The general premise of The Millionaire Next Door is that the pop culture concept of a millionaire is quite false and that most actual millionaires live a very simple lifestyle. The authors, Stanley and Danko, did extensive profiling of people whose net worth defined them as millionaires along with those whose salaries and age defined them as likely millionaires and, using this data, created a detailed profile of who exactly a typical millionaire is. From there, extensive interviews with these "typical" millionaires created a much more detailed picture of what it actually means to be a millionaire in today's society.
What does this have to do with personal finance? Rather than the image that most of us have of millionaires as people who inherited their money or got famous, most of the people that are actually millionaires got there through strong individual financial planning. They're frugal people with a head on their shoulders and are often indistinguishable on the street from anyone else.
In the introduction to the book, Stanley and Danko break these traits of millionaires down into seven basic factors (quoted from pages 3 and 4):
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.
Most of the rest of the book goes on to outline Stanley and Danko's findings on each of these factors. A chapter is devoted to each factor, bookended by an opening and a closing chapter.
For me personally, evaluating my life as a snapshot through these factors made it clear how different the old, crazy spending me was different from the newer, financially sound me. The biggest hurdles for me were living well within my means and not worrying about displaying social status; I bought into the psychology that the appearance of affluence was of vital importance, when what really matters is the money in the bank.
What's Inside The Millionaire Next Door?
On Spending The early chapters of this book really focus on defining this profile of a typical American millionaire, and it turns out that they're actually very thrifty. The early chapters do a solid job of exposing the pop culture concept of a millionaire - that of the wild spender with an extravagant home and material goods - as just that: a construct of popular culture.
This concept is perhaps best explained by a portion of the second chapter which describes four questions to which the answers determine whether you're living a wealth-building lifestyle or expending your wealth maintaining your lifestyle:
1. Does your household operate on an annual budget?
2. Do you know how much your family spends each year on food, clothing, and shelter?
3. Do you have a clearly defined set of daily, weekly, monthly, yearly, and long-term goals?
4. Do you spend a lot of time planning your financial future?
Unsurprisingly, the more "yes" answers that people give to the above questions, the more likely they are to have established significant personal wealth. For me, these questions were somewhat comforting, as I am now able to answer these questions with three strong "yes" answers and a "mostly" answer (the budget one is still in process), which compared to the four "no" answers that I would have delivered a month ago indicates that I'm psychologically improving my financial state.
The most powerful point (for me) was the strong correlation between time spent planning and considering personal finance and the actual presence of wealth. The extensive surveying that provides the backbone for this book repeatedly shows a direct relationship between attention to financial planning and accumulation of personal wealth. The people described in this book as prodigous accumulators of wealth generally invested the time in assembling highly detailed budgets and mechanisms for tracking their spending, while the underaccumulators did not invest the time.
The first chapters did expose a major flaw in the book, though: The Millionaire Next Door has a strong anti-youth bias. Early in the book, the authors define a simple rule of thumb for estimating one's net worth: multiply your age times your realized pretax annual household income from all non-inherited sources and divide by ten. Go on, do it yourself.
When I did this, I was shocked as to what the formula expected as a net worth for me: over a quarter of a million dollars. I've only been in the workforce for four years and I have a big pile of student loan debts, so I've worked hard to manage to just recently achieve a positive net worth. I'm not alone in this situation - many younger people have had to take on substantial amounts of debt in order to finish school, so only a very lucky or a very exceptional person under the age of thirty five could come anywhere close to matching this rule of thumb. Of course, when you hit your stride in your late forties and fifties, it's a solid rule of thumb, but the formula is simply not realistic for many younger people today.
Another way that the book exposes this anti-youth bias is via another interesting metric: evaluating your income tax paid as a percentage of your net worth. Now, for youth with student loans, the percentage is likely going to be quite large, but the book says that one should strive for a number approaching 7% (or even lower, if possible). For me, my income tax paid as a percentage of my net worth is probably going to be over 100% this year, and in years past it was infinite (as my net worth was negative). This is a great metric to define your progress in your forties and fifties, but for younger people, it's a metric that paints an overly critical picture of our financial shape.
In short, the book often ignores the sacrifices youth make early in their life in order to maximize their earning power later. The reason for this bias is in their sampling: everyone interviewed in the book is already well into middle age. They focused on the people that have already had many years to either accumulate wealth or put themselves in a position where their income is barely able to cover their lifestyle while largely ignoring the people early on who have to make sacrifices to allow themselves to be able to make such choices at all. For a younger reader such as me, this book often feels like a peek ahead at issues I'll be concerned with in ten years; it's nice for long-term thinking, but not as useful in preparing my finances now for financial accumulation while managing young children and a first home purchase.
On Learning One chapter of the book focuses on that most venerable of status symbols, the automobile. Millionaires tend to buy late-model used and underdramatic automobiles and use several techniques to obtain optimum value on the car. It's important to note that "optimum value" doesn't always mean the absolute lowest price, but instead refers to the lowest price that can be found with a reasonable amount of work invested in the hunt. One technique that particularly stood out was the concept of faxing requests for offers on a very specific model to several different dealers, then taking the best one of the lot - a very effective way of effortlessly creating a blind auction.
After this, the book spends two chapters criticizing in great detail the process of giving what the book calls "economic outpatient care" to children. In short, the book is highly critical of any sort of financial support to adult children. This philosophy is broken down into four clear points:
1. Giving precipitates more consumption than saving and investing.
2. Gift receivers in general are never able to fully distinguish between their wealth and the wealth of their gift-giving parents.
3. Gift receivers are significantly more dependent on credit than nonreceivers.
4. Receivers of gifts invest much less money than do nonreceivers.
Taken as a whole, these four points clearly indicate the solution to the problem: people who wish to instill good financial sense in their adult children do not provide them with any significant economic support. In general, I agree with this philosophy.
Unfortunately, the age bias that I discussed
yesterday rears its ugly head again in this section. Virtually all of the advice that deals with how to distribute money to children focuses on adult children; there is little discussion on how the average millionaire instills strong financial values in their own children. I already intend to cease regular economic support of my child upon the arrival of his eighteenth birthday, but how can I prepare him for this change? The book offers few clues, generally only ones that apply to both adults and to younger children.
There is one interesting phenomenon mentioned here that I've noticed repeatedly in my own life: parents tend to give more money to children with poor financial skills than to children with strong financial skills. Even in my own family, this is true; parents often give what little they have to the child who shows the least independence, while the child that works hard and shows the most independence get little assistance. On some levels, this makes sense, but on others, it merely reinforces poor behavior in the financially dependent child and can inspire resentment in the financially independent child. This further reinforces the idea that economic outpatient care is a bad idea.
On Living The final portion of the book focuses on finding one's niche - how can one find a role that will enable them to cultivate a healthy financial garden?
This final portion of the book felt very tacked-on and fell quite flat for me. It is quite brief and the content stands apart from the solid material that fills up the 90% of the book that precedes it.
In a nutshell, The Millionaire Next Door recommends that people seriously investigate service industries that cater to millionaires as a way to raise more money. They spend an entire chapter listing possible services that millionaires (as profiled in the book) are interested in or may become interested in in subsequent years.
The book closes by strongly encouraging people to become entrepreneurs. The final chapter is a lengthy pitch for starting your own business, as this is the best way to achieving great financial success. The book mostly paints a rosy picture of entrepreneurship, when in fact most small businesses fail within the first year. I feel that this again exposes an age bias in the book; most young people today are already at a level of debt that far exceeds what the baby boomers were experiencing at a similar age. This is due to the rising costs of education and the exploding housing market, both of which have aided the boomers in becoming millionaires themselves (at least the ones profiled here).
Buy or Don't Buy?
The Millionaire Next Door has a substantial amount of good content - more than two hundred pages of non-filler written in a reasonable sized typeface. This is in contrast to many personal finance books which are written in an enormous typeface in order to spread out a small amount of content to the point where it appears to fill a larger book.
The material in the book is cohesive and presents a logical and straightforward worldview, meaning you won't find contradictory statements throughout. The writing is very readable; I'd even go so far as to call it a "quick read," though the book wasn't all that short.
My primary nitpick with the book is the prevalent age bias. There is very little of this book that addresses people under 40 or people who are just getting started with personal finance outside of some general guidelines that can be found in any personal finance book. The meat of this book is written for people who are approaching retirement and are dealing with adult children, a situation that (for me) feels a long way off.
I give the book a "buy" recommendation if you are over the age of forty, if you have substantially greater assets than many people in your age group, or you are interested in long-term financial planning. The book does a great job of outlining what people should be doing in middle age if they want to build substantial wealth (and enable their families to carry on this tradition) for their later years.
On the other hand, I give the book a "not buy" recommendation if you are young and without appreciable assets. At this point in your life, the focus should be on building a solid foundation for your financial life and this book does little to address that topic. Your time and attention is almost assuredly better spent somewhere else.
I originally reviewed The Millionaire Next Door in five parts, which you may view
here if you'd like to read the original comments.
The Millionaire Next Door is the first of fifty-two books in The Simple Dollar's series 52 Personal Finance Books in 52 Weeks.