PDF Summary:The Millionaire Next Door, by Thomas J. Stanley and William D. Danko
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In The Millionaire Next Door, authors Thomas J. Stanley and William D. Danko skewer the myths about how (and where) most millionaires live, and what it takes to become one. Their extensive research published in 1996 identified the sometimes surprising characteristics and habits shared by many millionaires. For instance, millionaires are often bargain shoppers (they buy used cars and off-the-rack clothing), pay only a small percentage of their wealth in income taxes, and shun the lavish lifestyles we often associate with being rich.
The book explains how to determine what your net worth should be, according to your age and income, and how you can build wealth over time and become a millionaire—if you have the discipline.
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- If you’re in the top quartile (25%) for wealth accumulation in your category, you’re a PAW or “prodigious accumulator of wealth.”
- If you are in the bottom quartile (25%), consider yourself a UAW, or “under-accumulator of wealth.”
To be solidly in the prodigious accumulator category, you should be worth two times your expected level of wealth. Often, prodigious accumulators have four times the wealth of under-accumulators in their category. If you’re at half or less than the expected level for your category, you’re an under-accumulator. Here’s an example of each (both people are in the same income/age category):
- Prodigious accumulator (PAW): Richards, 50, owns a mobile home dealership and his income is $90,200. His net worth should be $451,000, but it’s actually $1.1 million. He lives a modest, blue-collar lifestyle.
- Under-accumulator (UAW): Davidson, 51, is an attorney with an income of $92,330. HiIs expected net worth is $470,000, but it’s actually $226,511. He lives above his means, spending significantly more than Richards to maintain the lifestyle/status associated with attorneys.
The Frugal Millionaire’s Lifestyle
The typical millionaire’s frugal lifestyle could be described as nondescript middle class. Many millionaires don’t stand out in their neighborhoods. Their watchwords are hard work, discipline, frugality, and smart investment.
In football terms, they play both great offense and great defense. They move the ball by generating income and by smart planning and budgeting, and they and their families hold the defensive line by controlling their spending. Both mindsets help them build wealth for the future.
Many millionaires budget their expenses. While you might think millionaires don’t need to budget, the fact is, they become wealthy and remain that way in large part by budgeting and controlling expenses.
For instance, millionaires don’t drive high-status vehicles. They often buy quality vehicles that are several years old, and they never lease or finance them. In contrast, most car buyers spend 30% of their net worth on a vehicle, while millionaires spend only 1%. Millionaires are also bargain-conscious in other ways: they buy items on sale or at discount or factory outlets.
Frugality and Taxes
Millionaires spend less and invest more to lower their taxable income. A rule they 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 under-accumulators 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 or prodigious accumulator may be cash poor due to investing 20% of her annual income in financial assets that appreciate without generating taxable income. (Shortform note: Examples of such appreciating assets include 401(k) plans and IRAs.)
Investment Planning
Smart planning is essential to wealth accumulation. Wealthy people spend a significant, but not overwhelming, 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.
Fully 95% of millionaires own stocks. However, very few millionaires—less than one in 10—are active traders. It’s expensive and time-consuming to trade constantly. Active traders or brokers often spend more time trading than thinking about and planning investments. They don’t accumulate much wealth because they don’t give investments enough time to grow. Further, any short-term gains are taxed.
In contrast, millionaires spend more time managing a small number of stocks. They’re focused investors, often investing in industries they’re knowledgeable about.
Employment
As previously noted, 80% of millionaires are self-employed, compared to 15% of the general population. The types of businesses owned by many millionaires are considered dull and unexciting by most people. They provide a product or service that’s needed in an industry that isn’t usually susceptible to downturns. These businesses also don’t face much competition, and they’re consistently profitable.
Businesses owned by the millionaires surveyed for this book included: building materials manufacturers, prefab housing, auto parts, auctioneer/appraiser, apparel manufacturer, janitorial services contractor, human resources consultant, real estate developer, beer distributor, construction equipment dealer, and restaurant chain owner.
These types of businesses aren’t typically associated with high status or lavish lifestyles. They don’t interest under-accumulators, whose primary needs are consumption and showing off their status. However, they meet the self-employed millionaire's needs to create wealth and become financially independent.
How to Become and Stay Wealthy
The experience of the self-made millionaires in this book shows that to become wealthy and stay wealthy you must:
1) Create and live by monthly and annual budgets. More than half of all millionaires budget their expenses. They’re motivated by visualizing the long-term rewards of achieving financial independence and being able to retire.
2) Know what your family spends annually for basic needs (food, clothing, and shelter). Fully 62% of the millionaires surveyed knew their monthly expenses, compared to 35% of high-income non-millionaires.
3) Set specific daily, monthly, yearly, and life goals. Most millionaires are goal-oriented and take a long-term view. Their goals are not spending and acquiring material possessions, but being able to retire, be financially secure, and enjoy life. People who are financially secure are happier than those in their age/income category who aren’t. Unlike those living paycheck to paycheck, they don’t worry about the next economic slump.
4) Spend time planning your financial future. The number of millionaires who spend time planning investments is more than double the number who don’t plan. Many of those who don’t plan are high-income under-accumulators.
5) Beware of giving ongoing subsidies to adult children and grandchildren, who may become dependent on them instead of self-reliant. Millionaire parents who provide ongoing gifts and subsidies have significantly less wealth than others in their category whose children are independent.
The bottom line is that many more Americans can become millionaires if they’re willing to consume less, control their spending, and focus on steadily building their wealth. The trade-off for spending less of your income today is financial independence tomorrow.
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