Using established guidelines is a way for many people to simplify their financial lives. For example, when they don't know how to divide up their assets in a portfolio, they'll use the "rule of thumb" of "100% - your age" to decide the portion of their assets that they should have in stock. (Your age would be the fixed income portion.) For example, if you were 60 years old, you might hold 40% of your assets in stocks and 60% in bonds.
An important aspect of financial planning, whether you are a "do-it-yourselfer" or you are working with a professional advisor, is to complete an annual financial progress report, which will tell you where you stand financially at a particular point in time. This is also called a net worth statement and is calculated by subtracting what you owe (debts) from what you own (assets). A commonly recommended guideline is to use is to try to increase your net worth by at least 5% a year.
Though net worth statements are invaluable on an individual basis, many people want to know how they compare to others in their peer group, age, and income bracket. Some individuals look at their neighbors who have very expensive houses, new luxury cars and sport utility vehicles, memberships to country clubs, and always dress very well, and feel that they are not as wealthy as these neighbors and want to know what they are doing wrong. They may be doing nothing wrong. On the contrary, they may be doing everything right.
It is very costly to maintain a "keep up with or beat the Joneses" lifestyle as it reduces your ability to save and invest for financial independence. Buying new cars that depreciate rapidly and expensive clothes that go out of style very soon does not add to your wealth, but detracts from it. In many cases, expensive homes do not appreciate in value as greatly as a good investment like a bond, stock, or mutual fund. But how do we judge where we are on the wealth ladder?
In the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko, the author identifies a simple formula that can be used to approximate what your net worth should be at any point in life. They identify the formula as follows: your current age ÷ 10 x your annual pretax income, excluding inheritances. A couple age 50 with combined annual incomes of $75,000 should have a net worth of $400,000.
Example: 50 ÷ 10 = 5
$75,000 x 5 = $400,000
Take this test yourself and see if your net worth is on target, based on your age and income. A net worth calculation worksheet can be found on the Rutgers Cooperative Extension web site at www.rce.rutgers.edu/money2000.