Remember the Magic 8 Ball? You could ask it a question, like “Will I be rich and famous?” and the Magic 8 Ball would give you an answer.
Fun, but not that accurate.
The St. Louis Federal Reserve Bank has developed a tool that might do a better job of predicting your personal wealth.
William Emmons and Bryan Noeth came up with their “financial health scorecard” that is based on the answers to 5 simple questions. They explain how it works in the Fed publication In The Balance.
Emmons and Noeth studied the responses to the 5 questions that participants provided in the Federal Reserve Board’s Survey of Consumer Finances between 1992 and 2013. They then cross-referenced the answers to the respondents’ reported wealth.
They placed the consumers who responded to the survey in groups based on age, education, and race and ethnicity, forming 48 non-overlapping groups. What they found was a very strong relationship between their simple measure of a group’s financial health and its actual wealth.
Here are the 5 questions:
- Did you save any money last year?
- Did you miss any payments on any obligations in the past year?
- Did you have a balance on your credit card after the last payment was due?
- Including all of your assets, was more than 10 percent of the value in liquid assets?
- Is your total debt service (principal and interest) less than 40 percent of your income?
If you save money, pay your bills on time, pay off credit card balances each month, have most of your wealth in performing assets and a low income-to-debt ratio, your chances of building personal wealth are greater.
Education not a good predictor
The authors noted several patterns among the group and found that the level of education the consumers had attained was not a reliable indicator of personal wealth. Age and ethnicity were.
Older families generally had greater financial health and wealth than younger and middle-aged families for any given race, ethnicity or level of educational attainment.
At the same time, non-Hispanic white and Asian families typically had greater financial health and wealth than Hispanic and African-American families for any given age or level of educational attainment.
“Whatever the causal mechanisms, our simple financial health scorecard provides a surprisingly accurate prediction of the median wealth of groups of families defined by their age, educational attainment, and race or ethnicity,” they wrote.