you save (As a percentage of income), your holding period and your rate of return (dividend yield + dividend growth).
Once you get the basics covered, all it takes is to invest consistently, and let the power of compounding do the heavy lifting for you.
