The Millionaire Next Door by Thomas J. Stanley and William D. Danko

It isn't a flashy get-rich-quick manual, in fact the process it recommends would disappoint some of the more entrepreneurial types. It involves the slow process of becoming successful in your career or business, saving up your money instead of spending it, budgeting down to the last cent, investing carefully and prodigiously, seeking out good advice when necessary, and spending a tremendous amount of time on money matters. Very few of the millionaires interviewed were young, this is a book more geared to someone that wants to become filthy rich by the age of 50 and retire in comfort, as opposed to the usual goal of retiring young while you still have the energy for a life of hedonism.

Thrift

A common thread that runs through the book is that people that are destined to become extremely wealthy are very careful about using credit and tend to save for things before they buy them.

The average millionaire in the book drove a second hand American built large family car, the Aussie equivalent being a Falcon, Commodore or maybe a four wheel drive of some description.

They live in middle class suburbs, not necessarily in the best house in the street. You would not know a millionaire by his house or car. Nor would you recognise him by his general lifestyle, the majority of millionaires were not members of yacht clubs and exclusive private golf clubs, and most sent their children to ordinary public schools.

The average millionaire interviewed would describe himself as a "tightwad", and never spent any money that was not absolutely necessary.

The average millionaire knows exactly what he spent over the last year on household items like food and domestic bills. They are extremely frugal and tend to avoid flashy brand name stuff, and are compulsive coupon savers and junk mail readers, with a freezer full of cheap meat and frozen vegetables.

The guys in this book avoided flashy consumer purchases at all costs. They drove normal cars, they lived in normal suburbs, they ate at normal places instead of gourmet restaurants, they drank beer instead of fine wine and generally did not own a boat. One interesting piece of advice the authors give is, "if you're not yet wealthy, but want to be some day, never purchase a home that requires a mortgage more than twice your annual income."

Clearly that is impossible advice to follow in Australia, where homes are very much more expensive compared to income. A six figure income is considered quite high in Australia and $200,000 is not considered to be a particularly high price for a house. Nevertheless I guess the point is still valid, and it concerns more than just the mortgage itself.

The authors make the point that it is much harder to live a frugal lifestyle in an expensive suburb. Keeping up with the Joneses is much easier when the Joneses can only afford a five year old Commodore Executive. Living in a street where everyone spends a fortune on keeping their lawn and garden immaculate, where the average car is a Holden Statesman at least but preferably a Lexus, BMW or Mercedes, where expensive decor is compulsory and any person of taste needs fine crystal glassware makes saving your money that much more difficult.

The project that inspired this book was originally a marketing exercise. The authors wanted to know how to market to the very wealthy. They did what most people would do first and started writing to people in the top suburbs. What they found instead was a bunch of high income earners with lots of expensive toys and lots of debt, but a low net with compared to their income. Trying to figure out why this was the case was what brought on the Millionaire Next Door book.

Benchmarks of wealth accumulation
The authors developed a formula for the amount of wealth a financially successful person accumulates as a function of their age and income. They had a complicated regression model, but it summarises nicely into:

• Multiply your age by your gross annual income from all sources except inheritances. Divide this by ten. This, less any inherited wealth is what your net worth (excluding home equity) should be.

The authors went on to classify two extremes of wealth accumulator

• A prodigious accumulator of wealth (called a PAW throughout the book) has a net worth twice as high as this formula.
• An under accumulator of wealth (UAW) has a net worth under half of this.
  

In between is the AAW (average accumulator of wealth), which is your ordinary garden variety rich guy.

Career
First generation wealthy individuals generally ran their own businesses, but they encouraged their children to enter into professional occupations. Reviewers of this book have often quote the authors as saying that most of the millionaires got to where they are by running small businesses like dry cleaning and pizza or fast food, but I didn't really get that impression from my own reading. They did point out that most were self employed but the authors did carefully point out that no specific occupation was represented any more among millionaires, there is no evidence to support the "quote" taken from the book that most of the millionaires owned laundromats, but they nevertheless were generally involved in service industries of various sorts.

Investment
Nearly all of the millionaires the authors interviewed owned stocks (about 95%), but few traded their stocks on any regular basis. Few cared what the London market did last night and few bothered following market commentaries. They just held stalwart blue chip stocks and held them a very long time.

Most millionaires were long term investors. In fact the authors hardly found any millionaire traders at all. The following table is interesting, it shows on average the frequency of most investors making changes in their portfolio.

Average holding time ======> Percentage of respondents
Less than a few days ======> Less than 1%
A few weeks ======> 1%
A few months, less than annually ======> Under 7%
Between one and two years ======> 20%
Between two and four years ======> 25%
Over six years ======> 32%

More than 42% of the millionaires interviewed had not made any trade at all in the previous 12 months. So much for the myth that to get good results you have to be a trader.

Yes, I am aware that the numbers in this table only come to 86%, but these figures come right out of the book. I have no idea why the numbers don't tally to 100%, but either way the message is clear - successful investors tend to buy and hold.

(Before anyone says this is simply because traders are a small group, I don't think that is the case at all. If anything the popularity and ease of trading via the Internet has had a huge impact on the way small investors behave, having direct stock market access has turned the market into a very addictive casino and if anything traders outnumber long term investors, and the percentage of short term traders seems to be increasing over time.)

UAWs consider cash/near cash and equivalents, such as savings accounts, money market funds and short term treasury bills to be investments. UAWs are nearly twice as likely as PAWs to hold at least 20% of their net worth in cash/near cash. Most of these cash categories are federally insured. Most are easily accessed when consumption needs arise. And, of course, it takes less time to plan cash-related investments than it does to allocate wealth the way PAWs tend to do.

PAWs are more likely to invest in categories that usually appreciate in value but do not produce realised income. They tend to have a greater percentage of their wealth invested in privately held/closely held businesses, commercial real estate, publicly traded equities and superannuation. These types of investments require planning and are the foundation of wealth.

Liquidity was generally not a huge concern for PAWs. For example the Australian equivalent of a PAW would use superannuation for a great deal of their investment. A UAW would shun super because preservation rules mean you can't get the money out while you are young. Having your money all available for immediate cashing in would be a disadvantage as far as PAWs are concerned.
UAWs tend to hold a large percentage of their net worth in motor vehicles and other depreciating assets.

Financial preparation
Often, traders spend more time trading than studying and planning.

The millionaires spent more time studying fewer offerings. Rather than getting stuck in front of a computer riding the swings all day long they tended to devote their energy to picking a prospectus to bits or reading up on a specific company. Rather than trying to know everything they decided to focus their time and energy by doing a few things very well.

PAWs on average allocate twice as many hours per month to planning their investments as UAWs.

Studying & planning (PAW ) 10 hours (UAW) 5.5 hours

Managing current investments (PAW) 8.1 hours (UAW) 4.2 hours

Another interesting point is that PAWs spent a lot of time trying to find a good financial adviser, and tend to have a rigorous process for screening candidates. UAWs were much less choosy about who they invested with.

Priorities
Millionaires believe that financial independence is more important than displaying high social status. A prodigious accumulator of wealth thinks more highly of having enough money to support him/herself and his/her family in the event of his/her income being cut off than owning a flashy car. They were generally conservative people not fond of taking huge risks, and valued security above all else.