Wednesday 29 December 2010

Book Review: The Millionaire Next Door

The authors originally set out to study millionaires in the United States. They visited posh neighbourhoods but discovered those people driving luxury cars and living in expensive homes didn't necessarily have much wealth. They began to discover something odd which went against their preconceived notions of what or who a millionaire was. These people may have had high incomes but they were spending it all.

Thomas Stanley, one of the authors was quoted as saying, "Most people have it all wrong about wealth in America. Wealth isn't the same as income. If you make $1 million a year and spend $1 million, you're not getting wealthier, you're just living high."

They found a group of relatively unknown people in society who were actually wealthy. Now not wealthy in terms we would usually consider, certainly not wealthy like a Donald Trump, but they did have a net worth of one million dollars or more. It just didn't show when you looked at them.

First published in 1996, this book has apparently sold over 2 million copies according to its author, Thomas J. Stanley, Ph.D.. While Dr. Stanley has a number of books under his belt, it is certainly this one which has struck a chord with readers and set the foundation for various strategies in dealing with personal finance. Oddly enough, the so-called secrets of these millionaires turn out to not be some sort of fabulous investment plan but just basic common sense. Considering that the majority of people are not among the Donald Trumps of the world or not even among these people making up the rich next door, it would follow that the majority are not missing this fabulous investment plan but are just missing common sense.

The book designates some terms with associated acronyms to categorise people according to their wealth: UAW is an Under Accumulator of Wealth; AAW is an Average Accumulator of Wealth and a PAW is a Prodigious Accumulator of Wealth. It uses a simple formula to determine their net worth and where the individual fits: age times annual income divided by 10. For example, a 50 year old man earning $80,000 per year should have a net worth of 50 times 80,000 divided by 10 or $400,000. An UAW would have less than this amount; a PAW would have more.

Of course, this simplistic formula leaves out many of the refinements a professional financial planner would use in assessing anybody's portfolio but the authors set out to provide an easy guideline for judging one's financial position. In looking at the idea of these quiet, unassuming millionaires next door, they had run into the phenomenon where people, sometimes high earners like doctors were blowing everything they made to maintain a fancy lifestyle. They were saving nothing and consequently actually had a low net worth. It is a bit of shock to find out that your doctor, somebody whom you would consider to be wealthy, turns out to look wealthy but is not.

The "secret" strategy
Common sense. It's an odd phrase when you think that the word common would mean something not out of the ordinary, something everyone would have. However the authors in studying those people who did have a net worth of a million or more, discovered some basic rules we should all live by.

Spend less than you earn
If you have a hundred bucks, don't spend two hundred bucks. That seems pretty obvious but there are other examples where the clarity may be ah, so clear.

Using a credit card sometimes removes us from the process of connecting our expenditures to our income. We arrive at the end of the month when we have to pay off the balance and there may not be enough in the kitty to pay off the whole amount. Our mistake? "No sweat, I've got enough to make the minimum payment." Oh brother, you are toast! The interest rates on outstanding credit card balances are astronomical and I can think of no better way to start your way down the slippery slope to financial ruin.

Avoid Buying Status Objects or Leading a Status Lifestyle
I suppose that we somehow think we have to keep up with the Jones but who actually said that? Is there some unwritten rule we have to keep up with if not undo our neighbours? Who the heck are we trying to impress anyway?

Why buy a Porsche for $80,000 when a Honda Accord for $32,000 will do just fine? (I owned a Honda Accord; good car) Why buy a ten thousand square foot home (929 sq metres) when a fifteen hundred square foot home (139 sq metres) would do just fine? Besides, there is a lot less vacuuming to do.

That's the trick. Don't buy unnecessary "stuff" and when you have to buy "stuff", don't buy the most expensive "stuff". Believe me, I ain't impressed.

Measure your financial success by your net worth
You're standing at the fence talking with your neighbour. He's a doctor. He makes - what? - two hundred grand a year? How to compete with that? Well, don't. Your measurement is net worth not income. Your home is paid off while that doctor still has a mortgage. Your income is going into the bank; his income is going to the bank to pay off the mortgage. Your home, your mortgage-free home is part of your net worth. That is the true measure of wealth.

Financial independence is the target
Imagine it. You live your life; you pay your bills; you go on vacation but... you don't work. Ah, sounds divine; let me check my lottery tickets.

However this isn't an insurmountable obstacle on our journey to the promised land. It is just basic common sense. Spend less than you make. Don't buy status objects or lead a status lifestyle. Invest your unspent money in solid, secure vehicles. What's not to understand? Slow and steady wins the race.

Calculating your net worth
Remember this simple formula: age times annual income divided by 10. The following are two online calculators which can assist you in finding out just where you are financially.

Retire Early
Scroll down to the bottom to find the calculator. This offers a few extras to the simple formula given above.

The wealth calculator
You are required to supply your age, your annual income and your net worth. It then classifies you as an UAW, AAW or PAW tells you what your net worth should be.

Dr. Thomas J. Stanley
The author's web site contains a list of his books, a blog, a biography and stories about various "millionaires". While this book originally appeared in 1996, I see the author has continued to write and his latest book, published in 2009 is called Stop Acting Rich and Start Living Like a Real Millionaire.

Final Word
In my review of the book The Wealthy Barber, I pointed out the same common sense approach to financial planning. The Millionaire Next Door expounds the same principles but describes the real people possibly living next door to us who have succeeded to put these principles into practice. It is inspirational in that it shows the problem is not insurmountable and the goal is not unattainable. I know I'll never be a Donald Trump but maybe the more modest goal of being an AAW would be within my grasp and give me a retirement which could be truly labelled my golden years.


Wikipedia: The Millionaire Next Door

official web site: Thomas J. Stanley


Site Map: William Quincy Belle

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