The millionaire next door by Thomas J Stanley & William D Danko
Affluent people typically follow a lifestyle conducive to accumulating money. In the course of our investigations, we discovered seven common denominators among those who successfully build wealth:
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.
How TO DETERMINE IF YOU'RE WEALTHY
Whatever your age, whatever your income, how much should you be worth right now? From years of surveying various high-income / high-net worth people, we have developed several multivariate-based wealth equations. A simple rule of thumb, however, is more than adequate in computing one's expected net worth.
Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be.
For example, if Mr. Anthony O. Duncan is forty-one years old, makes $143,000 a year, and has investments that return another $12,000, he would multiply $155,000 by forty-one. That equals $6,355,000. Dividing by ten, his net worth should be $635,500.
If you are in the top quartile for wealth accumulation, you are a PAW, or prodigious accumulator of wealth. If you are in the bottom quartile, you are a UAW, or under accumulator of wealth. Are you a PAW, a UAW, or just an AAW (average accumulator of wealth)? We have developed another simple rule.
To be well positioned in the PAW category, you should be worth twice the level of wealth expected.
In other words, Mr. Duncan's net worth/wealth should be approximately twice the expected value or more for his income/age cohort, or $635,500 multiplied by two equals $1,271,000. If Mr. Duncan's net worth is approximately $1.27 million or more, he is a prodigious accumulator of wealth. Conversely, what if his level of wealth is one-half or less than expected for all those in his income/age category? Mr. Duncan would be classified as a UAW if his level of wealth were $317,750 or less (or one-half of $635,500).
What are three words that profile the affluent? FRUGAL FRUGAL FRUGAL
Webster's defines frugal as "behavior characterized by or reflecting economy in the use of resources." The opposite of frugal is wasteful. Being frugal is the cornerstone of wealth-building. Yet far too often the big spenders are promoted and sensationalized by the popular press.
PLAYING GREAT DEFENSE
The affluent tend to answer "yes" to three questions we include in our surveys:
1. Were your parents very frugal?
2. Are you frugal?
3. Is your spouse more frugal than you are?
This last question is highly significant. Not only are the most prodigious accumulators of wealth frugal, their spouses tend to be even more frugal. Most people will never become wealthy in one generation if they are married to people who are wasteful. A couple cannot accumulate wealth if one of its members is a hyper consumer. This is especially true when one or both are trying to build a successful business. Few people can sustain profligate spending habits and simultaneously build wealth.
Do you wish to become affluent and stay affluent? Can you answer "yes" candidly and honestly to four simple questions?
QUESTION 1: DOES YOUR HOUSEHOLD OPERATE ON AN ANNUAL BUDGET?
Do you plan your consumption spending according to a variety of food, clothing, and shelter categories each year?
QUESTION 2: Do YOU KNOW HOW MUCH YOUR FAMILY SPENDS EACH YEAR FOR FOOD, CLOTHING, AND SHELTER?
QUESTION 3: Do YOU HAVE A CLEARLY DEFINED SET OF DAILY, WEEKLY, MONTHLY, ANNUAL, AND LIFETIME GOALS?
Financially independent people are happier than those in their same income/age cohort who are not financially secure.
QUESTION 4: Do YOU SPEND A LOT OF TIME PLANNING YOUR FINANCIAL FUTURE?
One earns to spend. When you need to spend more, you need to earn more.
To build wealth, minimize your realized (taxable) income and maximize your unrealized income (wealth/capital appreciation without a cash flow).
For example, one millionaire, Perot . .. minimizes his tax bill by investing heavily in tax-free municipals, tax-sheltered real estate, and stocks with unrealized gains
Why would a scholar who works for our treasury department spend so much time conducting a study like this? We consider the staff of the IRS a clever bunch. They study their target market. And they lust for its wealth. They want to know how many affluent people generate so few dollars of realized income. Since owners of closely held businesses are especially adept at this strategy, Mr. Steuerle selected for study those estates in which the value of the closely held business(es) exceeded 65 percent of the estates.
Here are some of the findings of Mr. Steuerle's study:
• The income realized from the assets of closely held businesses was only 1.15 percent of the appraised value of the assets. Note that even this small percentage is likely to be biased in the upward direction, since there are estate tax advantages for heirs and executors who provide conservative appraisals.
• The total income realized from all assets and all salary, wages, and income combined was only 3.66 percent of the value of all assets.
What do these results tell you about the affluent? They suggest that a business owner who is worth, say, $2 million on average has an annual realized income of only $73,200, or 3.66 percent of $2 million.
Could you live on $73,200 today and still invest a minimum of 15 percent each year? No, it's not easy. But it's not easy being financially dependent, either.
Here is another one of our rules.
If you're not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household's total annual realized income.
THEY ALLOCATE THEIR TIME, ENERGY, AND MONEY EFFICIENTLY, IN WAYS CONDUCIVE TO BUILDING WEALTH.
PAWs allocate nearly twice the number of hours per month to planning their financial investments as UAWs do.
There is an inverse relationship between the time spent purchasing luxury items such as cars and clothes and the time spent planning one's financial future.
Most PAWs agree with the following statements, while most UAWs disagree:
• I spend a lot of time planning my financial future.
• Usually, I have sufficient time to handle my investments properly.
• When it comes to the allocation of my time, I place the management of my own assets before my other activities.
Conversely, UAWs tend to agree with the following statements:
• I can't devote enough time to my investment decisions.
• I'm just too busy to spend much time with my own financial affairs.
Martin’s method: A millionaire called Martin filters fin/ consultants in the following method. Here is what he told us during the interview:
I am a businessman who goes out and tests people. Brokers call me a lot. They say, "I have a great deal of experience in Wall Street's best offerings. . . . I have a fantastic track record of making money for my clients. "
I always say: "Do you have some good investment ideas for me-really good?" He says, "Absolutely, especially if you're willing to make trades in your portfolio. I only handle accounts with a minimum of $200,000." Then I tell him, "So you're really good. Well, I'll tell you what. Send me a copy of your personal income tax returns from the last few years and a list of what you have had in your own portfolio for the past three years. If you made more money than I did from investments, I'll invest with you. Here's my address. "
When they say, "We can't show that to you," I tell them, "You are likely to be full of baloney.” This is my strategy for checking people out. It works. I check them all out this way. I mean it very honestly.
THEY BELIEVE THAT FINANCIAL INDEPENDENCE IS MORE IMPORTANT THAN DISPLAYING HIGH SOCIAL STATUS.
Mr. Allan, as well as those people whom he has backed financially, have never felt that their purpose in life was to look wealthy. According to Mr. Allan, "That's why I'm financially independent":
If your goal is to become financially secure, you'll likely attain it. ... But if your motive is to make money to spend money on the good life, you're never gonna make it.
It's much easier in America to earn a lot than it is to accumulate wealth.
Whatever your income, always live below your means.
The more dollars adult children receive, the fewer dollars they accumulate, while those who are given fewer dollars accumulate more.
RULES FOR AFFLUENT PARENTS AND PRODUCTIVE CHILDREN
1. Never tell children that their parents are wealthy.
2. No matter how wealthy you are, teach your children discipline and frugality.
3. Assure that your children won't realize you're affluent until after they have established a mature, disciplined, and adult lifestyle and profession.
4. Minimize discussions of the items that each child and grandchild will inherit or receive as gifts.
5. Never give cash or other significant gifts to your adult children as part of a negotiation strategy.
6. Stay out of your adult children's family matters.
7. Don't try to compete with your children.
8. Always remember that your children are individuals.
9. Emphasize your children's achievements, no matter how small, not their or your symbols of success.
10. Tell your children that there are a lot of things more valuable than money.