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The Millionaire next door

One of the great things about being on holiday is the time to kick back and read, and being on holiday on the other side of the world in down under Australia provides a lot of time for a lot of in depth reading, even between attending to the kids!. The Millionaire Next Door was one of those that made it onto the reading list.


For those of you that haven't had the opportunity to come across this book, this is one of the most detailed statistical profiles of America's millionaires that exist. Its a fairly dated book (published sometime in the mid 1990's), but I don't doubt that much of what the authors learned about the wealthy in America still holds true even today.


Who is the millionaire next door?


- On average, our millionaire next door is in his mid 50's, married with kids....and he's overwhelmingly male (I'm not sure if this was just a quirk of the sample that the authors pulled).


- The majority of the millionaire were self employed, not necessarily in glamorous professions, but they own decidedly normal businesses such as welding, pest control and paving.


- The majority of the millionaires were home owners (greater than 97%). I don't recall if home equity was included as part of the definition of wealth, but it would be interesting to see how the decimation of home owner wealth from 2008 impacted this group.


- The millionaires were also careful with their spending. There was a reference in the book to the millionaires wearing "inexpensive suits and driving American cars". (I never knew American cars were considered inexpensive before I read this book!). They also weren't interested in the latest model cars and preferred to own versus lease. As a group, the millionaires live on less than 7% of their total wealth.


- As a group, the self made millionaires were pretty highly educated. 80% had completed a college degree or higher education, with close to 20% having advanced degrees (ie masters, PHD etc).


- The self made millionaires love to invest, and interestingly they also seem to be self directed investors, meaning that they want to be in control of their decisions to invest their capital. Almost 80% of them have their own brokerage accounts. Interestingly, the authors note that they rarely "sell equity investments", which seems to suggest a buy and hold mentality.


The wealth equation


As an aside in the book, the authors derived a formula for determining wealth accumulation, based on age and income.


Expected Wealth = Age * Household Income * 10%


For example, a 35 year old making 100,000 per year would be expected to have wealth of $350,000.


Average Wealth Accumulation is considered to be between 50% -200% of your expected wealth. Above Average wealth Accumulation is considered to be >200% of expected wealth.

Below Average wealth is considered to be <50% of expected wealth.


Thus for the 35 yr old making $100k, anything less than $175k in wealth would be below average, while anything above $700k in wealth would be above average.


While the authors cut some slack for those below 30, who really haven't had much time to really generate wealth, I think this sort of guidance probably works best for the 50+ age group who have had a lot of time to see their income and wealth compound over a significant period of time.


What can we learn about the millionaire next door?


I really enjoyed my reading of the millionaire next door. It was very interesting to look into the behaviors, habits and attributes of a core group of seriously wealthy individuals who all created their own wealth. I was interested to see what could be generalized from this group to look at a "blueprint" for wealth creation. If I had to distill handful of key principles, they would be the following:


# Frugality is a common theme among the group. While the authors may have been trying to have a joke at the group's expense about how tight they are, this really struck a chord with me. Most of the group didn't care for the trappings of great wealth. They didn't go out shopping for the most fashionable car, they didn't blow through their newly acquired wealth on the most expensive suits. They have deliberately chosen to live within their means and live modestly. This reaffirmed for me that it is possible to be happy being frugal, if you can find your own balance.


Interestingly, the authors mention that the millionaires have more than 6 times the wealth of their non millionaire neighbors, yet non millionaires outnumber the millionaires more than 3 to 1 in the neighborhoods that they live in. I thought this was pretty telling because it speaks to the self made wealthy choosing modest accommodation that they can easily finance, and avoiding trophy properties, even though they could probably afford more.


# The self made millionaires have serious contingency planning. The wealthy take the concept of an emergency fund to new extremes. This may be a function of the fact that many of them have their own businesses and need to plan better for contingencies. Forget a 6 month, or even 1 year contingency fund. These guys have the equivalent of almost 13 years in living expenses on average that they can fund through their wealth alone. However, the key is that these funds aren't parked in cash that sits idle, but is part of realizable assets that can be cashed out if needed.


# Education is highly valued. Investing in yourself is a big, big deal to these guys. They all have some basic education, but they are also keen on ensuring a high level of education for their kids as well. They recognize education as a key lever to boost income returns, which in turn is a crucial part of driving wealth


# Ownership of assets is a key tool of wealth creation. I thought this was probably the most significant of all. In spite of the fact that the group had already reached impressive levels of wealth, they weren't looking to bunker down with their hard earned money stashed beneath a mattress, or parked in bank accounts earning 1%.


Much like the rich dad in Kiyosaki's Rich Dad Poor Dad, the millionaires that were studied by the authors were focused on continuing their path of asset acquisition. Roughly 20% of their income each year continues to be invested into a variety of asset classes, even though they have already all reached levels of comfortable wealth.


In general, the group loved stock investment, with roughly 20% of their holdings going into stocks. However they recognized the importance of being well diversified, with holdings in a variety of other asset classes as well.


The rich as a group realize that the key to consolidating a building wealth is having your money working for you with ownership of assets, and not to sit back and relax once you have achieved wealth. Rather, they are hungry to keep building and accumulating more.

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