Archive for May, 2009

Economic Outpatient Care

Posted By damien on May 23rd, 2009

payment“Economic outpatient care refers to the substantial economic gifts and ‘acts of kindness’ some parents give to their adult children and grandchildren.”

-The Millionaire Next Door

Another interesting finding from authors Thomas Stanley and William Danko is the contrast between the average millionaire and his/her children and grandchildren. The average millionaire went to public school, came from modest means, and did not receive monetary help from his/her parents. They are frugal (as outlined in previous posts), that’s how they became wealthy! But after they become wealthy and have children, their spending habits change.

For some reason, the millionaire parents spend lots of money on their kids, not giving them the same upbringing they received. The authors muse that perhaps the parents are ashamed of their humble upbringings, or they just don’t want their children to go through the struggles they did while growing up. Either way, the millionaire parents end up giving lots of money to their children, well into their child’s adulthood, in what the authors call “economic outpatient care”.

“These parents feel compelled, even obligated, to provide economic support for their adult children and their families. What’s the result of this largesse?…In general, the more dollars adult children receive, the fewer they accumulate, while those who are given fewer dollars accumulate more.“

Now, the authors do state that some monetary gifts are good for children: tuition, money to help start businesses. In other words, investments in the child can have positive effects on that child’s ability to become financially independent. But cash handouts are what make children of the affluent dependent on their parents’ affluence.

In my next post I will outline some of the guidelines The Millionaire Next Door gives for wealthy parents trying to raise children without spoiling them.

Posted in Building Wealth
Comments (0)

Millionaires Realize Less Income

Posted By damien on May 15th, 2009

taxesMore from The Millionaire Next Door: Following the statistic I pointed out in the last post, “[The average millionaire's] total annual realized income is less than 7% of their wealth”, I wanted to post an excerpt from the book that elaborates on why they realize so little of their income. It’s a lengthy passage, but learning and applying the principle taught in it will save you lots of money and teach you one of the “secrets” of the wealthy.

The typical millionaire in our surveys has a total annual realized income of less than 7 percent of his wealth. This means that less than 7 percent of his wealth is subject to some form of income tax…Millionaires know that the more they spend, the more income they must realize. The more they realize, the more they must allocate for income taxes. So millionaires and those who will likely become affluent in the future adhere to an important rule:

To build wealth, minimize your realized (taxable) income

and maximize your unrealized income

(wealth/capital appreciation without cash flow)

Income tax is the single largest annual expenditure for most households. It is a tax on income, not on wealth and not on the appreciation of wealth if this appreciation is not realized; that is, if it does not generate cash flow.

What is the message? Even many high-income-producing households are asset poor. One reason is that they maximize their realized incomes, often to support high-consumption lifestyles…It takes much discipline to become affluent. We have interviewed many people worth $2 or $3 million who have total realized annual household incomes of less than $80,000.

How much does the typical American household realize in income each year?…nearly the equivalent of 90 percent of its net worth. The result is that the typical household in America pays the equivalent of more than 10 percent of its wealth in income taxes each year. How about the millionaires whom we surveyed? On average, their annual income tax bill is an amount equal to only a bit over 2 percent of their wealth. That is one of the reasons they remain financially independent.

So, to recap: income tax is a major expense for the average American household. Millionaires reduce the amount they pay be directing their money into investments, rather than consumption, and live off less. Their money is then able to earn interest and grow their personal wealth rather than the government’s.

Posted in Building Wealth, Business
Comments (0)

Portrait of a Millionaire

Posted By damien on May 6th, 2009

keyJust finished The Millionaire Next Door, an interesting book about a study done to find the “average” millionaire. The authors (Thomas Stanley and William Danko) set out to discover what the average millionaire really looks like, as opposed to the opulent playboys that the media tells us they are. Their findings reinforce the good, old-fashioned qualities of frugality, hard work, responsibility and fidelity.

Here are a few of the (more interesting) attributes the authors list as a “portrait” of the average millionaire:

  • A 57 year-old male, married with three children. About 70% of them earn 80% or more of their household’s income.
  • About 20% are retired, and of the working, 2/3 are self-employed.
  • Many of their businesses could be classified as dull or normal: contractors, rice farmers, owners of mobile-home parks, owners of janitorial services, pest controllers, coin and stamp dealers.
  • Their total annual realized income is less than 7% of their wealth (net worth), meaning that they live on less than 7% of their wealth. (Now that’s frugal!)
  • About 80% are first-generation affluent (self-made millionaires, not inheritors of wealth).
  • Only 17% of them ever attended private elementary or high school, but 55% of their children do.

The book contains many more generalizations about the wealthy, but these were some that I found most interesting. I thought that many of the millionaires would be in flashy sectors of the economy, such as lawyers, physicians, stock brokers and the like. But they aren’t. (This study was done in 1996, so some of the data may have changed since then.) In fact, the authors call these types under-accumulators of wealth because they should be wealthy (high-income) but for some reason they aren’t.

The main reason the authors found for the under-accumulation of wealth in these high-earners is that they don’t play good defense. They earn lots (good offense) and they spend lots (bad defense). Why do people in flashier occupations spend more than the millionaires in dull sectors? Because it’s part of the image that comes with their occupation. To be seen as a successful lawyer, they have to have a large house. If they have a large house they have to have nice cars to park in front of it. If they live in a nice neighborhood then their neighbors send their kids to private school, so they have to send theirs as well. Their employment creates a cycle and culture of consumption.

The truly rich, those who play a good offense (high income) as well as a good defense (frugal, thrifty) are often business owners in dull sectors. Being in these less-flashy markets, their peers are less flashy. The owner of a janitorial service does not have to wear a $3,000 suit to work. In fact, if he did, many of his employees might feel he is not paying them enough or that he is a “snob” of a boss. It will have the opposite effect for his image because he is in a blue-collar environment.

Interesting stuff, and very different from what the media tells us about the wealthy.

Posted in Building Wealth, Business
Comments (0)
Get Adobe Flash playerPlugin by wpburn.com wordpress themes