The Millionaire Next Door

MillionnaireNextDoor

Until recently, I had never read The Millionaire Next Door by Thomas J. Stanley and William D. Danko. Why? A couple or reasons. For one, I don’t think you need to read a slew of introductory personal finance books. One or two will do it. Once you have those basic core principles down pat, you don’t need to keep up with reading the introductory stuff. If you want to improve yourself from a personal finance perspective, you should read more advanced books in specific areas that interest you. I’ve read my share of introductory level personal finance books. The Millionaire Next Door may be the best one. Now that I’ve read it, I think it puts a unique spin on the same topic. It has a competitive advantage over others in that they compiled their own data (and its good data) then drew conclusions in ways that fit their methodology. So even if you’ve read all the big ones, I think this one is worth reading as well. The other reason might be that I usually shy away from anything with “Get Rich, It’s Easy!” or “Millionaire” in the title. I only read it when I did because my wife was kind enough to pick me up a $4 copy (1997 hardback version) as a gift from a used bookstore (thanks honey!).

I’m going to tell you from the outset, that The Millionaire Next Door is excellent, and I’m not going to “review” it. Instead, I’m just going to hit on some of the key points that the book makes. The book was written by two Professors, and is full of excellent research. The Profs combed through gobs of data and surveys in order to try to determine who the wealthy in America are. Their research ultimately culminated in this book, and that research gives us some of the most basic tenets of personal finance. If you read this site and/or others like it, you’re not going to find anything earth shattering in this book, but you’re going to find it in a logical, straight forward way that’s supported by data. Here are 10 things that struck me:

1. Predictably, the data shows that most people who you believe to be very rich are not. They might have high incomes, but high incomes often does not correlate with a high net worth. The people with the highest net worths, statistically, aren’t the people you know with a $5000 watch or a Porshe. Millionaires tend to be entrepreneurs who live frugally and save their money, rather than spending it on expensive consumer goods. Does that surprise you? Many high net worth individuals have never actually earned a high income – many of the millionaires in the book have never made $100,000 in a year.

2. High net worth individuals, statistically, tend to be people that live within their means. They don’t spend a lot of money. They don’t waste money. They tend to be pretty frugal people. Obviously, the higher percentage of your income you save and invest, the higher net worth you’re going to have.

3. The book divides people into two basic categories, (1) Under Accumulator’s of Wealth (UAW) and (2) Prodigious Accumulator’s of Wealth (PAW). Doctor’s, for instance, tend to be UAWs. Surprised? In the book, one case study revealed that a doctor that had been making $500k per year had a net worth of less than $2 million (not counting his residence). Doctors are a group that is singled out again and again. My wife is a doc, and I can say from experience that she knows infinitely more about money than her peers. Most of the people she went to med school with can’t tell you the difference between a Roth IRA and a 401(k). To be honest, none of them think they need to know. For the most part, they’re taking the approach of the doctors in the book – I’m going to make a lot of money so I don’t need to know anything about it or consciously save it.

4. A decent amount of time is spent on how and what kind of cars that PAWs buy. The authors point out that most of the riches people you know aren’t driving expensive luxury automobiles. That’s what the people who want everyone to think they’re rich drive. Statistically the people who drive luxury cars are PAWs.

On this note, I can’t tell you how many times people tell me someone is SO rich and that they bought this and this and this (it’s a lot). Every time this happens, I think to myself – I bet that person isn’t as rich as you think he or she is. Statistically, people with a lot of wealth live beneath their means. Based on the data in the book, most of the people that have high net worths don’t look like it. They’re more likely to be wearing a Timex than a Rolex. Remember that the next time you’re tempted by the allure of a brand. Financial independence tends to be more important to PAWs than status symbols.

5. This is the most unsurprising thing I can think of, but statistically PAWs spend more time planning their financial future than UAWs.

6. A part of the book I found very interesting was the part about “Economic Outpatient Care.” Their research shows that parents tend to help the children that are the worst at making and managing their money – the authors refer to this (brilliantly), as weakening the weak. In most of the cases examined, often the parents are encouraging the children to live a lifestyle above their means. If you help your son or daughter with a down payment – they’re probably buying a house they couldn’t afford. This makes them weaker. Not only that, by putting them in that neighborhood they couldn’t afford – they’re setting them up for an unsustainable lifestyle. They’ll want to send their children to expensive private schools they can’t afford, drive cars they can’t afford, etc. This causes the parents to give them even more gifts. Many of these children are doctors, lawyers, engineers and other well respected professions.

According to the authors, if you are going to pay for something for your children in adulthood, the most prudent thing to pay for is education. I had an uncle that helped me with my education. He didn’t pay for it all, but he helped a lot. He subscribed to the “teach a man to fish” philosophy. My wife’s father paid for her school. We were very lucky in that respect. We haven’t had to take money from anyone otherwise. Our families taught us to fish, and put us in a position to be PAWs.

7. Statistically, many more PAWs went to public schools and public universities than private schools and private universities (this one is my favorite).

8. PAWs tend to have children that are economically self-sufficient.

9. Here’s an interesting note. An incredibly high percentage of PAWs tend to be self-employed or entrepreneurs. Many of these business owners own less than glamorous businesses. Let’s say, for example, that a pair of parents made their money by owning and operating a dry cleaning company. They were frugal, saved their money, and now they’re worth almost $4 million. What do they encourage their children to do? They encourage them to be doctors, lawyers, and accountants. Entrepreneurs often have money, but are insecure about status – so they encourage their children to pursue high status jobs. I found this interesting. They don’t encourage their children to become entrepreneurs and follow the path that they themselves have followed. I didn’t comb through the data like the authors did, but in my experience, they’re spot on in this regard.

10. There’s an entire chapter about what they think the jobs in demand will be. The premise they start from is that there will be more wealth in the future, and they try to pinpoint services that they think will be in higher demand because of that. I’m not going to reprint the job list here (read the book if you’re interested). I disagree with some of their picks (and it’s my blog;)). Overall, excellent book. It’s my new recommendation for someone that’s never read a personal finance book before, because, well, I love that they use so much data and that they compiled a lot of it (or funded the compilation) themselves. Have you read the book? Thoughts? Good luck on your road to becoming a PAW and thanks for reading.