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Stages of Wealth

Stages of Wealth

I started Math of the Rich to help people take control of their financial lives and become wealthy. Before we start talking about the stages of wealth as I define them, I want to add a disclaimer that there are many types of wealth. Health is a form of wealth. Family and friends are a form of wealth. The freedom to use your time as you see fit is a form of wealth. A well-rounded person should have a balance of wealth. These stages are specifically about financial wealth and the math you can use to figure out your current stage and how to move to the next.

To talk about the stages of wealth, we need to define Net Worth, which is a common measure of financial wealth. The formula to calculate net worth is:

Assets – Liabilities = Net Worth

What are assets? An asset is anything of value that you own. Do you have a car? A house? Cash? Jewelry? Furniture? Clothing? Collectibles? If you can sell a thing to someone else and get paid, it is an asset.

The first part of the formula is calculated by adding up the value of all the significant assets you own. Significant is the important part. Technically, you can add the spare change in your couch cushions to your assets. However, most people are just going to add up the big stuff because your net worth will fluctuate, and the small things don’t make much of a difference.

Example Assets:

Asset Value
Car $10,000
House $200,000
Checking Account $2,500
TOTAL $212,500

What are liabilities? A liability is money that you owe to someone else. Maybe you are making car payments? Most people that live in a house are paying a mortgage which is money that you owe the bank. Do you have a balance on your credit cards? Do you owe a friend $20 for lunch?

The second part of the formula is calculated by adding up all the liabilities:

Liability Amount Owed
Remaining Car Balance $5,000
Mortgage Balance $130,000
Credit Card Balances $1,300
TOTAL $136,300

The final step is to subtract your liabilities ($136,300) from your assets ($212,500).

$212,500 - $136,300 = $76,200

In this example, if you sold everything you owned, and paid back all the money you owed, you would have $76,200 left over to put in your pocket. That is your net worth.

What happens if your liabilities are bigger than your assets? Your net worth would be negative. If you sold everything, you could payback some of what you owed but you would still owe more money. That is the first stage of wealth, negative net worth:

Stage 1 - Negative Net Worth

A negative net worth is not a reflection of the person. It reflects their current circumstances. Medical students often take on hundreds of thousands of dollars in college debt and have a negative net worth early in life. Medical students are anticipating they will get high paying jobs as doctors and be able to pay back their loans. They expect to work their way from negative net worth to a higher stage of wealth. About 10% of US households (13 million) are in Stage 1. If you are in Stage 1, focusing on your savings rate can help you move to stage 2.

The lifestyle at Stage 1 can be difficult. Every unexpected expense creates hardship and may lead to borrowing more money and sinking deeper into debt. Sometimes, people with huge incomes are also in Stage 1. They’ve borrowed a lot of money and haven’t repaid it yet.

Stage 2 - Zero Net Worth

If you don’t own anything and you don’t owe anything, congratulations! You’re already at stage 2. If you do own assets and you owe about as much as the value of your assets, congratulations, you’re at great starting point in your journey to build wealth. You can use your knowledge of savings rates to quickly move into Stage 3 with 80% of US Households (98 million).

The lifestyle at Stage 2 can be tricky. You may be living paycheck-to-paycheck and the slightest unplanned expense could send you back to Stage 1. Focus on savings rate and building an emergency fund of at least $1000 with the $20 Challenge.

Stage 3 - Less than $1 Million

If you have a positive net worth, but not yet $1 million dollars, you are in the most common stage for households in the US. About half of US households have less than $121,000 in net worth and the other half has more. But 90% of households have less than a $1 million net worth. The closer you get to $1 million, the more safety net you’re building for your financial life.

Stage 4 - Millionaire

When your net worth reaches $1 million or more, congratulations! You now have a larger net worth than 90% of the households in the US. Only about 10% (13 million) households have reached this stage. If you live a lower-cost lifestyle, this stage may be enough to retire early and live comfortably for decades. Using the 4% rule, your net worth could generate $40,000 per year. Buying a Ferrari isn’t advised but you will likely also receive social security. You’ll probably reach the average household income of $56,000 per year and live an average American life some extra fun trips and splurges.

Stage 5 - $2 to $10 Million

About 6.5% of US Households (8 million) reach this level of wealth. Once you reach this level, savings rate and compound interest can help you move from $2 to $10 million but you will need new systems to reach the next stage. Salaried jobs are not going to pay enough to take you to Stage 6 in a human lifetime, even with a great savings rate. If you decide you want to jump to the next stage, you may need to own a business or use the leverage of other people’s money to move faster than income from salary. If you reach Stage 5, you may decide that’s enough. You have a large safety net, the ability to go on nice vacations, buy a new car every few years, and live in a very comfortable house. You may have a second home but those at the low end of Stage 5 still need to pay attention to spending to make sure they don’t overextend themselves.

Stage 6 - $10 to $100 Million

Only 1% of US households (1 million) ever reach this stage of wealth. If you have $10 million or more, you are in an enviable position. You have enough resource to live off your net worth for the rest of your life without much thought about spending. Within this stage, there are significant variations in lifestyle. $10 million usually means a very nice house, a luxury (but not exotic) car and very comfortable vacations. But $50 to $100 million (only 0.07% of US households) brings the option to travel by private jet, multiple homes across the globe, multiple exotic cars, and a staff of experts to help manage your wealth.

Stage 7 - $100 Million+

Only 0.03% of US households, about 35,000, ever reach this stage. That includes 768 US billionaires. Almost anything you wish for is affordable. Instead of just traveling by private jet, you may own one or more. You can have multiple estates in the most desirable locations. You can trade money for time in almost every situation.

  Stage US Households Paths to Next Stage
1 Negative Net Worth 10% (13M) Savings Rate
2 Zero Net Worth   Savings Rate
3 Less than $1 Million 80% (98M) Savings Rate
4 Millionaire 3.5% (5M) Savings Rate, Businesses
5 $2 to $10 Million 5% (7M) Businesses, Leverage, Networks
6 $10 to $100 Million 1% (1M) Businesses, Leverage, Networks
7 $100 Million+ 0.07% (95,000)  

Warren Buffet, net worth $100 billion+, has frequently commented that the difference between the average American and himself is much smaller than people believe. He says that most people are going to eat the same food as him, wear clothing that is just about the same, drive cars that are about the same and live in similar houses with heating and air conditioning. Travel is the one area he calls out as significantly different because he can travel by private jet on-demand. This is important because the Stages of Wealth are not a game where the only way to win is to become a billionaire. They are a way to measure your current situation and can provide a roadmap if you decide you want to put in the effort to move to the next stage.

Most people won’t ever get to Stage 4. Those that get close to Stage 4 will have more retirement options but may also have to work a few more years to achieve their goals. The good news is that by being interested enough to learn about the stages, you’re setting yourself up for an achievable journey to Stage 4 or 5. An income, a focus on savings rate, and time are all you need to be better off than 90% of US Households.