The Millionaire Next Door: Lesson #2. Avoid Buying Status Objects or Living a Status Lifestyle

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

by: Thomas J. Stanley and William D. Danko

My TakeawaysLesson #2 Avoid Buying Status Objects or Living a Status Lifestyle

According to the authors, a common UAW drives a current model car, purchased new, and may have financed it on credit. PAWs rarely purchase new model cars and are less likely to own foreign or luxury vehicles. An example from the book details a UAW that spent roughly 60 hours researching, negotiating and purchasing a new car. In the end, while the car was purchased “near dealer cost,” in the long run the UAW’s time and money could have been more efficiently spent creating wealth rather than collecting possessions notorious for depreciating in value. The authors contrast the story with a PAW who decided that the pride of owning a brand new car wasn’t worth the $20,000 price difference.

Buying or leasing brand-new, expensive imported vehicles is poor value. Buying status objects such as branded consumer goods is a never-ending cycle of depreciating assets. Even when you get a good deal on premium items, if you choose to replace them frequently, the older items hold no value and have become a sunk cost. Living in a status neighborhood is not only poor value, but you will feel the need to keep buying status objects to keep up with your neighbors, who are mostly UAWs. The authors make the point that Hyperconsumers must realize more income to afford luxury items and become more vulnerable to inflation and income tax.

Some of the financial choices that UAWs make are considered to be “million dollar choices” because if the choice hadn’t been made, the UAW would have in excess of a million dollars. One example of a million dollar choice is to smoke. Smokers and drinkers tend to be UAWs because instead of building net worth, they spend their income to purchase alcohol or cigarettes. Another hypothetical example given in The Millionaire Next Door explains how a small purchase of cigarettes over a long period of time can accumulate a large sum of money. Mr. Friend’s poor parents were smokers and drinkers. They smoked at least three packs of cigarettes a day during the week. Three packs a day over 46 years translated into a sum of money that exceeded the value of their home by $33,000.[1] Even more extraordinary, if the Friends had invested and reinvested that money over a 46-year period, the portfolio would have exceeded $2 million. The value of a small amount of money over a long period of time is amazing. A UAW makes choices that, although financially insignificant at the present value, have a very significant future value. Choices such as drinking two cases of beer a week, smoking several packs of cigarettes a day, and buying large amounts of unnecessary food and objects are some examples of typical UAW choices. These choices are not necessarily large financial purchases right now, but over a long period of time, the opportunity cost of that money is very expensive.

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The Millionaire Next Door: Lesson #1. Spend Less Than You Earn

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

by: Thomas J. Stanley and William D. Danko

 

My TakeawaysLesson #1: Spend Less Than You Earn

The most prominent idea shared by Under Accumulator of Wealth’s (UAW) and American society in general is “spending tomorrow’s cash today”.[1] This is the leading cause of debt and a lack of net worth in the UAW category. This contradicts the common belief of a PAW (Prodigious Accumulator of Wealth): “save today’s cash for tomorrow”.[1] Many UAWs do plan, under certain conditions (such as a rise in income), to use investment strategies to accumulate wealth; however, most don’t actually use investment strategies to accumulate wealth once the initial conditions are met. For example, Under Accumulators of Wealth will promise to start investing once they have earned ten percent more in annual income. Unfortunately when most receive that extra ten percent of income, there isn’t an investment made.[1] These claims and ideas usually branch off an initial belief that a lack of wealth can simply be solved by an increase in income. Even among those that do invest money, most invest only because they have an excess of income. Between 2001 and 2004, the median family income dropped 2.3% and in response, the percentage of families who owned investment stocks fell by 3.3% showing that investments are only made in times of excess.[3]

When it comes to spending habits, Under Accumulator of Wealth’s (UAW) are everything but frugal. A typical UAW tends to live in luxury, style, and above all, comfort. Not all UAWs fit these characteristics. A $50,000-a-year janitor can be more of a PAW (Prodigious Accumulator of Wealth) than a $700,000-a-year doctor. The spending habits that UAWs have are a direct effect of the “Better Than” theory.

The “Better Than” theory is one of the main reasons many UAWs don’t hold true to their promise to invest after a rise in income. The theory is that the UAW’s “necessity” for that income will also rise in response to the risen income level. Most UAWs are possessed by possessions. According to a study conducted by Yale and stated in The Millionaire Next Door, individuals measure the level of their success through comparison to nearest neighbors and/or closest relatives.[1] Therefore, as the level of income rises, so will their desire to outperform those that they compare themselves to. This leads directly into my next Major takeaway from the book “Avoid Buying Status Objects or Living a Status Lifestyle” More on that in the next post but in the mean time……

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

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

by: Thomas J. Stanley and William D. Danko

This book is a compilation of research done by the two authors in the profiles of ‘millionaires’. In this case they used the term ‘millionaire’ to denote U.S. households with net-worths exceeding one million dollars (USD).

The authors compare the behaviour of those they call UAWs (Under Accumulators of Wealth) and those who are PAWs (Prodigious Accumulator of Wealth).

Under Accumulator of Wealth (UAW) is a name coined by the authors used to represent individuals who have a low net wealth compared to their income. A $250,000 per year doctor is an “Under Accumulator of Wealth” if his/her net worth is less than the product of their age and one tenth of his/her realized pretax income. Take for example a 50-year-old doctor earning $250,000, according to the formula she should have (50*250,000*10%) or about $1.25 million in net worth. If her net worth is lower, she is an “Under Accumulator”. The UAW style is based more on consumption of income rather than on the method of saving income. Prodigious Accumulators of Wealth (PAW) is the reciprocal of the more common UAW, accumulating usually well over the product of the individual’s age and one tenth of his/her realized pretax income and are usually considered to be millionaires; however, not all are.

The authors define an Average Accumulator of Wealth (AAW) as having a net worth equal to one-tenth their age multiplied by their current annual income from all sources. E.g., a 50-year-old person who over the past twelve months earned employment income of $45,000 and investment income of $5,000 should have an expected net worth of $250,000. An “Under Accumulator of Wealth (UAW)” would have half that amount, and a “Prodigious Accumulator of Wealth (PAW)” would have two times. This metric has been criticized since, for example, a 20-year-old making $50k a year should have a net worth of $100k to be considered an “average accumulator of wealth”. That makes little sense since it would take a new graduate years of strong savings and investments to accumulate that amount. The formula fails to take into account compounding interest; younger people up to age 45 or so will generally have much less as a percentage of income than older wealth accumulators due to compounded growth.

The authors go on to chronicle a few ways Prodigious Accumulators of Wealth handle their money:

1.) Spend Less than You Earn

2.) Avoid Buying Status Objects or Living a Status Lifestyle

3.) PAW’s are Willing to Take Financial Risk if The Reward is Worth It

4.) Family & Generational Wealth

I will go into the authors findings in more depth in my next few posts. The authors dig so deep into the profile of what our American millionaires really look like and what habits have led them to that status. This is one of the best reads for the young and old to get a true look at finance and what wealth really looks like. If you want to become a Prodigious Accumulator of Wealth follow my next few posts and serious….

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