Wednesday, November 6, 2013

The Millionaire Next Door

I went on a search to determine the number of millionaire households in the United States. These would be households with a total net worth in excess of $1,000,000. This proved to be a pretty elusive number. Different articles and even different statistics collected by Government agencies present different results. I have learned that net worth and even the number of households are estimated and reported in different ways.

The best numbers I can come with are between 5.2-5.9 million American households have a net worth in excess of $1,000,000. There are somewhere between 114-118 million American households. That means roughly 4.5%-5.0% of American households are worth in excess of $1,000,000. Somewhere between 1 out of 20 to 1 out of 25 of the cars you see out on the Interstate as you drive from here to there contain a millionaire family. Any way you cut it; that is a lot of millionaires.

What else can we say about millionaires? The most complete study of millionaires I have read is The Millionaire Next Door by Danko and Stanley. I classify this book as a must read for anyone looking to better their financial situation. It will totally revolutionize the way you think about wealth.

The millionaire household is normally a traditional family unit, one husband, one wife, for one lifetime. Divorce is a great destroyer of wealth. The number one cause of divorce is money problems. Then people who could not maintain one household are forced to maintain two households after enriching a couple of attorneys.

About 50% of millionaires are self employed.

About 80% have college degrees, but only 18% have Master’s degrees. 8% have law degrees and 6% have medical degrees.

Dry cleaning has produced a larger number of millionaires that any other business.

Between 75%-85% of millionaires are self made first generation millionaires. Most inherited wealth is dissipated by the second or third generation.

Most are in their 50s or are older, but 80% are still working. Only 20% of millionaires are retired. This makes sense. Most people outside of sports, music, and entertainment aren’t going to make most of their money in the first three years of their career. Danko and Stanley also discovered that millionaires, particularly self employed millionaires love their jobs.

Jewish and Asian households contain a much higher than average number of millionaires. I couldn’t find a good number on the percentage of Asian households, but I discovered that about 18% of Jewish households have a net worth in excess of $1,000,000. It would appear that a strong work ethic, a love of and respect for education, a strong social or family support network, a willingness to take risks, and an above average IQ all contribute to high personal net worth.

Some of these components, such as the ability to take a calculated risk have been studied by Danko and Stanley. Millionaires typically know how to evaluate risk. Think about the boat people from Vietnam. After risking death on the high seas in a rickety boat in a nearly suicidal effort to escape Communism, what is the risk involved in quitting a secure job to start a new business?

I have seen studies that demonstrate a close correlation between salary and IQ up to 120. Beyond that number there is no correlation between IQ and salary. I have never seen a study that correlates net worth and IQ.

Danko and Stanley have observed a number of common characteristics of millionaires that have made their study famous. Millionaires consistently live below their means. They avoid buying luxury or status items. They avoid debt. They spend more time planning their investments than they spend in researching and buying their cars. Generally they buy pretty ordinary used cars. Like everything else they purchase they avoid debt when buying a car.

Danko and Stanley discovered a simple formula that is surprisingly accurate for individuals and couples over 40 years old. It produces some pretty weird results for folks in their 20s.

Predicted Net Worth = (Age X Current Annual Salary)/10

Hence a 50 year old couple earning a combined income of $100,000 a year should have accumulated a net worth of approximately $500,000. That seems pretty reasonable with equity in the family home and things like 401 (k) accounts or IRAs added into the total.

People with roughly twice that number are categorized as Prodigious Accumulators of Wealth.

People with half that number or less are termed Under Accumulators of wealth. Surprisingly many professionals, such as doctors, would be classified as Under Accumulators of wealth. Many doctors tend to live a high consumption lifestyle, buying mansions and driving the latest and finest examples of German technology. They tend to believe they can earn their way out of any cash flow problem or debt. Since their income is somewhere in the top 1% or 2% of all American households. This is probably true.

So how are you doing? What could you do to improve your situation?

Remember the money equation:

Money In = Money Stored + Money Spent
(integrated over the course of a lifetime).

Earn more, spend less, or put your savings to work. Any or all of these actions will lead to financial freedom; however you may choose to define that term.

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