Millionaire Next Door Summary
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I just finished listening to The Millionaire Next Door by Thomas Stanley on audible and I want to share with you some of its key takeaways.
The Millionaire Next Door
When you think of a millionaire, did you think of the people living on the Upper East Side in New York City or the residents of Beverly Hills California?
The answer is yes, you’re right but the typical millionaire doesn’t live there. They live next door to you, practicing stealth wealth.
What can we learn from the millionaire next door so that one day, we can call ourselves millionaires?
Main point number 1: The 12 characteristics of a millionaire next door
Contrary to many people’s beliefs, it’s rarely luck or inheritance that decides whether you will be a millionaire or not.
Instead, it’s the result of hard work, lifestyle decisions, planning, and self-discipline.
The 12 characteristics of the millionaire next door
Let’s pretend that we can interview the millionaire population. This is what they would tell us:
- We live below our means: income > expenses, about 50% of us have lived in the same house for more than 20 years
- We spend more than twice the amount of time on financial planning and investing as our non-millionaire friends
- We think that freedom and financial security are more important than displaying high social status
- We never receive cash gifts from our parents
- We are self-employed, about 2/3 of us have ourselves as our bosses. 75% of us consider ourselves entrepreneurs
- Most of us are in our 50’s and are males
- We have enough funds to keep our lifestyles for 10 years or more, without bringing in additional income
- We are well educated, only 1/5 of us aren’t college graduates
- We invest a lot, on average, about 20% of our realized income per year, and we make our own investment decisions
- We invest in the long run, over 90% of us hold our investment for more than 1 year
- We buy cars by the pound and screw those environmentalists,
- We are frugal
Main point number 2: Play Defense
Let’s answer some of these hypothetical questions:
- Does your household operate on an annual budget?
- Do you know how much your family spends each year on food, clothing, and shelter?
- Do you have a clearly defined set of daily, weekly, monthly and lifetime goals?
- Do you spend a lot of time planning your financial future?
Did you answer yes to all the above?
You may wonder why does a millionaire needs a budget? The likely answer is that they became a millionaire that way and they maintain their affluent status the same way.
Another way to think of this is a professional bodybuilder. They are already fit, but they still go to the gym every day. Becoming and staying financially independent is not much different from that.
How do you play great defense?
- Buy or rent a house in a modest neighborhood, not an upper-class one. If you live in an affluent neighborhood, you’re expected a certain lifestyle to fit in. A modest lifestyle will be easier to keep up with and accumulate wealth at the same time. In general, spend as little as possible on consumables and spend smart on possessions that will depreciate in value.
- Most millionaires play both offense and defense. They have a decent offensive as well as quality defense.
Main point number 3: The true cost of consumption
Let’s go back to the apartment on Manhattan example. The price tag does not fully represent what you pay when buying something.
Two reasons why this is not true.
- The opportunity cost of money
- The opportunity cost of time
If you decided to buy an iPhone XS (me) at a cost of $999 today. What if instead of buying the iPhone, you invested your money in the stock market?
Let’s be opportunistic and assume a 10% return:
- In 10 years your opportunity cost is $2,591
- In 20 years it is $6,720
- in 50 years it is $117,000
Is it still worth it?
The opportunity cost of time
You don’t buy a Lexus (me) without first studying the market. You can’t be a fashionista without investing a lot of time in understanding the latest trends, the greatest brands and so on.
This is the time you could have used to increase your financial intelligence, improve your business or set up a proper budget for your household instead.
Time and energy are finite resources
The time value of money is applicable to high-income earners. Why would you spend 60 to 80 hours a week at a job trying to become wealthy and then spend the remaining few hours ruining the same wealth?
It’s like building a house on the weekdays and bringing in the wrecking ball (looking at you Miley) on the weekends.
Main point number 4: Cash gifts are a disservice
Every parent wants to make sure their kids get a head start in life. Wealthy parents naturally provide them with extra money.
However, this proves to be counter-productive. The more money the children received, there is a negative correlation with earnings.
In other words, adults who sit around waiting for the next lump sum gift from their rich parents are much less productive than their peers.
In fact, the extra money allowed them to live above their means. Eighty percent of gift receivers have a lower net-worth than their peers.
Adult gift receivers also have trouble distinguishing between their own money and their parent’s money. Over time, they falsely claim that they are self-made.
It’s much easier to spend other’s money than your own money.
What kind of gifts does millionaire give their adult children? The most common gift is tuition, money for a down payment, a car, and furniture.
Let’s look at an example. Millionaire parents gave their son a brand new Indian rug that cost $20,000. Well, now the rug looks out of place in the living room. The son will now have to buy matching furniture, all on credit. Thus the gift is training the son to be a hyper consumer.
Main point number 5: How to decide if you’re on the right track
Are you on your way to becoming financially independent or are you going in the opposite direction?
Your expected net-worth can be estimated using the following formula:
Age x realized yearly pre-tax income/10= networth
Exclude any inherited wealth on the yearly pre-tax income and your net worth.
Let’s do a few examples:
Example 1) 18-year-old pharmacy technician, the average salary is $30,000
18 x 30,000/10=$54,000 net-worth
Example 2) 26 years old pharmacist, the average salary is $126,000
26 x 126,000/10=$327,600 net worth
Central to the Millionaire Next Door is the following classifications:
Under accumulators of wealth (UAW)
You are worth only 1/2 of the suggested net worth.
Average accumulators of wealth (AAW)
Your net worth is what it should be.
Prodigious accumulators of wealth (PAW)
In order to quality for PAW, you are worth twice what the formula suggested.
Above the PAWs are the Super-prodigious accumulators of wealth (S-PAW)
In order to join this elite group, you have to have a net-worth 10x of the suggested formula.
Final Thoughts on the Millionaire Next Door
Here’s a quick recap:
First, becoming a millionaire is the result of hard work, lifestyle decisions, planning and self-discipline, not inheritance or luck.
The second takeaway is that you must play great defense to accumulate wealth.
The third takeaway is that opportunity costs, both in terms of money and time, should be added to estimate the true cost of a purchase.
The fourth takeaway is that cash gifts are counterproductive to accumulate wealth, and last but not least.
The fifth takeaway is that you can decide that you are on the right track towards becoming a millionaire by taking your age x yearly income/10.
The most important point of the millionaire next door is takeaway number 2. A study has shown that if you write down your financial goals, you’re more likely to achieve it.
What is your financial goal in the next:
- 5 years?
- 10 years?
- 20 years?
Are you a UAW, AAW, PAW, or S-PAW? Care to share? Please comment below.