I finally had a chance to pick up the book The Millionaire Next Door from the library this week. The book was reviewed on a number of finance related blogs that I read regularly including Get Rich Slowly a great blog on personal finance, the title says it all.
Although the book is a bit dense (it’s written by two PhDs), there are lots of insightful nuggets of information and statistics that I found intriguing. Since a full review would be quite lengthy, I will instead list my top three takeaways.
Note: This book was published almost ten years ago, so most of the data will be outdated, but the points they support are still valid and relevant.
1. Most Millionaires Don’t Inherit Their Wealth, They Earn It
Overall the aim of The Millionaire Next Door is to debunk general myths about wealthy Americans. One of the common myths, something that I assumed but never really verified, is that most wealthy Americans are old money, meaning they inherited their wealth through previous generations.
Following this line of thought, the most wealth Americans would be those who were here first. Who were they? The British. However, according to the book, this is not the true. Although, overall there are more millionaires among Americans of British descent (7.7 out of 21.1 million in 1998), percentage wise they rank fourth. The top three wealthiest ancestry groups in America, according to the book, are Russian, Scottish and Hungarian.
So the obvious question is, Where did all the money go?
What most likely happened was that the fortunes generated by the first generation was quickly squandered by the second and third generations. The authors of the book Thomas J. Stanley and William D. Danko state that wealth accumulation in America has more to do with the achievements of the current generation than what took place in the past.
Point: most millionaires (the book says 80%) are first generation, meaning that they build their wealth on their own rather than inherit it.
The authors estimate that approximately 22 of every households headed by someone of Russian ancestry has a net worth of $1 million or more. That’s over one in every five!
“Russians in disproportionate numbers are manager-owners of businesses. Further, this entrepreneurial spirit seems to translate from one generation of Russians to the next.”
No wonder there are so many wealthy Americans of Russian ancestry. Among smaller ethnic groups, people of Israeli descent rank #1 for economic productivity. I wonder if the statistics have changed a bit in ten years. It seems the book didn’t take into account Asian immigrants, because their history in the United States is so short. Though I’d be willing to wager that Asians would rank pretty high up there as well.
As one might expect, most of America’s millionaires are self-made entrepreneurs. While this is a fact, the book doesn’t try to convince readers that becoming a successful entrepreneur is easy. According to the authors, most self-made millionaires wanted their children to pursue higher degrees and develop skills, such as law and medicine, that could be marketable in many areas. S
“In America, fewer than one in five households, or about 18 percent, is headed by a self-employed business owner or professional. But these self-employed people are four times more likely to be millionaires than those who work for others.”
While the odds of success are slim, if you make it, the chances of becoming a millionaire are quite nice.
2. Millionaires Care About Overall Net worth, NOT Realized Income
The common misconception about wealth is that it is measurement of one’s annual salary. The Millionaire Next Door defines wealth as overall net worth, which is assets (investments and property) minus liabilities (expenses and debt). The book illustrates the difference between high earners and high net worth individuals by giving examples of six-figure income earners who have very small net worth.
One of the interesting examples the book mentions is Ross Perot, the billionaire guy with the big ears who some say snubbed Al Gore’s chances at beating George W. Bush in the 2000 U.S. Presidential Elections. When the book was published in the late 1990s, Perot’s estimated net worth was around $2.4 billion. Not bad. His realized income was approximately $230 million, which is 9.6% of his overall net worth. He paid only 8.5% or $19.5 million in federal income tax.
Many high earning individuals in American with low net worth, pay over 15% of their income in taxes, some as high as 25%. If you don’t think 9% makes much of a difference, for Perot 9% of his net worth would be over $200 million dollars.
The key difference between high earners and high net worth people is that high net worth people pay less in taxes as an overall percentage of their net worth. They invest more in tax free municipal bonds, tax-sheltered real estate and holding stocks for the long term, which results in untaxed unrealized gains. This allows them to build wealth faster by paying less taxes.
Since I started working in NYC, I’ve experienced first hand the chunk that Uncle Sam takes out of my monthly paycheck. 25% of my paycheck is lost to federal, state, city and other taxes such as Medicare and social security. If I were to calculate my wealth solely based on my paycheck, without additional investments, I’d lose nearly 25% of my earned income to taxes every year. Currently that’s $7500. If I didn’t invest any of my earned income and received no raises, in ten years I would have paid approximately $75,000 in taxes.
However, if I invested $7500 each year to offset the amount paid in taxes, over ten years with an average annual gains of 10%, I’d end up with over $120,000.
That’s approximately a $45,000 difference.
Here’s a valuable nugget about wealth building from the book:
To build wealth, minimize your realized (taxable) income and maximize your unrealized income (wealth/capital appreciation without a cash flow)
3. Millionaires Drive, Eat and Dress Cheaply– They Also Budget Their Expenses
The Millionaire Next Door states that over 62.4 percent of millionaires surveyed knew how much their family spends each year for food, clothing and shelter.
Do you know how much you spend per year on those things ?
The average millionaire paid less than $140 for shoes, $235 for a wrist watch and $399 for a new suit.
How much do you spend, on average, for shoes, clothes and watches?
What about for your newest car?
The typical millionaire paid only $24,800 for his most recent automobile. 30% spent $19,500 or less. What’s interesting is that the average American spent more than $21,000 for their most recent vehicle.
Most people don’t know how much they spend on durable goods, and for a long time I didn’t either. Growing up it was easy to not think about it because my parents paid for everything. But as soon as I began to support myself, it didn’t take me long to realize how quickly my purchases added up.
Budgeting has proved invaluable in helping me to save consistently. In my previous post, How to Become Rich With Patience I explained in detail how I graduated with $10,000 in savings by budgeting my income from part time jobs, internships and scholarships. Without the help of my trusty excel spreadsheet and a determination to save a specific amount of money every month, I would have graduated with much less.
Budgeting and saving are active choices of the will, while spending is usually passive. It’s easy to not count the dollars when you go out to eat with friends, but they add up quickly. After reading through The Millionaire Next Door I believe there are three general disciplines that the wealthy have over the non wealthy and they are: the discipline of earning money, saving money and investing money consistently.
If there’s anything to be learned from this book it’s that the combination of those three skills can yield a $1,000,000+ net worth and long term wealth.
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Tags: Book Reviews · Personal Finance · Wealth building1 Comment
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