Investing For Your Future Monthly Message
Barbara O’Neill, Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension
Secrets of the Millionaire Next Door
There are approximately 7,135,000 millionaires in the U.S according to 2014 statistics from Boston Consulting Group. For more information on millionaires, see http://time.com/2852740/china-millionaires/ Want to join their ranks? This article describes strategies to build wealth over time. It is possible to accumulate a seven figure net worth (assets minus debts) if you plan ahead and invest part of what you earn. Other factors found to be associated with wealth accumulation include getting a good education and taking advantage of tax breaks provided by federal and state governments.
Let’s begin with some highlights from the classic book The Millionaire Next Door (TMND). One of the book’s key points is that you cannot tell a millionaire necessarily by looking at one. Many people with expensive possessions (clothing, cars, etc.) are not wealthy and many wealthy people do not own expensive items. Self-discipline, also known as living below your means, is a common characteristic of millionaires.
The authors of TMND, Stanley and Danko, found that wealth seldom results solely from luck, inheritances, or advanced degrees. Instead, it takes discipline, sacrifice, and hard work. Even a high income is no guarantee of wealth. If you earn six figures and live “paycheck to paycheck,” you’ll forgo the opportunity to become wealthy. In the book, there is a formula to determine whether you are doing well for your specific age and income. Simply multiply your age by your pre-tax income and divide by 10. This is the amount that your wealth should at least be. For example, a 35 year old with a $40,000 income should have a net worth of at least $140,000.
Being frugal is the cornerstone of wealth-building. Living frugally has helped many millionaires accumulate wealth. Stanley and Danko found that most were not interested in a lifestyle of consumption and high-status items. Instead, they tended to plan their spending carefully and follow a “pay yourself first” strategy of regular saving. They are also goal-oriented, maximize tax breaks, and have relatively low expenses for housing.
Stanley and Danko also found that many millionaires bought relatively inexpensive cars. They divided a car’s price by its weight and found that many cars owned by millionaires were cheap on a “cost-per-pound” basis. Many millionaires also buy used cars. Spending less than they earn is a common characteristic of millionaires. They distinguish between needs and know that small savings here and there add up over time.
Another characteristic of millionaires is that they leverage the awesome power of compound interest to grow their money. Most people simply don’t earn enough to become wealthy from their incomes alone. They need help from compounding. Three key principles are to: save part of what you earn starting early in life, achieve a reasonable rate of return, say 7% on a diversified portfolio, and be patient and allow money to grow over time.
Another characteristic of many millionaires is that they get married and stay married. Thus, they tend to earn more and have more wealth than singles. Marriage is not essential for wealth accumulation, but it helps. Married couples often enjoy economies of scale. Divorce, on the other hand, can deplete financial assets due to fees for lawyers and the cost of maintaining two households instead of one.
Good physical health can also contribute to financial wealth. This means eating right, exercising, and getting adequate rest. Healthy people are more productive and are more likely to get promoted and earn more. They also live longer and get a better return on money contributed to retirement savings plans and Social Security.
Taking prudent investment risks can also increase wealth. Most millionaires invest regularly and include a healthy percentage of stock in their portfolio. Everyone can invest successfully without special knowledge or skill. One easy, low-maintenance, way is to purchase index funds. Another is to buy a target date mutual fund with an asset allocation aligned with your age. Be sure to diversify your portfolio to reduce investment risk.
It is possible for people of ordinary means to become millionaires through hard work, steady investing, and the magic of compound interest. Generally, it takes three or four decades. Will you be a millionaire someday? This easy three-step online calculator can help you develop a plan: http://money.cnn.com/calculator/pf/millionaire/.
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