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Everything You Know About Wealth is Wrong

by Matt Jones, CPA
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The Millionaire Next Door by Thomas J. Stanley and William D. Danko

There’s a good chance you’ve heard of The Millionaire Next Door. It’s been immensely popular since its release nearly 25 years ago. It’s a good read that pairs a lot of data with a lot of stories. I preferred the audiobook, but whichever way you explore it, it reveals astounding facts about wealth.

“These people cannot be millionaires! They don’t look like millionaires, they don’t dress like millionaires, they don’t eat like millionaires, they don’t act like millionaires — they don’t even have millionaire names. Where are all the millionaires who look like millionaires?”

Very, Very Frugal

The biggest surprise to most readers of The Millionaire Next Door is that wealthy individuals are typically very, very frugal. That’s not to say they don’t spend money, but they are focused on budgeting, most are entrepreneurs and live simple, conservative lifestyles. 

The majority of millionaires got there by not spending money on jewelry and watches, expensive (or even new) cars, or big homes. In fact, the way they became wealthy – by being frugal – is how they ensure they stay wealthy. 

Some examples:
-Buying used cars to avoid the massive depreciation that happens over the first several years on new cars. Also, keeping those cars for a long time
-Budgeting, tracking their Net Worth and investing
-Avoiding status symbols – jewelry, club memberships, first class travel, expensive clothes, etc.

Another surprising fact from the book is that the most agreed with statement in the survey of millionaires was “my spouse is more frugal than I am”. Picking the right partner is extremely important to achieving wealth and financial independence.

You Can Do It

The next major realization for readers is how achievable becoming a millionaire in one generation is. A lot has changed since the book was released 25 years ago. Inflation has reduced what it means to be a millionaire and wealth is more concentrated in the top percentages of society.

But, the authors found that most millionaires are first generation wealthy. Read that sentence again. You should be thinking, “wait, I thought millionaires all had rich parents”. Au contraire – most millionaires become millionaires by being frugal and entrepreneurial. 

The majority of millionaires became wealthy slowly over their lives without inheriting a penny. Very few ever had salaries in the top 10% of earners, won the lottery 1or had a trust fund. Many were small business owners with some unusual concentrations in industries such as auctioneering.

Becoming wealthy isn’t impossible, or even that complicated. Be frugal, save as much as you can, be entrepreneurial if you have the temperament for it, invest the difference, track and plan your finances, and don’t worry about status symbols.

“It’s pretty easy to get well-to-do slowly. But it’s not easy to get rich quick.” — Warren Buffett

Warren Buffett

Your Net Worth

High income does not equate to wealth, which the authors emphasize repeatedly, sharing many examples of high earners who have relatively small Net Worths. This is the result of high spending, low saving rates, and poor investment decisions. 

It’s common that people experience increased spending with a higher income. To a degree it makes sense — a big raise leads to a new home which wouldn’t be complete without new, equally fancy furniture, a luxury SUV in the driveway, and a membership at the local country club. Suddenly, expenses have risen to meet (or exceed) income.

Pairing high income and high spending is a recipe for disaster when misfortune inevitably strikes. Lifestyle and corresponding expectations rise dramatically. If the flow of income stops and the lifestyle cannot be maintained, prepare for painful loss of the good life or, in all likelihood, debt to cover the costs. Wealth tends to build upon wealth, as long as you don’t fall into the trap of lifestyle creep

You’ll find that children of the wealthy don’t always remain wealthy themselves; families are always rising and falling in America. 2

Net Worth is a measure of financial independence, whereas high income (without a small Net Worth) can be a sign of income dependence. This is the reason the authors emphasize Net Worth.  

Net Worth Target

Ok, focus on Net Worth – but what does that mean? The authors suggest multiplying your age by your pretax income and dividing by ten to establish a Net Worth Target. The authors’ rule applies well after you’ve had years to accumulate wealth and pay off debt. For instance, if you are 40 years old and have an annual pretax income of $100,000, the authors would expect you to have a Net Worth of $400,000. 

This is somewhat unrealistic when you are younger (since time and interest assist in the building of wealth). The average actual Net Worth for those under 35 is ~$11,100 according to Federal Reserve data. In fact, most people have a negative Net Worth until age 30. 3

Having a negative Net Worth makes it even more important to track your progress. Getting to Net Worth Zero is an important and admirable goal; one to be celebrated and striven toward. 

This is a very simple calculation for a target Net Worth and not without flaws. Perhaps you made much less in years prior and only recently earned a higher income, skewing the calculation. That said, it’s important to have a long-term goal in mind. If you’d like to get started tracking your Net Worth, you can use my free tool available here.

So Who Buys All Those Expensive Cars??

Many people want to feel wealthy by having expensive things. I can’t blame people for enjoying nice things or aspiring to wealth. But, buying expensive clothes, leasing luxury cars, and using credit to party like a rock star leads further from wealth. You probably wouldn’t recognize the wealthy people in your neighborhood; they likely drive the same car they have for years, run a small business, and have a seemingly boring, but stress-free (about money, at least) life.  

I plan to go into great detail about how most people are at best sugar-coating, and at worst downright lying about wealth (especially on social media) in the near future. Until then, The Millionaire Next Door can help you understand who the wealthy are, how they got there, and more importantly what they didn’t spend their money on that allowed them to accumulate great wealth. 

Thanks,

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