“The people you see jogging every day are already fit, and look like just the type of people who don’t need to jog. But it is because they are out there jogging every day that they are fit. Wealth accumulation works in the same way; these individuals are wealthy because they are living frugally and saving diligently every day of the year.”

Financial Friday: The Millionaire Next Door

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Welcome to The Wealthy Healthy, the podcast and blog dedicated to inspiring better mental, physical, and financial health. Today’s Financial Fridays episode is essentially going to be a summary and exploration of the 1996 book, “The Millionaire Next Door” by Thomas J. Stanley and William D. Danko.

I should preface this entire episode with the following: this is one of the most popular finance books in the world, and has been explained and summarized and written about many times before this. So, if you’ve already read the book, this may not be a particularly valuable episode for you unless you’re interested in hearing essentially a summary and analysis of the concepts already explained so well in the book. This episode is primarily for people who have not read this book yet or in a long time, to understand how self-made, first-generation rich people made their fortunes, the slow and steady way.

“The Millionaire Next Door” is the first finance book I read. It was the gateway drug, so to speak, to my own interest in financial independence, early retirement, retirement, and just effortful saving and spending in general. Since first discovering the book 3 months into working full time after graduating, I’ve read or listened to many of the more popular finance books and I still find this one special enough to revisit every so often.

What makes the book unique is that it features a lifetime of research, often in the form of longitudinal studies by the writers. The concept Stanley and Danko explore is simple: what does the profile of a self-made, first-generation rich individual look like, and what behaviors and professions characterized those who managed to generate a net worth in excess of $1 million. Hence, the concept of a “millionaire next door” — someone who looks just like any other neighbor on any other street but actually has a high net worth.

One of the primary ideas explored in the book revolves around what the authors refer to as UAWs and PAWs, or Under Accumulator of Wealth and Prodigious Accumulator of Wealth. They developed a pretty straightforward formula to determine these designations, which I won’t outline here but it shouldn’t be hard to find if you want to run your own numbers against it. As a fair warning, it is difficult to get a good read if you’re on the younger side, or if you’ve very recently had a significant raise. Nonetheless, an Under Accumulator of Wealth is someone with a low net wealth relative to their income and age. So, you could be 50 years old with $1.1 million saved, but if your income is $500,000 a year, you would still be considered a UAW.

Prodigious Accumulators of Wealth are essentially the opposite; they have a high net worth relative to their age and income. In a majority of cases, particularly with individuals over the age of around 40 or 50, this equates to having a net worth in excess of $1 million. It’s worth noting that net worth in this case is looking at assets, investments, and savings excluding debt and not counting depreciating material liabilities such as expensive cars and watches.

So taking these two concepts into consideration, what did Stanley and Danko find? Most first-generation millionaires had what they call “dull-normal” jobs. Many of them were business owners working in scrap metal, laundromats, engine repair, janitorial services, and so on. And as you might expect given that list of professions, the typical millionaire looks nothing like what one expects based on what we see in the media of athletes and celebrities living extravagant, hyper-consumption lifestyles. But maybe the biggest point made in this book is that those who build wealth are frugal. Frugality is at the core of the approach taken by nearly every single rich person or family they surveyed. If one plays great financial offense — that is, they have worked hard to get to a position of earning a very high income — but poor financial defense — meaning they don’t do anything to save or protect that wealth — then they are destined to live paycheck to paycheck and struggle to ever retire from their jobs due to the sheer cost of their high consumption lifestyle. In living such a high-cost lifestyle, even someone with $200,000 saved might not even last a year without working to earn a paycheck.

So what does the average millionaire actually look like then? A typical millionaire does not dress in fancy clothes, drive fancy cars, or wear fancy jewelry. In stark contrast, a significant majority of millionaires drive practical American cars that they often buy used. Most of them have never spent more than $400 on a suit, never spent more than $500 on a watch, never spent more than $300 on a pair of shoes. So who did they find keeps the luxury car, clothes, and accessories industries alive? People with incomes in the $50,000 to $200,000 a year range, who spend every single dollar they make. These Under Accumulators of Wealth earn to spend.

The authors quote one of the millionaires they spoke with in their research, a middle-aged Texan business-owner who looks so unassuming that he was originally mistaken for one of the truck drivers rather than the business-owner himself. He references the idiom, “big hat, no cattle” to describe the typical high-consumption citizen. Of himself, this Texan millionaire says, “I don’t own any big hats, but I have a lot of cattle.”

And of course ties in directly with what I’d mentioned before as a primary finding of Stanley and Danko’s research. A vast majority of millionaires do not own big hats. Prodigious Accumulators of Wealth rarely purchase new or luxury cars. In fact, Under Accumulators spend more time researching the purchase of news cars than they do researching appreciating investments such as 401ks and IRAs. Unsurprisingly, the PAWs are by comparison spending several hours more per month on average researching ways to reliably and passively turn their money into more money. On average, a UAW works on deliberate financial planning about 4.6 hours a month, while the typical PAW works on their budgets and investments nearly twice as many hours per month.

The book also highlights an example I liked, in which a UAW they spoke with shared that his parents were also lifelong UAWs. One of the vices this individual’s parents had was smoking cigarettes, at a rate of 3 packs per day over the course of 46 years. This equated to tens of thousands of dollars — which, had they instead invested in a cigarette company, over the course of 46 years that money spent on cigarette packs would have been worth over $2 million at the time of their retirement. These are the types of expensive choices UAWs make: a small expense like a pack of cigarettes here or there, or eating out frequently, can add up over the course of many years to life-changing sums of money had those sums been instead invested properly.

The authors also make an interesting point: they note that many people look at individuals who have accumulated a lot of wealth and think, “why does he or she continue to save and live frugally? They are already rich, they don’t need to keep saving.” The response from the authors? An analogy. The people you see jogging every day are already fit, and look like just the type of people who don’t need to jog. But it is because they are out there jogging every day that they are fit. Wealth accumulation works in the same way; these individuals are wealthy because they are living frugally and saving diligently every day of the year.

In addition to failing to live frugally, Under Accumulators of Wealth are also more likely to directly or indirectly teach their kids these exact same habits, and thereby doom their children to a lifetime of credit card debt, earning to spend, and living paycheck to paycheck despite the appearance of wealth in the form of large homes and luxury vehicles. But this trap is relatively simple to avoid, so if you fear you are in this boat, putting your kids in this boat, or could potentially end up there, listen to episode 6 of the podcast entitled “How Lifestyle Creep is Ruining Your Financial Health.” I go into a bit more detail there, but the basic idea is that by budgeting to better understand your current spending, you can identify areas to cut back. Further, by paying yourself first — for example, automatically deferring part of your paycheck to a 401k — you can create an environment of relative scarcity and learn how to live on that amount.

In any case, it’s important to note that among all of these examples, I’m of course simplifying many of these findings. In the book the authors do a better job of addressing common rebuttals or criticisms than I’ve made thus far here. That being said, I do want to address a few of those now, including some ideas that I don’t feel were deeply touched on in the book.

You might try to argue, “but Riki, isn’t this a terrible way to live? To surrender the now for a future? What if you die tomorrow, then it’s all a waste! You even said yourself in an earlier episode that all you have is right now and I agree with that!” There are some decent points in there. Yes, if you die tomorrow, in a sense, your efforts are wasted, assuming of course you’re not leaving something behind for your family. But I don’t see any of this as an argument in favor of totally depriving yourself. I’ve mentioned in previous episodes as well that I think at the end of the day, money is in part meant to be used, and one of the better things you can use it on is experiences and entertainment such as small vacations and concerts and fulfilling social events.

So I’m not saying, and neither is “The Millionaire Next Door” saying, that you should completely forego enjoyment of today for promises of a better tomorrow. Financial independence and freedom from the requirement of working may be its own reward in itself, and Stanley and Danko do mention in a few case studies that many self-made millionaires put in the time to budget and track spending and cut coupons because they recognize and enjoy the freedom of excellent financial health. So even if your argument is that you love your job and never want to retire, let me ask you this: do you love the feeling of struggling with bills? Will you love having to borrow from friends and family to make ends meet in the event you become ill, get injured, or simply age to the point of struggling to do your work in a safe and effective manner? Do you love having to work consistently through the year, not traveling the world because the ones and zeros in your bank account won’t let you? Do you love when your car needs a repair and you can’t afford it right away, so you avoid using your car for weekend trips and instead miss out on opportunities to experience fun activities with friends or family?

Obviously these are loaded questions and nobody really loves those things, but hopefully I’ve illustrated my point — there is always, always, always a value in planning for tomorrow, and that doesn’t necessarily mean you have to sacrifice today for it.

Here’s one way I think about it. Let’s say you’re 22 and you decide you’d like to enjoy the next 30 years of your life to the 100% capacity, and are willing to enjoy the following 30 years to nearly 0% capacity. Instead, if you enjoy now to 50 or 60% capacity so that you can enjoy the future to 90 or 100% capacity, then your averaged quality of life and total enjoyment is higher in the latter example than in the previous. Of course these are just made up numbers, but I think there is some value to thinking about things in that way from time to time.

Another potential argument against this is, “why would I want to take the slow lane? Wouldn’t it be better to earn a much higher income, or earn a lot all at once and then I can do whatever I want?” There’s actually something to that. Of course, it’s much, much easier said than done. Yes: if you have a relatively low income, one of the best things you can do for your financial health is take the necessary steps to work toward increasing that income. But if you want to earn a giant lump sum and sell out, retire early and live life like a reality show millionaire while still having a smart amount of savings to spare? Well, that’s something you can actually do, and many do. I live and work in the Silicon Valley where stories like these aren’t even particularly unique — there are a bunch of tech CEOs and execs who turn an idea into big money in a relatively short amount of time. But of course, this is not an easy task, and is far from a sure thing.

That all having been said, I will actually be tackling this idea in next month’s episode of Financial Friday, when we take a similar look at MJ DeMarco’s book “The Millionaire Fastlane,” which is essentially a criticism of the “slow and steady” approach to wealth building. So, if you truly feel that this approach of frugal living and working hard to improve at work, earn promotions and obtain raises to increase your income sounds entirely NOT for you, then be sure to tune in to next month when we talk about “fastlane” concepts, and the episode after that I’ll talk about my own personal philosophy which involves somewhat of a combination of both approaches which I call “The Next Door Fastlaner.”

Alright everyone, thanks for tuning in, as always feel free to share your thoughts, your praise, your criticism, it all serves to make the show better.