A common question that people often ask is: ‘How do I become financially independent?’ or ‘How do I become a millionaire?’ Many individuals think that there is a secret to achieving this goal and it is something that can be obtained overnight. In reality, there is no secret. As Thomas J. Stanley said:
“Wealth is more often the result of a lifestyle of hard work, perseverance, planning, and, most of all, self-discipline.”
The Millionaire Next Door is an incredibly insightful book written by Thomas J. Stanley and William D. Danko. Although it was published in 1996, it still remains to be one of the most meaningful and significant books I have read when it comes to finance and building net worth. I recommend everyone should read it at least once. Through their in-depth research of the habits and characteristics of wealthy individuals, T.J. Stanley and W.D. Danko prove that it is the combination of consistent, frugal, and hardworking values that allow individuals to achieve financial success.
T.J. Stanley and W.D. Danko set out to study how individuals became wealthy by surveying people in upscale neighborhoods across the United States. They quickly came to realize that the wealthiest individuals do not actually reside in these upscale neighborhoods and in fact live in more modest areas. The people who lived in these large and expensive homes with luxury vehicles were often spending beyond their means and living an extreme consumer lifestyle. Although some of the individuals appeared to have a lot of money due to their possessions, they had minimal savings and debt, which meant they were living pay cheque to pay cheque.
The most important lesson that is presented in this book is that wealth is not the same as income. If an individual is making a lot of money but not saving anything, they will have minimal net worth and will not achieve financial freedom. It is those who save and are conscious of their money on an on-going basis who will experience the benefits of financial independence and freedom. T.J. Stanley and W.D. Danko developed an equation to help determine one’s expected wealth considering their age and income:
Expected Wealth = [age x pre-tax annual income] ÷ 10
This equation helps determine the expected net worth of an Average Accumulator of Wealth (AAWs) and can be used as a benchmark. An AAW is someone that does not overly spend but they are not exceptionally wealthy either. T.J. Stanley and W.D. Danko used the terms Under Accumulator of Wealth (UAWs) and Prodigious Accumulators of Wealth (PAWs) to distinguish between those who are wealthy and those who are not. UAWs have high incomes however, they have less than half of their expected net worth. PAWs on the other hand have twice their expected net worth. Through studying UAWs and PAWs and their habits, T.J. Stanley and W.D. Danko found that there are consistent characteristics that sets them apart.
UAWs allow their budget to be defined by their income. If an UAW receives a pay increase, this translates into their budget increasing. This mentality leaves them to rely on their income to maintain their livelihood. If they lost their job, they wouldn’t have any savings or income to support them. UAWs spend a lot of time stressed and worried about how they will get by and little time on budgeting and planning. Their material possessions become more of a burden than a luxury because of their poor financial standing that results from these large and abundant purchases.
“All too often young people are indoctrinated with the belief that ‘those who have money spend lavishly’ and ‘if you don’t show it you don’t have it.’”
This belief unfortunately promotes individuals to spend their hard earned income instead of saving it leaving them in a poor financial position and ultimately not having much wealth.
PAWs contrastingly are very frugal and they dedicate time to budgeting and planning. They spend below their means and opt to make economically friendly decisions. T.J. Stanley and W.D. Danko made the comparison between personal finances and fitness and emphasized how they both require consistent upkeep. Those who appear healthy and wealthy, don’t come across as someone that needs to worry about their health or their finances however, it is that exact reason why they are fit and in good financial standing. PAWs accumulate their wealth slow and steady through their consistent routine and commitment to working, planning, investing, and consuming. They do not waiver from their money conscious values.
One of the lessons that I have taken away from this book is that it is important to approach and operate your household like it is a business. Businesses require plans with short and long term goals and they also seek to hire the best people to fulfill their needs. It is important to set aside time to determine your financial needs and goals and to put a process in place that will allow you to achieve it.
When you are consistently saving and you are investing in great quality dividend paying stocks it is pretty staggering what the impact of the power of compounding can have on your net worth. Additionally, investing in companies that pay a growing dividend on a consistent basis will provide you with an income, which you can live off of. No matter if the price of the dividend paying stock is up or down, the growing dividends provide you with an income that can be used to allow you to live life your way.
"How will you replace your current income in retirement?"™ - Jim Seyers