What Does Being "Rich" Actually Mean?
By: Pat Cote
What does being “rich” actually mean? I was recently asked this question by a client when we started talking about HENRYs (High Earners, Not Rich Yet). It is a great question and the answers will vary from person to person. Please note that we are talking about being financially rich, as there are other aspects of our lives that can also be rich.
The extremes are obvious, as nearly everyone considers billionaires to be rich. It gets harder to describe the cutoff for people who are well below the billionaire level. At what point is someone considered rich?
Some people will see people with beautiful homes, fancy cars and an extravagant lifestyle and assume they are rich. Some folks who do have that lifestyle are in fact rich, or at least very comfortable financially. However, it can be deceiving to go by someone’s lifestyle, as there are a significant number of people who live paycheck to paycheck with no savings, even with a nicer lifestyle. Many of these folks are “house rich and cash poor.” This type of circumstance can be a real issue if they plan on living in their house for most of their lives – where will the money come from to cover future costs like kids’ college expenses, retirement, and health care?
One of the more common situations we see is when people are “401K rich and cash poor.” They do a good job of making sure they save at work, especially when their employers provide matching contributions to their 401K. However, they may have little to no investment assets outside of their 401K. This can create challenging situations if large unexpected expenses come up that must be paid immediately. 401K loans are not a good idea because of the huge cost associated with them (tax penalty as well as opportunity cost) and the $50K limit for 401K loans.
Another consideration is location. If you live in expensive housing areas like New York City or San Francisco, the amount required to be considered rich would be much higher than if you live in a lower cost area of the United States. Clients who live on the Upper West Side in Manhattan have explained that it costs about $500K/year to live there with a two-bedroom condo, a couple of kids in private school, one car and one family vacation per year. They emphasized that while it is a nice lifestyle, it is not a lifestyle of flying first class and eating out at nice restaurants every day. That contrasts with less expensive parts of the country where $150K/year or less would be able to cover an equivalent lifestyle.
Since both personal lifestyle choices and location can make a big difference in defining whether you are rich, I tend to use a simpler definition: being rich is when the income from your investments comfortably and consistently exceeds what you need to live the lifestyle you want and leave behind your desired legacy for the people or organizations important to you. This will differ for everyone, but often includes having a nice home, nice car, being able to do the things you want and not worrying about expenses that might come up.
One quick way to calculate what you would need to be rich is to estimate how much your desired lifestyle costs, then multiply it by 40. For example, if you estimate that your lifestyle costs $250K/year, then you would need 40 x $250,000 = $10 million to be rich. Some might argue that you could use a lower multiple than 40 in the calculation, say 25 or 30 (you could definitely do so, however, it becomes riskier at that point so you may not comfortably and consistently generate the income to cover your expenses). These multiples are based on how much you could withdraw from your portfolio each year, and still not run out of money before you die. There used to be a “4% rule” commonly used in the investment industry, which meant that if you were age 65 and withdrew 4% of your investments each year, you were unlikely to outlive your investments. You would then use a multiple of 25 times your annual spending to calculate how much your investments need to be (multiple of 25 because 25 = one divided by 4 percent). However, interest rates are much lower now, so many investment advisors no longer believe the 4% rule holds - instead a lower withdrawal rate of 2.5% to 3% should be used. In addition, if you are younger than age 65, you would want to use a lower multiple because you have additional years to cover. With a withdrawal rate of 2.5%, you would need 40 times your annual spending to be rich (multiple of 40 because 40 = one divided by 2.5 percent).
So what amount does the investment industry consider to be rich? The SEC considers people to be “high net worth” individuals if their investment assets exceed $1 million. This is in line with what many people thought years ago, when anyone with $1 million was considered rich. In practice, the investment industry now uses a higher minimum, typically $5 million - $10 million, as the high net worth cutoff. The next tier up, the “ultra high net worth,” refers to families with $30 million and up. The important distinction is that these measures usually refer to the family’s investment assets excluding their primary residence.
So what does being rich actually mean? The bottom line is that it is a personal measure that is really driven by lifestyle and location. The investment industry cutoffs of $5 million - $10 million in investment assets probably are what most people would consider to be the minimum needed to be rich.