I read sad news a few months ago the co-author of The Millionaire Next Door book Thomas Stanley was killed by a drunk driver
in a car accident. I checked out the book from the library for a refresher.
After I read it this time, I see the book is misinterpreted by many people.
If you ask people what The Millionaire Next Door book is about, people will tell you that it said the keys to become wealthy were frugality and living below your means. It showed most millionaires lived in modest homes, drove practical cars, and they didn’t buy expensive clothes, shoes, or watches, etc. Some people think it means frugality made them millionaires, but that would be misinterpreting the book.
The authors were very clear in the introduction that the book was only talking about people who had a decent shot to become wealthy in the first place. They wrote:
How come I am not wealthy?
Many people ask this question of themselves all the time. Often they are hard-working, well-educated, high-income people. Why, then, are so few affluent?
That was the scope. It was conditioned on your being hard-working, well-educated, high-income people already. Then you add frugal living, inexpensive homes, cars, clothing, shoes, and so on.
The authors’ rule of thumb for measuring whether one is a PAW (prodigious accumulator of wealth) or a UAW (under accumulator of wealth) is directly related to income.
Total Wealth Accumulated = Sum of (Income * Savings Rate * Investment Growth Factor)
It’s possible that a UAW with a higher income will accumulate a higher wealth than a PAW with a lower income .
When it comes to paying for retirement, the wealth in absolute dollars matters more than the savings rate before retirement. A UAW with $2 million will have more options than a PAW with $0.5 million.
The reason income is more important is that a person with a higher income can do everything a person with a lower income can do, including living frugally, but the reverse isn’t true. Increasing your income requires another party’s cooperation — either an employer if you work as an employee or your customers if you are self-employed.
Some people think the book showed owning a business was a better way to become wealthy than working for someone else. The book did say that 2/3 of the millionaires who weren’t retired were self-employed, and that many businesses they owned were in dull industries such as welding or pest control. However, the book didn’t say everyone should just go out and start a business.
What’s really happening is that self-employment produces a wider dispersion than working for someone else. When you only look at the top, you will find more self-employed business owners there — those who succeeded. Only looking at the successful ones suffers from survivorship bias.
Of course everybody is confident they will beat the odds. This is demonstrated in an NPR episode on a free throw contest held by a casino. Stoking people’s overconfidence is a great way to make money.
Working for someone else won’t necessarily put you to the top but it may very well be a more reliable route to arrive at “good enough.”