Wednesday, May 29, 2019

The Next Millionaire Next Door

Back in 1996, the book The Millionaire Next Door was wildly successful. I recall enjoying it without thinking too critically about its messages. The latest follow-up book in this millionaire series is The Next Millionaire Next Door, written mainly by Sarah Stanley Fallaw, daughter of one of the earlier book’s authors, Thomas J. Stanley. I enjoyed this book as well, but mainly for the interesting personal stories of millionaires’ journeys.

The book is based on surveys of millionaires. As with the first book, this one attempts to use the collected data to draw conclusions about how people become wealthy. This presents a number of challenges. A big challenge is that the data is all self-reported. What people say is often very different from reality. For example, when asked about investment fees, “33% of [millionaires] paid zero.” But how many just don’t know they pay fees?

Among millionaires, “luck was rated among the least important success factors, while being well-disciplined was at the very top along with integrity.” Few successful people think they were just lucky, but lots of unsuccessful people believe they had bad luck.

In another example, “marketing tactics related to homeownership had little influence on millionaires in our study.” Even if marketing tactics were wildly successful, few people would ever admit to being influenced or even be aware they were influenced.

In a different study, “only 54% of Americans could manage a $400 emergency expense.” This statistic has been widely repeated, but it seems likely that the respondents were answering a different question: “Does the thought of an unexpected $400 expense sound scary?” It’s doubtful that more than half of Americans are really less than $400 from bankruptcy.

Another challenge with drawing conclusions from data about millionaires is survivorship bias. Looking at the traits and actions of millionaires tells you nothing about how many people with the same traits and actions and failed to become millionaires. Which traits and actions lead to wealth and which are irrelevant? It’s hard to know. Some actions such as “save lots of money” seem safe to say that they help with getting rich. Others are less clear.

No doubt the authors attempted to minimize survivorship bias, but it’s hard to tell how successful they were. One conclusion that “how we feel about ourselves and our abilities related to financial matters significantly impacts net worth” seems suspicious. I would guess that causation in the reverse direction would be strong. Getting rich, even by luck, makes us confident about our financial choices.

Another example of what looks like survivorship bias is “economically successful people demonstrate an uncanny ability to select the right occupation.” And lottery winners show an uncanny ability to buy the right ticket.

“To build and maintain wealth over time, it will be necessary for you to approach all financial management—spending, saving, generating revenue, investing—in a different, more disciplined approach than anyone else around you.” This makes sense; getting rich is a competition among people, because we can’t all be rich.

“Those who do not budget or account for annual consumption categories demonstrate a lack of respect for money.” This one puzzles me. Plenty of people just naturally spend little without agonizing over details. I’ve added up my past consumption, but never budgeted or worried about categories. I definitely have respect for money.

In this period of ever-rising real estate prices, it was refreshing to read that it is dangerous to purchase “a home that requires more than three times your annual income.” Buying too much house can be a financial ball and chain.

“Too many Americans may believe that by driving a new car they are emulating economically successful people. But only 16% of millionaires drive this year’s model motor vehicle.” Doesn’t that mean millionaires buy a new car roughly every 6 years? Seems like rich people do drive new cars.

Some great advice for a young person starting a new job: “invest [your] money because one day ‘you may decide you don’t [like your job] anymore. That money will give you the independence and, more importantly, options to choose, rather than to continue working. Money isn’t about being rich. Money is about giving you choices. You are young and may not be able to see this now, but someday you will.’”

An interesting statistic: “just under one-third of millionaires reports relying on a financial professionals to make investment-related decisions.” Financial advisors seek out wealthy people, but catch them less often than I would have guessed.

Overall, I enjoyed this book because it is filled with entertaining personal stories written by wealthy people. What’s much less clear is whether the book’s conclusions form a useful blueprint for seeking wealth.

6 comments:

  1. After The Wealthy Barber, the original book was the most influential financial advice I received. It reinforced the idea to spend below your means (save). It introduced the idea that being rich did not mean having an expensive lifestyle and toys. A modest lifestyle could be a rich one too. Regarding your comment about cars, my limited survey indicates that we buy used cars and hold them rather than buy new every few years. These two books were a springboard to furthering my investment knowledge through further reading. I highly recommend these books. Cheers.

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    1. @Jan: The original Millionaire Next Door had a similar effect on me -- it validated my tendency toward frugality and building assets. That said, I find that many of the conclusions don't seem to be supported by evidence. However, the most important conclusions about frugality seem unassailable. As for the cars, the authors' quite extensive survey indicating that 16% of millionaires are driving a current model-year car means they get a new car every 1/16% = 6.25 years.

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  2. “only 54% of Americans could manage a $400 emergency expense.”
    Would the author be referring to actually going bankrupt, or that being the amount that would simply force them to use some form of credit rather than have $400.00 in savings to draw from? (Or their credit is already maxed out and the $400.00 is the straw...) A little ambiguous.

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    1. @Paul: This $400 figure has been very widely repeated. I even heard a loud group eating at the table beside me in a restaurant talking about it. What it means is whatever the questionnaire respondents thought it meant. However, it's widely reported as "half of Americans are within $400 of insolvency."

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  3. I guess I'd want to know the median age of wealthy people's cars. If some 30% of multi-millionaires exclusively lease for two-year periods, there could be a sizable number that drive cars for 15 years.

    I think you were insightful to pick out the detail on how wealthy people discount luck. I remember when I was doing really well in the stock market, I never thought it was luck, but looking back it seems I was extremely lucky. It seems harder than ever to confidently pick stocks now that I've got more experience at it, and I guess I should be happy I feel that way!

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    1. @Gene: As you point out, the 6 years between getting new cars is just an average. No doubt some millionaires never buy new cars and others get a new car every year or two. What seems clear is that millionaires as a group don't buy new cars less often than less wealthy people, but this is what the authors implied.

      Looking back, I was insanely lucky in 1999. You're right that you're lucky to have a realistic view of your own stock-picking skills. I've decided that with the competition that exists today, I have no useful ability to pick superior stocks.

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