The Millionaire Next Door is a classic with the timeless message that anyone can become wealthy. I first read this book 10 years ago or so, and recently re-read it for this review. When reading this book, first I kept wishing it had up to date numbers; so in the mid 90′s millionaires, on average, lived … Continue reading
The Millionaire Next Door is a classic with the timeless message that anyone can become wealthy. I first read this book 10 years ago or so, and recently re-read it for this review. When reading this book, first I kept wishing it had up to date numbers; so in the mid 90′s millionaires, on average, lived in a $350,000 house, what is that number today? Then I realized I was missing the big picture. This book offers a look into the lives of millionaires and shows that contrary to what you may think, most wealthy people did not get that way through big salaries or inheritances, nor are they flashy with their wealth.
Thomas Stanley and William Danko spent many years studying the habits of millionaires in the United States with the majority of the research taking place between May ’95 and Jan ’96. It turns out you cannot always judge a book by its cover and there are many wealthy Americans who are not driving fancy cars or living in fancy houses.
The Seven Characteristics of Millionaires
1) They live well below their means.
2) They allocate their time, energy, and money efficiently, in ways conducive to building wealth.
3) They believe that financial independence is more important than displaying high social status.
4) Their parents did not provide them with a lot of financial support, what is referred to in the book as ‘outpatient care’.
5) Their adult children are economically self-sufficient.
6) They are proficient in targeting market opportunities.
7) They chose the right occupation, often as small business owners or self-employed professionals.
This book offers two concrete formulas that I found very helpful.
1) This first determines whether or not you are wealthy.
Use the following equation to determine what your net worth should be given your age and income:
(Age * Realized pretax annual household income from all sources except inheritances) /10
With this number you can then determine whether you are a prodigious accumulator of wealth (PAW), under accumulator of wealth (UAW), or just an average accumulator of wealth (AAW). You are a PAW if you have 2x what you should have based on this formula, or more. If you have less than this formula, you are a UAW. After running my own numbers using this equation both for where I am now and also thinking back a few years ago, I realized this formula sets a high bar and it motivated me to try to save more. If you are in your 20s and just starting out, it will be hard to reach even the AAW level.
2) The second formula helps you determine how much house you can afford, or more specifically, what size mortgage.
If you’re not wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s annual realized income.
This formula is a lot more conservative than anything you hear in the main media, but will also allow you to save enough so you can someday become a PAW.
Four Questions to Ask Yourself
If you want to become and stay wealthy, you should be able to answer ‘yes’ to the following four questions:
Does your household operate on an annual budget?
Do you know how much you family spends each year for food, clothing, and shelter?
Do you have a clearly defined set of daily, weekly, monthly, annual and lifetime goals?
Do you spend a lot of time planning your financial future?
Is this book for you?
This book is a great read for anyone looking to lead a more frugal life in return for more financial security or anyone who is too worried about keeping up with the Joneses. While not a ‘how to’ book, this book describes how by living within your means, you can amass great personal wealth even without a big fancy salary or inheritance. In addition, this book will make you look at people differently. If you are someone who is always try to keep up with people who have more than you, this book might make you realize that, while those people spend a lot of money, their net worths are low. On the other hand, your neighbor who lives in a modest house, but owns his own business and drives 10 year old cars, might be a millionaire several times over.
Finally, if you look at your salary and feel like you don’t know where it goes each month, or that you should have more assets at this stage in life, this book is for you. Not only does it have ways to assess your current situation, it should also provide you with some motivation to amass more wealth.
I’m working on a series of reader profiles and interviews. My hope is that as these interviews go on you will learn a little, recognize someone in a similar situation to yourself, and also realize that even people who are very different can still have similar financial issues and goals.> Tell us a little about … Continue reading
I’m working on a series of reader profiles and interviews. My hope is that as these interviews go on you will learn a little, recognize someone in a similar situation to yourself, and also realize that even people who are very different can still have similar financial issues and goals.>
Tell us a little about yourself including any relevant financial info.
I am married with a one-year old son. I work in politics and my husband is a professor. My husband and I both chose our current jobs because they are fulfilling and provide flexibility. I know that we could both earn higher salaries if we were willing to trade a little bit of flexibility or fulfillment but so far we haven’t been willing to make that trade. We own a home in Minneapolis that we are hoping to stay in for many years.
What are your biggest financial challenges right now?
I took a pretty long maternity leave and just returned to work full-time last month. We had planned financially for the leave but it’s still a little disconcerting to see your savings go down each month. Building the savings account back up is also slower now that we are paying for daycare. Making sure we keep a significant emergency savings account is our biggest financial challenge right now.
Discuss your financial goals.
In the short term, I would like to increase our savings so that if we have a second baby I could take a long maternity leave again. We also need to make a will – that has been on our To Do list for a long time. In the medium term, I would like to increase the amount we are putting away for retirement (we currently putting aside about 11% of our income but my goal is to set aside at least 12%). I would be curious how much readers of NTF set aside. I would also like to increase the amount that we are saving for my son’s college education, though my husband has some education benefits as a professor so this is a lower priority for us. In the long term, we would love to save for an addition on our house and/or a cabin. Having a fun, long-term goal seems to motivate us to be frugal and save. I even opened a savings account called “Addition” even though I count that money in our emergency savings. When we get a windfall that we weren’t expecting, it’s more fun to put it in the “Addition” account than just regular savings.
What is the best piece of financial advice you have ever received?
Don’t buy the biggest house you can afford. When we were house hunting four years ago (near the peak of the market) we did not buy at the top of the price range we could afford. Now that we have the added expense of a new baby, daycare, and a year of below-average income due to maternity leave, I am glad that we didn’t stretch ourselves too thin. Also, something obvious that I wasn’t very good about until I started reading the NTF blog was bringing my lunch to work. It’s such an easy way to save money!
What is the best piece of financial advice you could give?
Make a budget and revisit it when you are feeling stressed about money. I handle most of the financial planning in our family but when I feel like we aren’t sticking to our budget, it’s helpful to sit down with our Excel spreadsheet and make adjustments together.
What is your biggest financial extravagance and in what areas are you most frugal?
My husband and I are both frugal about material purchases – we don’t spend a lot on clothing or gadgets and we don’t have cable. We also have not taken any big vacations in the last two years – that was one of the major ways we saved so that I could take a long maternity leave. It was a little easier to give up vacations since an extravagant vacation with an infant didn’t sound very appealing. Long-term, I would like to go back to taking interesting vacations. Biggest extravagance: We pay a babysitter to come every other Saturday so we can have a fun night out. If you don’t have kids, this may not sound extravagant but 6 hours of babysitting runs about $65 plus splurging on a nice restaurant (maybe another $65) and a movie ($20) adds up. We have decided not to skimp on our precious few date nights and we really enjoy them. Before our son was born, we definitely splurged on eating out and taking nice vacations.
What would you do if money were no object?
I would pay people to help do the chores around the house (cleaning, shoveling, mowing weeding) so my husband and I could spend time doing other things. I would only work three days a week. I would take an extravagant vacation a few times a year. I would buy a cabin and pay someone to maintain for me when I wasn’t there. I would also go the spa once a month with my sister or a good friend (my treat, of course).
*If you might be interested in sharing your financial story in the interest of helping other people please contact me at notrustfund <at> gmail <dot> com and we can discuss different options.
The stock market has been extremely volatile over the past few months with 400-500 point daily moves in the Dow happening regularly. With all the political and economic uncertainty, particularly in the United States and Europe, it is likely that this market volatility will continue in the the upcoming months. While it is hard to … Continue reading
The stock market has been extremely volatile over the past few months with 400-500 point daily moves in the Dow happening regularly. With all the political and economic uncertainty, particularly in the United States and Europe, it is likely that this market volatility will continue in the the upcoming months. While it is hard to shrug off the news coming out of Greece, Europe as a whole, and the U.S. if your financial house is in order, you should be able to sleep soundly at night even when the economy is not doing well and the markets are volatile. Here are a few things you can do to make sure your finances are in order, which should help reduce your stress level.
1) Have an emergency fund
Having an emergency fund is the #1 thing you can do to help you sleep better at night, regardless of economic climate. With a strong emergency fund of 6-12 months of living expenses, maybe more if you are particularly worried about your job security, you can relax as the market moves, knowing you can cover your expenses should an emergency hit. You should not start investing money in the stock market until you have a solid emergency fund. Most importantly, your emergency fund should be in a cash account such as one at your local bank or an online savings account. Anywhere you can have easy access to this money and also know that the fund will not decline in value is sufficient.
2) Know your time horizon and invest accordingly
Your emergency fund isn’t necessarily the only money you should have in cash. How you invest your money depends on your time horizon. Financial time horizons are usually broken down into three categories: short term, medium term, and long term. Any money you will need in the next 0-5 years, the short term, should not be invested in the stock market. Depending on your age and financial goals, this could include money for a car, a downpayment on a house, your kids college, or your retirement fund.
The medium term is typically described as 5-10 years. Money that you will need in the medium term does not necessarily all need to be in cash, but it should also not be invested 100% in stocks. Typically medium term money is invested in short to intermediate bonds and some stocks.
Finally, once you start looking at longer term goals, such as retirement if your are younger or college funds for your kids if your kids are under the age of 10 or so, you can start investing in the market. With such a long time horizon, your money will likely have time to bounce back should the market take a big dip, and you will also have time to invest money at these lower prices and dollar cost average into a better overall price over time. Long term money is not invested 100% in stocks; exact asset allocation is determined by your exact time horizon and also your risk tolerance.
3) Assess your risk tolerance
Even if you have a long time horizon, investing a large percentage of their money in stocks is not for everyone. If your stomach cannot handle large moves in the market, you should have less money invested in the stock market. You may need to invest more over time to make up for lower return expectations, but you will be able to handle market volatility. One rule of thumb for a long term time horizon, retirement, is to invest 100 – your age in stocks. So if you are 30, 100-30 = 70. 70% of your portfolio would be invested in stocks, and 30% in bonds. However, if you have a low risk tolerance, you may choose to have more of your portfolio in bonds.
4) Stay your course and try to not to be swayed to action by big market moves
Everyone now wishes they had bought gold a few years ago when it was only $500/oz or sold some of their stocks where the markets were at their highs in the fall of 2007. However, if you invest regularly into the market, and as appropriate for your time horizon, market swings should not matter. In addition, if gold was not right for your portfolio at $500/oz, you should not be considering it at $1700/oz unless something about your long term goals changed a lot in the last couple of years.
As I have mentioned, we have some big short term financial goals right now, namely buying a house and a car. While I don’t know exactly when we will need this money, I am almost positive it will be in the next three years. Therefore, this money is sitting in a high-yield checking account not even earning 1%. Last year, when the market was doing well this was hard to stomach. I kept thinking, if only this money was in the market, our housing budget could be bigger. However, over the last couple of months, we have been very happy to have this money in such a stable investment.
On the other hand, we have continued to invest both retirement savings and college savings in a mixture of stocks and bonds. While there has been a lot more volatility in these savings as a result of how they are invested, that is ok because we will not be needing any of this money for at least 16 years.
It is hard to turn on the T.V. or open a newspaper right now without hearing news of market volatility and economic uncertainty. If you have your financial house in order by having a solid emergency fund and investing according to your time horizon and risk tolerance, hopefully you can hear this news without it causing you too much stress. You can sleep better at night knowing your money will be there for you when you need it.
*Photo by WalkingGeek via flickr
Happy Fall everyone. This is my favorite time of year. Sometimes it feels like we go straight from summer to winter, but we’ve been having amazing weather here that is making Fall even better than usual. I realize it has been awhile. Here’s a little about what has been going on here: Baby #2 Baby … Continue reading
Happy Fall everyone. This is my favorite time of year. Sometimes it feels like we go straight from summer to winter, but we’ve been having amazing weather here that is making Fall even better than usual. I realize it has been awhile. Here’s a little about what has been going on here:
Baby #2 arrived last month and it’s another girl for Mr. NTF and me. I did not fully comprehend how exhausted I was during this pregnancy until now, when I’m no longer pregnant. Turns out holding down a full time job, caring for baby #1 and being pregnant is very tiring.
On a happy note, everyone is healthy and we’re really enjoying getting to know this kid. That last few weeks have been exhausting but we’ve been spending a ton a time with family and friends and it doesn’t get much better than that.
On a financial note, we’ve been spending a lot of time over the past months going over our finances. In the next couple of months we will be purchasing a new house (still looking) a car (picked out but waiting a few more months to pull the trigger) and starting to pay for two kids in daycare which is alarmingly expensive. The upside of this being baby #2 is that we have not had to buy anything for this baby, unless you count the car and house we are shopping for! We will need to buy a crib for the baby soon, but right now she’s in the bassinet we used with baby #1.
I’ve received great feed back on the interviews I posted recently. If you missed them you can find them here and here. I’d like to keep this series going with the hope that all readers will at sometime read about someone in a situation similar to their own. I also think it’s great to remember that everyone has financial challenges, regardless of their life stage and financial situation.
If you are interested in being featured in this interview series, please contact me at:
notrustfund <at> gmail <dot> com
All interviews will be posted anonymously.
While I have not been doing a lot of writing over the past couple of months, I have been reading a lot and many of those books have been on personal finance. Looks for some upcoming book reviews.
*photo by sponselli via flickr