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The Millionaire Next Door: The Surprising Secrets of America's Wealthy

by Thomas J. Stanley and William D. Danko

The Millionaire Next Door: The Surprising Secrets of America's Wealthy, by Thomas J. Stanley and William D. Danko, offers some great insights on the habits of the wealthy and common misconceptions on the lifestyles of the wealthy. These insights provide some guidance that people who aren’t wealthy can use to build wealth and become financially independent.

The Millionaire Next Door is based on studies and research done by two professors about millionaires in the United States. “Millionaire” is defined as a person with a net worth of $1 million or more (assets less debts, including residence). Many people associate millionaires with high class lifestyles -- including nice cars, nice clothing, shoes, and watches, expensive houses, etc. One of the points that the authors make again and again, is that most millionaires do not live this type of lifestyle. They are often millionaires because they live a more conservative lifestyle, not in spite of it.

Early in The Millionaire Next Door, Stanley and Danko provide a very simple formula for determining how much wealth a person should have. The formula is:
Age * Income * 0.1
(Apparently they have derived a more robust formula, but they don’t provide it in the book.) This means that a person who is 50 years-old and makes $90,000/year should have accumulated $450,000 in net worth. I feel that this is somewhat reasonable, however, this formula has some limitations. For example, if one’s income has recently increased (say from $70K to $90K) then it will take a while to build the wealth commensurate with the higher level of income. Also, it seems to me that this is much more difficult to achieve at a lower age. For example, a recent 22-year-old college graduate making $50K is likely to have a very low or even negative net worth, not $110,000 (22 * 50K * 0.1). Nevertheless, the same graduate’s income is likely to accelerate and he can start saving and building wealth.

Despite the limitations of the formula, it seems that it can be a good guide, and the authors of The Millionaire Next Door use it to classify people broadly into two categories: Prodigious Accumulators of Wealth (PAWs), those above the threshold, and Under Accumulators of Wealth (UAWs), those below the threshold. Stanley and Danko then proceed to discuss the various differences of PAWs and UAWs, which are often quite enlightening.

Offense versus Defense

One topic they address is the difference between offense and defense. We often assume that millionaires mostly just play great offense, that is, they achieve very high incomes. It’s easy to jump to this conclusion with the way the media idolizes athletes and movie stars, who have very high incomes. Doctors, lawyers, and similar professionals are often assumed to be wealthy due to their six-figure incomes. However, The Millionaire Next Door cites numerous examples of people with high incomes who really haven’t saved much money. They play good offense, but they neglect defense. While offense is income, defense is how income is used (or not used). A lawyer making $300K per year may tend to live a lavish lifestyle since she has clients to impress and coworkers who likely live expensively. Mortgages, luxury automobiles, private schooling, vacationing, etc. can quickly add up to exhaust one’s salary, no matter how large it is. A high income can lead to a neglectful defense.

Many millionaires take a different approach. No matter their income, whether it’s five digits or seven, they live frugally. Often they’ll live in a typical suburban neighborhood near families with a fraction of their wealth. The authors of The Millionaire Next Door point out some of their lifestyle choices (these figures are from the book, which was published in 1996):

• 50% have never paid more than $29,000 for a car
• 50% have never paid more than $399 for a suit
• 50% have never paid more than $235 for a watch
• 50% have never paid more than $140 for a pair of shoes

This was one of the big take-aways I got from the book. Just because someone goes on nice vacations and drives nice cars, it does not mean that they are wealthy. Judging someone’s wealth by what they spend often doesn’t work. This is very counter-intuitive, but it’s true.

Occupations of the Wealthy

Millionaires can come from virtually any occupational background -- contractors, pest controllers, collectors, farmers, doctors, accountants, etc., but, The Millionaire Next Door points out that many of them are self employed. Many are entrepreneurial types that prefer to be their own boss. While it may be risky to be self-employed, they pointed out that someone employed at a corporation basically has one customer for their work, while those who are self-employed might have hundreds of customers to diversify themselves. Additionally, many millionaires are self-employed as professionals. Doctors, accountants, lawyers, etc. tend to have their own practices and therefore they are self-employed.

While being successfully self-employed may help drive a high income (keep in mind that many business don’t make it), it can also be correlated with good “defensive” habits. Successful entrepreneurs need to budget, be frugal, and be cautious with their money. These good business habits translate into good personal habits which help build wealth over time.

Inheritance

The authors of The Millionaire Next Door note that most millionaires didn’t inherit their wealth -- in fact, about 80% are first generation affluent. Many wealthy people come from families where they learned to work hard and live frugally.

Being wealthy can have an adverse impact on children, and the authors found that children of the affluent tend to be below average. As an example of why this is so, consider an affluent couple that generously offers to pay their newlywed child’s mortgage. The child will likely move into a house they couldn’t otherwise afford in a wealthier neighborhood. Rather than saving money, the child will then spend more money on cars, private schools, etc. to be able to keep up with the neighbors. This is one example of how children can become dependent on gifts from their wealthy parents.

The authors’ research found that leaving children a large inheritance often did more damage than good. They suggest that millionaires who would like to leave their children an inheritance should do so very carefully. For example, inheritance can be placed in a trust and not released until certain milestones are met such as achieving a graduate degree or turning a certain age (like 35 years old). This can ensure that children don’t rely on the inheritance when they’re young and develop bad habits. Rather than giving monetary gifts, paying for enabling gifts like an education can result in greater benefits for the heirs.

Conclusion

There were a couple things I didn’t like about The Millionaire Next Door. First, since the book was written in 1996, some of the statistics seem a bit outdated. Inflation has increased a lot of prices used in the book as well as effectively reducing the threshold to being a millionaire. Also, since 1996 we have been through the tech bubble and bust, a couple recessions, and the reemergence of tech, so none of this is covered in the book. Tech millionaires are likely still the exception to the typical millionaire, although some of their attributes are similar anyways. Second, I found myself really valuing wealth when I read this book. While I don’t think wealth is bad, I also don’t want to dwell on it too much and I want to be sure that it’s not my priority. My priority is family and God. Wealth doesn’t make an individual more or less valuable and that needs to be kept in perspective: wealthy people are not “better” than poor people. There are circumstances and exceptions that are beyond our comprehension in the lives of those around us. This book didn’t address situations like when someone is cheated or is unlucky and ends up going bankrupt and never becoming wealthy.

Still, overall I thought The Millionaire Next Door was a great read. It left me thinking about how I spend my money and my habits and goals. I think it would be wise for every individual to read this book and think about how they use their financial resources.

by Blake Taylor

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