Book review: The Millionaire Next Door by Dr. Thomas Stanley

My family in Nebraska understood the value of a dollar. Dad used to say seeds are a lot like dollars. You can eat the seeds or sow them. But when you see what seeds turned into … ten foot high corn … you don’t want to waste them. Consume them or plant them. I always get a kick out of watching things grow.

This quote came from one of the millionaires that was interviewed for this book, and I believe it encapsulates very well the message of The Millionaire Next Door. The Millionaire Next DoorThomas Stanley and his partner William Danko have spent a career studying America’s high income and high net worth individuals by studying several thousand individuals.

One would naturally assume that in order to become a millionaire it must be a given that a person would have a high income. Our culture highlights the millionaire movie stars and athletes or those who have inherited fortunes from their families and many think that these are typical of the average millionaire. In fact these type of people represent a very small percentage of millionaires in America. Most are in fact small business owners and entrepreneurs. The overwhelming majority are self-made first-generation millionaires who lead comfortable but far from extravagant lives.

What do you do with what you have?

The essence of the book compares the habits of those whom Stanley refers to as “PAW’s” (Prodigious Accumulators of Wealth) vs. UAW’s (Under Accumulators of Wealth). Stanley defines wealth as follows: Take your age times your annual household income minus inheritances and divide that total by 10. This should be your approximate net worth. PAW’s are those whose net worth significantly exceeds this amount and UAW’s are those who are well below this amount.

Common characteristics of The Millionaire Next Door

Stanley notes that the 7 characteristics of those who have become PAW’s are:

  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 economic outpatient care.
  5. Their adult children are economically self-sufficient.
  6. They are proficient in targeting market opportunities.
  7. They chose the right occupation.

First and foremost Stanley points out that PAW’s are completely unconcerned with keeping up with the Jones. Most have never spent more than a few hundred dollars on a suit or a watch. Their favorite stores tend to be Sears or J.C. Penney’s as opposed to Nieman Marcus or Saks Fifth Avenue.  They are more likely to buy American made 2 or 3-year-old vehicles than fancy foreign sports cars. In essence they live a comfortable but frugal life style. This is how they have become prodigious accumulators of wealth. They live on considerably less than they make. In fact they might be living right next door to you and you wouldn’t even know it.

It is interesting that high incomes do not seem to have any particular relevance to the ability to accumulate wealth. Many high income earners also live highly consumptive life styles. While these people may make well in the 6 to 7 figure annual incomes, there is no money left over for the accumulation of wealth by the time they make their huge house payments, payments on all their vehicles and “toys, the country club dues, the private school tuition for their kids, etc.

Millionaires aren’t always from the professions you might expect

An interesting and related note is that some occupations that we think of as being highly desirable and that come with high incomes may actually contribute to the production of UAW’s. Doctors, lawyers and executives with large six figure incomes may feel that they need to drive the expensive sports car or hang out at the country club in order to convey what they feel is the appropriate image for someone in their profession.

Not only do PAW’s tend to live more frugal life styles than their UAW counterparts, but I think more importantly they pay attention to where their money goes. PAW’s actually – are you ready for this… They live on a budget. Even though they have plenty of money coming in they have a careful plan as to how that money will be used. When asked how much money they spent on things like food or clothing most PAW’s could quickly and accurately state what they spent. UAW’s on the other hand most typically had no idea what they spent on basic categories like that. They simply rely on the fact that they bring in enough money each month that whatever they spend will probably be covered. The end result is that there is little planning and a great tendency to simply consume all that comes in.

Teaching our children well

The other significant topic of this book is how parents handle the financial instruction and well-being of their children. Stanley calls this economic outpatient care. Interestingly, there seems to be a typical cycle where often the children of these first generation millionaires do not learn to handle their money nearly as well as their parents. Most of these first generation millionaires are entrepreneurs that have started their own business and succeeded through much hard work and a little luck along the way. They know that this is a difficult life filled with risks and they want their children to have an “easier”, less risky life. Therefore they encourage their children to get advanced education. Many are encouraged to go into professions like medicine or law. But as we noted earlier many times these professions tend to be more prone to encouraging a highly consumptive life style, just the opposite of what their parents lived.

Also, Stanley noted that there is a natural tendency for parents to want to help their children who have economic issues. For example, maybe one son becomes a business man, he’s watched his parents’ life style through the years, and learned to live similarly. While perhaps not having the wealth of his parents, he certainly has things well under control and needs very little assistance from his parents. Meanwhile, perhaps their daughter marries a man who does not make a significant income. Together they are struggling to make ends meet. Meaning well the parents give them a large gift to use as a down payment on a new home. However this is not a home or neighborhood that the young couple could have ever afforded on their own. Naturally most of the kids in the area go to private school, but the daughter and her husband can not afford that so “for the benefit of the grand kids” the grandparents again step in and give generously to pay the private school tuition. Of course, it doesn’t do to be driving their 15-year-old beater car in this neighborhood so again the daughter and her husband end up purchasing vehicles they really can’t afford in order not to be embarrassed. Etc. etc. The grandparents’ well-meaning “assistance” actually paves the way for them to be trapped in a consumptive life style. Meanwhile the other son who has not received that assistance has had to learn to live within his means and is starting to build his own wealth much like his parents had. The end result of the grandparents’ attempts to provide assistance to their children is that the one they helped has had her financial well-being seriously damaged while the son who received less help has been greatly strengthened in the long run. I found this to be an interesting thought and an important warning for those who are succeeding at managing their finances.

Most millionaires don’t fit our TV stereotypes

I will admit that The Millionaire Next Door is not the easiest book to read. Not exactly summer beach reading. However, it is well worth the effort. There is much to be learned from those who have succeeded at building a secure financial future for themselves vs. those who may seem successful to the outside world but are actually one missed paycheck away from disaster.

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