This article is an excerpt from the Shortform book guide to "The Millionaire Next Door" by Thomas J. Stanley and William D. Danko. Shortform has the world's best summaries and analyses of books you should be reading.
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What are the traits of the best wealth accumulators? How can you adopt the habits of a prodigious wealth accumulator?
A prodigious wealth accumulator prioritizes wealth-building investments, minimizes taxable income, and controls household spending to accumulate wealth. You can become an excellent wealth accumulator by changing the way you spend and manage your money.
Discover the three major traits of wealth accumulators below.
A Strong Wealth Accumulator Plans Investments Regularly
Smart planning is essential to wealth accumulation. A typical wealth accumulator spends a significant amount of time—8.4 hours a month or 1.2% of their time—planning their financial future. They do regular planning each month and prioritize managing their financial assets over other activities.
High-income under-accumulators—many busy doctors are a prime example—feel they don’t have adequate time to plan their financial future. Compared to millionaires, they spend half as much time—4.6 hours a month—on financial planning.
Of course, simply increasing the amount of time you spend planning doesn’t automatically translate into building wealth. You need to focus on the right kind of investments, educate yourself, get quality financial advice, and follow that advice.
Prodigious accumulators and under-accumulators have different ideas on investments. One reason under-accumulators spend less time on financial planning is that they consider assets that are easily convertible to cash to be investments—for instance, saving accounts, money market funds, and short-term Treasury bills. In fact, under-accumulators are two times more likely than prodigious accumulators to keep at least 20% of their wealth in cash or near-cash, which they can easily access and spend. These types of assets take less time to plan than those pursued by a prodigious wealth accumulator. High-income under-accumulators also have more of their wealth tied up in vehicles and other assets that depreciate.
A prodigious wealth accumulator is more likely to invest in assets that appreciate in value without producing taxable income, such as 401(k)s and IRAs. Also, they have more of their wealth invested in businesses, real estate, stocks, and other tax-deferred assets.
The Top Wealth Accumulators Minimize Taxable Income
One important way the wealthy benefit from spending less and investing more is that this lowers their taxable income. Indeed, a rule that millionaires live by is that to build wealth, you need to minimize your taxable (realized) income and maximize your nontaxable income (assets that grow without generating taxable income).
The typical millionaire in the survey had an annual realized income of less than 7% of his wealth, meaning that less than 7% of his wealth was taxable.
Paying income tax is the biggest expenditure for many households. High-income spenders pay the most in taxes because they focus on increasing their earned (taxable) income to support a consumption-oriented lifestyle. They can’t accumulate wealth because their taxable income is too high. In contrast, the typical millionaire may be cash poor due to investing 20% of her annual income in financial assets that appreciate without generating taxable income.
For example, at the time this book was written, a 51-year-old woman with an annual income of $220,000 paid $69,440 in federal income tax—18.8% of her total wealth of $370,000. Her net worth should have been much higher—$1,122,000—but she couldn’t accumulate wealth because most of her financial assets were equivalent to cash and taxable.
Yet there are prodigious accumulators worth $2-3 million, who have annual realized incomes of $80,000; they’re living on 6.7% of their wealth.
Remember that every dollar you spend is taxed. For example, you need $100,000 to buy a $68,000 boat, which is why few millionaires buy boats—they prefer to invest their money rather than allowing it to be taxed. They forgo spending to build wealth and ultimately achieve financial independence.
Along with minimizing taxable income, many millionaires avoid buying expensive homes. A sensible rule for everyone is don’t assume a mortgage that’s more than twice your annual realized income. Living in a less expensive home enables you to spend less of your income and invest more to build wealth and minimize taxes.
Wealth Accumulators Control Household Spending
As previously noted, controlling your household spending and lifestyle is critical to having enough money and time to invest wisely. In prodigious accumulator households, all members follow a frugal lifestyle and budget.
Under-accumulators not only fail to control their own spending—they don’t control spending by other members of their household either. The adults also spend independently of each other, so that neither knows the total being spent.
Further, high-income under-accumulators children tend to emulate them. The children become addicted to overspending, and to maintain their lifestyle in adulthood, their parents often continue to support them. The adult children are unlikely to become self-sufficient because they’ve never learned to live within their means. In addition, supporting adult children makes it even more difficult for under-accumulator parents to build wealth for their own future.
Sometimes, high-income under-accumulators turn to CPAs or other professional planners to help them save money to invest. Their CPAs put them on a budget, but like people who suddenly go on a diet, their willpower soon fails and they resume their high-consumption lifestyle.
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