Saturday, July 19, 2008

The Millionaire Next Door

The Millionaire Next Door - The Surprising Secrets of America's Wealthy. Thomas J. Stanley and William D. Danko. Highly Recommended.

Who are America's wealthy? Most of us go by what we see in the media...the Hollywood megastar, professional athlete, the powerful CEO, and perhaps other successful professionals like doctors and lawyers. Of course, many of these people are wealthy...but they make up an extremely small percentage of America's millionaires. The Millionaire Next Door lets us in on a little secret... not only would you not recognize most of America's millionaires, but they may be living in your neighborhood. Better yet, the author's research shows that anyone can become wealthy in one generation, if they so desire.

This book relies on two decades of research on the wealthy in America. Very quickly, the authors realized that many of the assumptions that we all make about rich people were false. For instance, many people that live in upscale neighborhoods and drive fancy cars have very little wealth; with the corollary that many of the wealthy live in regular neighborhoods and drive normal cars. As their research progressed, they highlighted seven factors that were common among the wealthy.

1. They live well below their means.
2. They allocate their time, energy, and money efficiently, in ways conducive to building wealth.
3. They believe that financial independence is more important than displaying high social status.
4. Their parents did not provide economic outpatient care.
5. Their adult children are economically self sufficient.
6. They are proficient in targeting market opportunities.
7. They chose the right occupation (not what you might think).

The book examines each of these characteristics in great detail.

Chapter 1 introduces us to the prototypical millionaire. From all outward accounts, he is an average, normal looking guy. He has a 'dull-normal' job (contractor, builder, farmer, small business owner). He has an above average, but not extreme salary (only 8% of them make 500k or more per year). He most likely did not inherit any of his wealth (80% are first generation wealthy). So how did he do it? One word: frugality.

The second chapter highlights the secret for anyone in America to become well below your means. It seems common sense. It seems like a no-brainer. It seems like nobody in America is doing it. The authors equate wealth building to must play good defense. High scoring teams (high earners) that don't play good defense (spend frivolously) will not win many games (become wealthy). We have all heard the adage "Defense wins championships". How good is your defense? Here is how the authors suggest to determine if you are on track:

Multiply your age times your realized pretax annual household income from all sources except inheritance. Divide by ten. This is an estimate of your net worth. If you are above it, you are a prodigious accumulator of wealth (PAW). Under it? An under accumulator of wealth (UAW).

The next chapter examines the efficiency habits that allow PAWs to build their wealth. As would be expected they spend more time financial planning than UAWs. Twice as much, in fact. Luckily, UAWs spend very little time in this increasing it is not as hard as one might think.

Up next, the spending and consuming habits of the rich. As previously stated, most of America's wealthy are frugal and do not spend excessively. The authors use an American icon, the motor vehicle, to examine PAWs. Many more drive late model American sedans than new foreign luxury vehicles. This highlights the fact that most prefer financial independence over displaying high social status and material goods.

The role of family is examined in detail, as well. Both the spouses and children of the wealthy were researched. Obviously, a non-frugal spouse can counteract the miserly tendencies of the other. Also, economically dependent children will drain resources...and paradoxically, leave the child in worse financial shape than not providing assistance.

Finally, the author drives home the point that the wealthy make the most of opportunities. Not only have they accumulated capital through frugal living, they have researched and implemented investment strategies that maximized those funds. They saw emerging trends...and capitalized.

The book is chock full of interesting case studies to drive home the points. Thus far, I feel as though I have given a pretty glowing review, however there were a few drawbacks:
Gets preachy at times - frugal living is equated with morality in many cases. High spenders are not given much slack.
Data is a little dated - written in 1996. There have been some big world events since then. However, in my view, the main points of the work are timeless.
Correlation does not equal causation - just because many rich people drive late model American sedans, the fact that you do does not make you rich.
You only live once/you can't take it with you - there is something to be said about enjoying life. Especially with many of the case studies showing that much of the wealth left as inheritance is quickly squandered and does not necessarily lead to happiness for one's decedents.

I highly recommend this book to nearly everyone. I feel it is especially important for young people, as they have the most to gain from its lessons. Buy it, read it, share it. It may change your life.

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