Foolish Special
Book Review
The Millionaire Next Door: the Surprising Secrets of America's Wealthy, by Thomas Stanley and William Danko
[Buy this book from the Fool's Bookshop]
By George Row (TMF Grow)
Do you want to be a millionaire? Do you know anyone who does? Would you know how to recognise their success if they achieved it? You might expect that they would be wearing a Rolex watch and driving a Porsche. According to the authors of this book, you would be mistaken.
The Millionaire Next Door is about the most affluent 3.5% of American households that have accumulated assets of one million dollars or more. There are plenty of cultural differences between us and the people who speak English on either side of the Atlantic, and many of those differences are apparent in this book. However, when given the opportunity to choose the first book to be reviewed in this series, I picked this one because I think that it is full of Foolish lessons.
The book is based on twenty years of research by Thomas Stanley and William Danko. They have analysed thousands of questionnaires. They have interviewed thousands of millionaires, both individually and in groups. There is plenty of rhetoric and opinion in the book but, like a good company valuation, it rests on a foundation of solid numbers.
Readability
About six months ago, someone on the Living Below Your Means message board recommended that we all read The Millionaire Next Door in order to appreciate that living frugally is part of the process of becoming wealthy, while displaying what we think are the outer trappings of wealth is a way to stay poor.
After the nice man from BA in Dulles Airport had insisted that I check in my bag, I was left with nothing to read. I found this book at the book shop and thumbed through, dipping in at half a dozen places -- each time I found an amusing or informative nugget. So the decision on my in-flight reading was made. By the end of the flight I had read it from cover to cover. The authors' message is simple, illustrated by case studies and reinforced with numbers.
Content
The simple message carried in the title is that millionaires are ordinary people and that ordinary people can become millionaires. Lots of ordinary middle class Americans would find, if they only thought to look, that they have a millionaire living next door. Stanley and Danko define what they mean by wealthy and identify an opposing category, which they refer to as "high income low net worth". The people in that category often look more like the popular perception of a millionaire than do the real millionaires. However, they are more concerned with displaying what they believe to be the trappings of wealth than they are with actually accumulating wealth. They wear expensive watches, drive new luxury cars. They convince many people, perhaps even themselves, that they are rich, but when it comes to time to retire it becomes apparent that they have not been able to afford to save.
In Texas they refer to this sort of high income low net worth behaviour as "big hat, no cattle".
In contrast, Stanley and Danko identify key characteristics of an American millionaire. They include the following:
- one in five are retired
- two out of three of those still working are self employed
- they are involved in a wide range of businesses, including auctioneers, coin dealers, doctors, farmers, lawyers, mobile home owners, truck drivers and welding contractors
- the average value of their home (in 1997) was $320,000 (£200,000)
- about half had occupied the same home for 20 years or more
- they live below their means and are aware of their family budget
- only a minority drive a current model car
- they typically have more than 6 times the wealth of their neighbours
- they are fastidious investors, investing 15%-20% of household income
- 80% have a brokerage account but make their own investment decisions
- on average they have a realised annual income of 7% of their capital
For me the essential message is that the typical American millionaires are not big spenders, but are big investors. Most importantly, they are in control of their own destiny. This sounds pretty Foolish to me.
Most people are Average Accumulators of Wealth. Stanley and Danko identify two extreme categories -- the Prolific Accumulator of Wealth, or PAW, and the Under Accumulator of Wealth, or UAW.
The PAWs are the people who end up as millionaires. As a guide along the way, the authors suggest that you check your current net worth. To calculate your net worth, take the value of your house, your savings and investments -- and don't forget the priceless collection of early pub beer mats in the attic -- and then subtract the mortgage, the car loan, the overdraft, the credit card debts and the tenner you borrowed down the pub last Wednesday in order to buy your round.
Having calculated your net worth, compare it to your age divided by ten, multiplied by your annual income. Net worth>(Annual Income x (Age/10)). So a wealthy thirty year old should have a net worth of three years' income -- by age fifty, it should be five times income.
The UAWs, on the other hand, are destined to remain on the same level of wealth, with outgoings matching income. When Stanley and Danko first introduced these acronyms, I thought that maybe the sound they had in mind for the UAW was the one a football crowd makes when the forward wrong-foots the defence and strikes the ball firmly over the bar. You know the one: "Ooooh? Aaaah!"
Then I read one of the case studies. It compared Dr North and Dr South. Both are surgeons, both earn high incomes and both drive German cars, but there the similarities end.
Let's take the example of car purchase. Last year, Dr South spent sixty hours choosing a car and bought a new Porsche. He got it at the keenest price available. Dr North bought a Mercedes. The first car he ever owned was a Merc, which he kept for twenty years. So when he came to replace it he decided to let someone else fund the first three years' depreciation. He plans to keep this one as long as the first. This translated into an expenditure of $12,000 (and six hours' effort) per decade for Dr North and $70,000 (and sixty hours' effort) per year for Dr South. So perhaps it is becoming clear who is the PAW and who is the UAW between this pair.
Let's look at their investment behaviour. I can paraphrase page 101 as follows:
Dr South, in traditional UAW fashion, has been burned by financial advisors. Too often he is late entering the market and exits too early. In sharp contrast, Dr North, like most PAWs, takes time to study investment opportunities -- his investment decisions are his own.
Of course North and South are not their real names, but the facts all come from real case studies. It is no surprise that Dr North, the PAW, has a few million in his retirement fund and few worries. Dr South says that he is worried that he will never be able to afford to retire.
Having read this and other case studies, I came to the conclusion that when they coined the term UAW, Stanley and Danko had in mind the sound that an old donkey makes when it finds that it has been retired into a field of thistles.
Conclusion
This is a very Foolish book. The heroes are in control of their own destinies. They are skeptical of supposed experts -- they use numbers, not emotion. Their concern is for the reality of wealth accumulation rather than the superficial trappings of wealth. The authors write from deep experience in a light and readable style.
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