After reading Jim’s recommendations for the best personal finance books for your library, I went to my local library and picked up “The Millionaire Next Door” by Thomas Stanley and William Danko. Stanley and Danko don’t provide any stories about getting rich quickly or even any revolutionary methods for getting rich slowly. The best way to become a millionaire is to have a great defense (think 85 Super Bowl Champion Chicago Bears), not a great offense (think 08 Super Bowl Losers the New England Patriots).
A great offense means earning a high income. Most would expect that there would be a direct correlation between earning a high income and achieving a high (million plus) net worth. The correlation is not as direct as you might think. Stanley and Danko provide evidence that high-income earners end up spending more money to match their social status. For instance, a CEO has to maintain a certain appearance with luxury foreign cars and expensive suits to entertain clients. In order to build wealth, a great offense helps, but a great defense helps more.
A great defense means spending significantly less money than you earn. Thomas and Danko provide evidence that you don’t have to be a high income earner to achieve the elusive millionaire title. They argue that a more important factor for becoming a millionaire is to save, invest and let the power of compound interest to build your wealth. Instead of spending your hard earned money on depreciating assets like expensive luxury cars and big screen TVs, someone with a great defense will invest their money in appreciating assets like equities and real estate.
Seven Characteristics of the Wealthy
Stanley and Danko provide seven characteristics in common for all of the millionaires they surveyed.
- They lived 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.
- They chose the right occupation.
Many of these characteristics can be achieved by the common person. Anybody can live well below their means. Allocation of your time, energy and money is completely up to you. Wanting to be financially independent instead of displaying a high social status is a frame of mind that you have control over.
Not receiving economic outpatient care, having self-sufficient adult children and proficiently targeting market opportunities all depend on the first three characteristics. If you live below your means and allocate your time, energy and money efficiently, you won’t need economic outpatient care from your parents. Additionally, your children will be economically self-sufficient by learning from how you live and work. Proficiency in targeting market opportunities is directly related to allocating time and energy towards building wealth.
Risk vs. Freedom
Stanley and Danko discovered that of the non-retired millionaires, over two-thirds are self-employed business owners. I would argue that this fact isn’t because self-employed business owners make more money. Instead, I would argue that this stat is because self-employed business owners operate with a better defense.
The one section of the book that really made me take notice came in the very last section. In this section, a story is told about a business professor asking a class of MBA students what they think risk is. The class agreed to define risk as being an entrepreneur. The professor then shared a quote from an entrepreneur with his class that said risk is having one source of income. Entrepreneurs have numerous clients who provide them with multiple sources of income.
I found this book really entertaining and easy to read. One of my ultimate goals is to become financially independent. This book provides a lot of insight into how to become wealthy and financially independent.
Additionally, the last section about risk really got me thinking. In economic times like these it is really important to diversify your income. Risk boils down to having only one source of income, especially if you’re not in total control of that source. Currently, I have two sources of income with my 9 to 5 job and self-employed tutoring. I still want to add more sources of income and even passivate my income. Are any of you striving to diversify your income or generate new sources of passive income?None found.