If you are familiar with the title of this article, you will know it’s a book written by Thomas Stanley and William Danko. It is a fantastic book and was extremely revelatory and over the years has been revered by many as an inspiration for folks who have pursued the path of financial independence. For me personally, this book was pretty life changing and has helped me and my wife think about how we want to live our lives. This article is not so much a book review but more of my own thoughts on the principles in the book and how I believe all of us can think of applying certain principles in our lives. If you have been reading my articles consistently, you should know by now that I will never tell anyone how to live their life or for that matter pass any judgment on that. This article is merely an approach to a path to wealth. You will notice a lot of consistent themes from my previous articles as well. This article is in some way bringing a lot of those together.
Background
First, a bit of a background on the book itself. The basic premise of the book essentially debunks the myths that the average millionaire in America is not someone we read about in the papers and magazines, the business magnates, celebrities and so on. It says the average millionaire is someone we won’t even think is a millionaire because he/she does not look, dress or live like one as what we expect a typical wealthy person to be. In fact, a lot of them are in very typical middle class professions like teaching, firefighting etc who live in normal middle class neighborhoods and earn a very average salary. The book explains how and why they are able to do that.
Unfortunately, in America (and a lot of parts of the world), there are people who make a high income, who end up also having a lifestyle where they spend most or all of it, or worse, more than they make!
Wealth is not the same as income
This is probably the most fundamental principle that people misunderstand. When I first read this, I was confused. Essentially what this means is – don’t make the assumption that just because people make a big income, they are wealthy. And vice versa. What gives? There has to be a strong correlation between high income earners and wealthy people -right? Well, yes and no – it depends. It comes back to a very basic behavioral finance principle – Unfortunately, in America (and a lot of parts of the world), there are people who make a high income, who end up also having a lifestyle where they spend most or all of it, or worse, more than they make! What is considered high income is a bit relative to the place you live. But needless to say, we have heard and read about people earning $200K a year and above living paycheck-to-paycheck. We have also read about extreme examples like NBA players and celebrities who made millions of dollars and went broke. While there are exceptions, almost always this happens because of a lifestyle that cost them more than they could afford.
On the flip side, we do know of folks who make an average income – say $50K – $60K a year who have become wealthy. How? The answer again lies in something I explained in my article “Creating long lasting wealth”. They saved their money and invested it to create wealth.
So lifting straight from the book – “Wealth is more often the result of a lifestyle of hard work, perseverance, planning, and, most of all, self-discipline.”
What are the factors that make people wealthy?
The book fundamentally explains seven factors or common denominators of people who become wealthy:
- They live well below their means
- They allocate their time, energy and money efficiently in ways conducive to building wealth
- They believe that financial independence is more important than displaying high social status.
- Their parents did not provide economic outpatient care
- Their adult children are economically self sufficient
- They are proficient in targeting market opportunities
- The chose the right occupation
I would like to dig into the first three of the above factors for this article which are in my mind foundational to develop a mindset to become a millionaire.
Living below your means
I originally come from India. My parents generation and millions of my friends/families’ parents generation all lived and breathed this principle. The motto of living below your means was something as basic as breathing the air around us. I grew up and lived a very comfortable middle class life and I never lacked for anything. We were a single income household but my parents ensured our expenses were managed well and the savings invested carefully in the stock market and other instruments. This story is not unique to my family though. This is how much many middle class families I know across India lived. I believe a lot of it is cultural and I feel fortunate to have imbibed some of those values. However, I do believe some of my current generation has strayed away from this.
Why do I mention this? Well, after I moved to America, I was astounded to see the consumerist society and I was seeing myself getting influenced by that. Over time, I developed a philosophy that said – hey the reason I earn all this money is to spend it. So I did not really save money for many years and while I earned a pretty good income, I had no idea where my money was going or how much I was saving. As I reflect on it now, there were only 2 reasons that drove me to not go crazy on the spending side. One, I had a huge student loan with a double digit interest rate, that scared me, so I aggressively paid it off during the initial years. Two, I got married to a wife who preferred a simpler lifestyle and kept telling me we needed to invest the money in something. Wanting to get her off my hair, I started putting aside money to make some investments.
The simple act of keeping track of your expenses, budgeting and ensuring you save more money each month is ground zero for any wealth building to happen – unless you do this, you can forget about creating any wealth.
Being frugal is not the same as being stingy. There is a fine line sometimes – but ultimately, this is the toughest part of the entire wealth building journey for a lot of people. I talk about this in an earlier article. I had to re-learn the lessons of being frugal in America by going back to my roots. I did an honest assessment and pivoted my thinking significantly. My wife now looks at me in disbelief – is this the same guy I married? 🙂 Believe it or not, the book actually talks about a critical success factor for the wealthy was having frugal spouses – a couple cannot become wealthy if one of them is a hyper consumer. You need two to tango in this journey. Bless my lovely wife – I never knew this side of her when I married her but I am grateful for that trait of hers now! 🙂
Unfortunately, the simple act of keeping track of your expenses, budgeting and ensuring you save more money each month is not natural for a lot of people in this world. This is ground zero for any wealth building to happen – unless you do this, you can forget about creating any wealth.
Allocating your time, money and energy to accumulating wealth
When people read this, they think you are someone who is going to become ‘money-minded’ and singly focused on money and not care about anything else. That is far from the truth. And let me tell you this – most millionaires don’t want to have to think about money all the time. This is so they can use their time to do things they enjoy. But in order to get there, you do have to spend some time being deliberate with your finances. It starts with knowing your basic financial picture as I describe in this article. And then, it requires you to understand your taxes, your investment options, and decisions around paying down debt to name a few. I would explore some of the articles in this section to get yourself grounded. If all this sounds tiring and boring, I hear you – but don’t knock it off till you dig into it. I was in that camp – I would rather watch a good movie on Netflix than spend time understanding my finances. I can tell you from personal experience that I feel a tremendous amount of satisfaction in really digging into this. Not because I have suddenly become a millionaire by doing this but because I now know where our money is going and how it is going to ultimately create wealth – with the ultimate goal being financial independence. The book talks about how the millionaires they interviewed always spent a certain number of hours each month on managing their finances. In today’s world, with all the tools and automation, this can be made even easier and less cumbersome.
I started writing this blog because I really want to help people understand managing your money does not have to be difficult – money can be simple. It does require some time and effort from your side – but more importantly it requires the motivation and desire to want to do this. If reading is not your thing, then reach out to someone you trust to help you. Of course, all of you know this – any of you are welcome to reach out to me to ask me questions or help out. I am not an expert but I know enough to at least point you in the right direction.
A lot of millionaires who Thomas Stanley and William Danko interviewed for the book had a clear goal – they wanted to be financially independent but never cared about actually appearing wealthy.
Financial independence over social status
This is a bit more controversial so I will try and tread carefully here :). Everything I am about to say now does not apply to the ultra-rich who have so much money that they can afford to do whatever they want and still gain financial independence. For the rest of us lesser mortals, we have to consider some trade-offs. And this is deeply personal – so you have to decide what are the right trade-offs for you.
A lot of millionaires who Thomas Stanley and William Danko interviewed for the book had a clear goal – they wanted to be financially independent but never cared about actually appearing wealthy. This becomes very apparent on things you can actually see – the houses they live in, the cars they drive, the clothes they wear. So these are the true millionaires next door. Whether we like it or not, a significant portion of our budget/income goes into housing and transportation. For some others this includes food and clothes too. So given money is a limited resource (and if you are not among the ultra-rich), you may need to make some trade-offs here if you wish to pursue becoming financially independent. I have touched on this in some of my previous writing.
Let me start by talking about housing. This is a touchy subject. But this is for most people the single biggest item in their expense category. In America, size matters – everything is big. We want huge houses. I marvel at how my wife and I used to live in much smaller houses back in India with more individuals in the house (my wife actually grew up in a large joint family living under the same roof) yet as we live here in the US, we feel this deep desire to have much bigger houses. We live in a house double the size of what we grew up in and yet, it feels small! Now, what makes this harder is we not only need to buy big houses but want to ensure we are in the best neighborhoods. That is unfortunately setting us up for not just a high monthly mortgage payment and property taxes, but also higher utility and maintenance bills. Now, I am not for a moment making any judgment on people’s decision on where or how big a house to live in. This is definitely a tough trade-off. My wife and I have chosen to live in a nice neighborhood due to the good school districts here. We made that choice to pay more to do so because that is what we value. The trade-off we chose was to live in a relatively (relative is the key word here – its still a big house in my opinion) smaller house because we decided that would not necessarily give us more happiness. Lately I have been observing in some situations that the only options to live in certain neighborhoods are at significantly higher price points. And of course this is relative to location – a million dollar house in the Midwest of the US may be a mansion whereas in San Francisco might be a small 2 bedroom house. Wherever you choose to live, however big your house is, my only point here is – understand the costs relative to your income. If the cost of your housing is more than a third of your after tax income, then it definitely does indicate you are going to have a lot less money to save (that is a general rule of thumb based on everything else you need to spend money on). The book identifies housing choices as a key factor for these millionaires.
Cars are very similar to housing. America’s love story for large cars/SUVs is well known. One of the millionaires interviewed in the book said – “You are not what you drive”. Now, again I am not advocating driving old, beat up cars all the time. But buying used, relatively inexpensive cars that meet your requirements may be enough. Btw, my wife and I have always bought new (or almost new) cars but our hope is to drive them for another 10+ years. Next time I buy a car, it will likely be an older, used one. The book goes into a tremendous amount of detail on how car buying habits and brand preferences to cars tend to be a factor that drives wealth.
But all this is not simply in isolation about houses and cars and clothes. It is the fact that if you are someone who cares a lot about how you are perceived, you are going to choose to want to appear wealthy. This is what they call ‘keeping up with the Joneses’. That can generally be a symptom of a broader consumerist mindset for every aspect of your life and a possible indication of lower savings. I know I am wading into controversial territory here but you get the point. Ultimately if you make these purchases eyes wide open, understanding the financial implications and trade offs then more power to you.
Concluding thoughts
As I mentioned, these are not the only factors that drive people to become wealthy but are the foundational elements that can set you down the path. If someone comes to me with counter arguments giving examples of people like Mark Zuckerberg or other billionaires explaining how they did not follow any of the above principles but created wealth by starting companies, my only response to them would be – those are statistically speaking more anomalies and not the average. That said, they are still inspirational examples we could follow to try and create wealth through starting businesses. For most of us though, these principles in the Millionaire next door will be a critical element to becoming wealthy. There are enough critics about the book but I believe these principles are timeless. Ultimately this is not all actually about creating wealth for the sake of having money, but simply giving you the power of choices through financial independence. So that you can put your time to do things you enjoy more.
Thank you for reading. I wish you success in your financial independence journey.
Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.
