Ever since I was a teenager, I was fascinated by finance. I ran my own businesses in my teens; yard care, piano lessons, multi-level marketing, and performed in a rock-n-roll band which I also managed. I have read many books about finance and wealth over the years. When people ask me about my favorite books, several pop to mind, with the list continually evolving through time, but The Millionaire Next Door (published by Taylor Trade Publishing, and written by Thomas J. Stanley and William D. Danko) is always on the list.
I’m not sure why this book has touched me so deeply. I think it was the fact that it reset my thinking about what it means to be a millionaire. Prior to reading this book, I had thought of millionaires as they were portrayed in the old 90’s TV series “The Lifestyles of the Rich and Famous.” The people on the show had over the top lifestyles and that became my impression of a millionaire.
That was also the impression the authors of this book had before they started interviewing millionaires. From their interviews, they discovered something very different than what they thought they would find. The average millionaire doesn’t live in the big city, own an island and drive a different color Lamborghini each day of the week. It turns out, the average millionaire probably lives right in your neighborhood, maybe even right next door.
This was the first time I really understood that millionaires are just regular people like you and me. They don’t drive fancy cars, live in extravagant houses, or wear $1,500 silk suits. They are normal business owners who work hard, spend less than they make and invest their money. That was a key point. If you make a lot of money and just spend it all on fancy stuff, you are not becoming wealthy, you are just living high.
If all it took to become a millionaire was to live on less than I make, invest the money I don’t spend on living, and keep doing that for a long period of time, then anyone, including me could do it. It was a lot like being physically fit. Here is an excerpt from The Millionaire Next Door.
“Have you ever noticed those people who you see jogging day after day? They are the ones who seem not to need to jog. But that’s why they are fit. Those who are wealthy work at staying financially fit. But those who are not financially fit do little to change their status.”
Millionaires are not usually born wealthy. They work their way to wealth. Self-made millionaires account for about 85% of all millionaires. I figured if they can do it, then so can I. Reading this book was the first time I learned the real difference between wealth and income. There are a lot of high income people who are not wealthy. There are also a lot of low income people who are wealthy. Income is not the factor that determines whether or not you will become wealthy. Accumulating financial assets is what counts.
Are you accumulating assets? The authors of this book put forth a formula to help determine the answer to that very question. Think about your current net worth. Based on your income, is your net worth high or low? Many doctors who contact me for help with their finances have a negative net worth. This is usually caused by outstanding student loans. Both your income and how long you have been earning that income factor into how much you should have accumulated.
Their formula multiplies your annual income by one tenth of your age. That number becomes your reference point. If your net worth is lower than your reference point, you are not accumulating wealth. If your net worth is higher than your reference point, you are an accumulator of wealth. What I have observed is that most people’s net worth is either way under or over their reference point.
As an example, let’s say you are a doctor making $200,000 a year and you are 50 years old. One tenth of your age is five. Multiply your annual income by five and you get $1,000,000. If you have a net worth less than this, you are not accumulating wealth, you are spending too much of your income. I know doctors who are around 50 years old with a $200,000 annual income who have a net worth near zero. I also know doctors with these parameters who have a net worth in excess of $5,000,000. So what is the difference between these two types of doctors?
The main difference is one doctor spends all of the income that comes in on their lifestyle and the other doctor, the accumulator, lives on less than her annual income and has been putting a substantial amount of money into investments for the future. Those investments have been growing and compounding over their entire career. The results are astounding.
There is one point in the book where the authors shared the lifestyles of two doctors like I discussed above. One accumulates and one spends. Here is another quote from the book about an under accumulating physician:
“A plastic surgeon added that he had three boats and five cars but hadn’t gotten around to assembling a pension plan. Financial investments? Didn’t have those either.”
It is amazing how many doctors I meet with similar portfolios. I met one doctor who was having a struggle paying the bills. After reviewing this doctor’s income and debts, it didn’t seem like there should be a struggle to make ends meet. I asked if there was any other debts they might have forgotten to mention. “Oh yeah, we still owe money on our boat.” The boat loan’s remaining balance was in excess of $500,000 and they were currently shopping for a bigger boat to replace this boat that they had outgrown. That little debt had slipped their mind and completely blown their budget.
There is so much good advice in this book about the pitfalls that keep us from accumulating wealth. They talk about how your house choice can influence your wealth. How the wealthy buy cars. And one of my favorite topics, how you behave financially with your children and what it teaches them about money.
The chapter on kids is called “Economic Outpatient Care.” It turns out that giving your kids money, before they have established a good job, lifestyle and savings program, causes them to depend on you to survive financially, which stifles their wealth accumulation. There are a lot of great suggestions on how the wealthy should conduct themselves financially with their kids, and even one area where providing economic outpatient care will actually help children.
Another area I especially liked was learning that most self-made millionaires do not carry debt. They did not become wealthy by avoiding paying off their low interest loans (school, auto, house) and instead investing the money for potentially higher returns. They avoided paying interest if at all possible. When they did have to pay interest, they paid off their loans quickly, ahead of schedule. If you want to pay off your debts early and become debt free, get a copy of my book, The Doctors Guide to Eliminating Debt, and stop managing debt and start eliminating it so you can free yourself from the weight of debt like the millionaires do.
If you are not a millionaire but would like to be someday, The Millionaire Next Door lays out the framework that most self-made millionaires have followed to accumulate wealth. Following the examples in this book is not difficult and can change your financial life forever. I know, because it changed mine.
If you think you should be wealthier than you are, you will likely discover the reason for your lack of wealth in this book.
If you are wealthy and are worried about how your children will turn out financially, you will find the section on children very helpful.
Have you read this book? Do you have another great book to recommend? Leave your comment on my blog. I’d love to hear your recommendations.