Jane Mepham the author, is the Principal Advisor at Elgon Financial Advisors (EFA). EFA is a registered investment advisor in the state of Texas, serving successful foreign-born individuals/families nationwide. To continue being a part of the conversation on financial issues that affect foreign-born individuals/families subscribe to Elgon’s blog posts by email here.
My review of the Millionaire Next Door by Stanley Thomas, Ph.D. and William Danko, Ph.D.
Growing up, I secretly I harbored a dream to be a millionaire one day. There was something magical about that number.
When I got my first job after college, I quickly came to the realization that I didn’t know a lot about personal finance. This was going to be an issue in my pursuit of the millionaire club membership.
I started reading everything on the subject that I could lay my hands on. My goal was two-fold. First figure out how the American financial system worked. Second pick up some practical steps, that I could implement in my life that would allow me to start down the millionaire path.
My curiosity bordering on obsession at that point was to figure out how ordinary Americans lived, how they managed their money, how they could afford to buy the assets they owned and apply it to my life.
Introducing the “Millionaire Next Door”
I tell the story above to help explain, why I was so blown away by one of the first books that I read at this point. This was the “Millionaire Next Door” by Thomas Stanley, PH.D. and William Danko, Ph.D. written in 1996. To this day it is still one of my all-time favorite books, and one that I highly recommend to anyone looking to understand personal finance. The two Ph.Ds. wanted to find out how people become wealthy.
Reading the book, felt like I was finally getting a front-row seat in a movie that provided the blueprint of how to live your live if you wanted to be a millionaire. In my quest to understand the American financial landscape, I felt like this book held the keys to the kingdom.
Reality Versus Perception
I finally started to get a sense of the reality of those around me in terms of their wealth.
The guy driving the fanciest car was not necessary the richest guy on the street.
The LA celebrity was not the millionaire that I thought they were.
My next-door neighbor down the street who owned a couple convenience stores and drove a 5-year-old older model car was probably a millionaire or was well on his way.
I love numbers and having the actual research included in the book, made it more real for me. The authors do not provide a lot of investment-related information, but they provide something far more valuable. They provide an insight into how the majority of millionaires think and make life decision that end up determining how much wealth they accumulate.
To this day, I still get new insights every time I read the book.
So, to round out the Financial Literacy Month – here are my top lessons from the “Millionaire Next Door.” Anybody can apply these lessons to their lives.
Lesson 1: Spend Less Than You Earn
A lot of folks find it very difficult to say no to unnecessary purchases. A part of this is driven by the desire to buy status objects or the desire to lead a certain lifestyle.
Choosing to live in a status neighborhood leads to a need to keep buying status objects to keep up with the neighbors. This is what has led to very high levels of consumer debt. It’s almost impossible to accumulate wealth with the competing need to pay off debt.
Lesson 2: Income Does Not Equal Wealth
The assumption we make is that a higher income means more wealth. But that’s the complete opposite of the findings from the book.
Thomas and William came up with a formula to determine if your net worth matches your income. Multiply your age times your annual household income, divide it by 10. For example, a 40-year earning 100k pretax should have a net worth of 40*100000 / 10 = $400,000.
Based on this rule, it’s easy to figure out if you are a Prodigious Accumulator of Wealth (PAWs), or an Under Accumulator of Wealth (UAWs) or an Average Accumulator of Wealth (AAW).
When it comes to income, what really counts is how much of that is spent and how much is invested. On average millionaires invest about 20% of their income.
Lesson 3: Learn the Right Investing Strategies
PAWs use investment strategies focused on increasing nontaxable incomes and decreasing taxable income. At a high-level, examples of these are investment vehicles like 401ks, IRAs etc.
They also spend more time dedicated to financial planning and investments. On average they spend about 83% more time planning their financial futures compared to UAWs. This does not imply that they are day traders, but that they are more thoughtful about where they invest, and they are willing to give that money time to grow.
Lesson 4: Choose the Right Career
This was possibly one of the more interesting lessons. The professions likely to lead to a UAW type of lifestyle are the ones we think of as being prestigious. This includes doctors, physicians, lawyers and dentists. They spend a lot of time in school, and in the process a lot of them end up accumulating a lot of student debt.
When they finally graduate and start working, they tend to want to live a consumption focused lifestyle, since that’s what society expects of them.
They can become accumulators of wealth, but they need to make a very conscious decision to live below their means and focus on PAWs lifestyle habits.
Parents want their kids to have the best education and to pursue this type of careers, but its so key to teach them these ideas before they leave home. It’s also important to teach them, that their level of education is not corelated to their level of wealth.
Lesson 5: Live Intentionally
When asked the question “Do you know how much your family spends each year on food, clothing and shelter?.” About two-thirds of the millionaires could answer in the affirmative, while only 35% of high-income earners, low wealth could answer that question.
A similar number of millionaires also had a yes answer when asked the question “Do you have clearly defined set of daily, weekly, monthly, annual and lifetime goals?”
This shows that this group plans their lives, and allocates resources needed for that. They don’t let life happen to them and by extension are not caught up in situations where they are forced to borrow money.
Lesson 6: Choose Carefully the Car You Drive
Cars in America today represent independence and freedom. It’s probably one of the most expensive purchases after the house. The most important thing that the car does is provide a means of transportation. But it has become a status symbol and more money is allocated to this than is needed in the authors opinion. I tend to agree with them on this.
According to the book, UAWs will spend countless hours researching, and shopping for a new car. They end up driving the latest model, purchased new, with the latest upgrades and most likely financed.
On the other hand, PAWs rarely drive new luxury cars, and usually have older models a couple years old. It’s all about priorities and where you choose to spend your time and resources.
Lesson 7: Watch out for Generational Wealth Destruction
According to Thomas and Williams, children that grow up in a UAW household, are more likely to become UAWs. There is also a high possibility that they have not been taught about money, budgeting and investing by their UAWs parents.
There is a tendency for these kids to become very entitled and grow up believing the lifestyle they are accustomed to is their birthright. They expect to lead the same lifestyle regardless of their income in future.
Once the kids leave home, the parents continue providing financial assistance, a term referred to as Economic Outpatient Care (EOC). According to the authors, this is a big contributing factor to passing on the UAW mentality to the kids. The grown-up kids continue living lives beyond their means, the parents continue helping and with every generation, the accumulated wealth continues to go down.
Generational Wealth Destruction and UAWs
An interesting observation which is still very relevant today. The first generation in the country tends to work very hard, is very frugal, saves prodigiously and is the perfect example of PAWs. They pass on the wealth to their kids mainly in the form of small businesses.
The kids work the business, but sometimes choose to move on to other ventures. They spend more and save less and start living the lives of UAW.
The 3rd generation sells whatever is left and continues down the path to UAW land.
The 4th generation completes the Generational Wealth Destruction, they have very little, spends everything they have and end up completely broke.
Being aware of this, means we can start educating and helping our kids know what’s in store for them, if they don’t take some of these lessons to heart.
If you’d like to chat about any of the topics above or anything else money related, I would love to connect here.
The financial challenges you are likely to face as an immigrant are many and varied. But you don’t have to face them alone, we are here to walk with you every step of the way.
Do you know how to protect yourself if you become incapacitated? Do you know how to appoint guardians including international guardians? Read the post for answers to these questions, as well as an introduction to a new estate planning solution – Trust & Will
To protect your financial future – you need to constantly change and adapt. One way to do this is to invest in yourself.