In the 1996 book “The Millionaire Next Door,” authors Thomas Stanley and William Danko set out to find wealthy individuals and learn what a typical one looks like. They began by searching ZIP codes of the most prosperous areas only to be shocked to find that while many of these individuals displayed the trappings of wealth, many did not have the asset levels to match. Instead, they discovered that many of the wealthiest, in terms of accumulated portfolio holdings, were regular people living “next door” unbeknownst to their unsuspecting neighbors. These individuals’ habits with their time and money stood in stark contrast to how “rich people” were “supposed to” act. They put their holdings to work for them and made wise choices. You can learn from their examples.

“I like two kinds of beer, Budweiser and free.” This is one of many responses the authors got when trying to get these millionaires in for an interview for their book. Many took them up on their offer to talk with free drinks. A common theme throughout the book is that being frugal is a key tenet in building wealth. Instead of competing with their neighbor’s flashier cars, bigger houses, and material trappings, these people put their money into endeavors that provide income streams. Two-thirds of their subjects own their own business, invest purposefully, and marry spouses who share their financial values. The book divides high earners into two categories: UAWs and PAWs, “under accumulators of wealth” and “prodigious accumulators of wealth.”

Characteristics of UAWs

We often think of a UAW when we see a “rich person.” They drive fancy cars, live in a mansion, and belong to the best country club. When they dug deeper into the finances of these professionals, they found that many live paycheck to paycheck. Despite high-paying jobs as doctors, lawyers, and executives, the pressure to keep up with their peers shifted their spending habits to “look the part” for their station in life. Material possessions like cars and boats took much of their time to research and plan for but depreciated quickly after purchase. Their spouses often compete with similar high-end tastes and spending habits. A friend described her brother’s time on the Chicago White Sox, which illuminated this situation. While he made a great salary near the league minimum, his wife spent a lot of time with the other players’ wives, which happened a lot, given the extreme travel schedule. Naturally, some teammates made millions, so she tried to keep up. When his short career ended, he was left with nothing except a closet full of designer dresses and shoes and the bill from his divorce attorney. He was an under-accumulator of wealth.

Characteristics of PAWs

The PAW, on the other hand, looks like a lot of people. He buys reliable used cars because he knows they depreciate anyway, and more so when they drive off the lot. Much like the legend of Warren Buffet, he lives in a relatively modest house that is well maintained but did not upgrade to a mansion when he could have afforded one. As a business owner, he may have struggled at the beginning and become used to “tightening the belt” so he could pay their bills. Much like someone who lived through the Great Depression, they know that a safety net is important in case their variable income drops quickly. Their modest surroundings make this a bit easier as their circle of friends is not competing with BMWs and boats either. They also try to pass their example on to their children. In short, they live below their means.

The biggest contrast between UAW and PAWs is shown in how they raise their children. They opine that the UAWs demonstrate to their children that a high consumption life with material trappings is the indicator of success. Sadly, when given much (if not all) of what they asked for growing up, their offspring lacks the drive to achieve the income level to support this level of spending when they grow up. Thus, they become dependent on their parent’s largesse as they age to keep them in their accustomed lifestyle. This target is especially unrealistic for young adults who get their first “real” job. Surveys reflect that the newest college graduates expect to earn $103,880 when they begin, a far cry from the real starting average of $55,620. Not only do the sons and daughters of the UAW get frustrated with their low relative income, but the supplementation of their income from their parents is emasculating for them and their mates. This is even more true for the spouse “failing” to provide at the expected level. Compounding their plight, they feel the need to live in neighborhoods far exceeding their income, leading to more “Economic Outpatient Care” (EOC), according to the book. This EOC does not add to their assets but rather gets added to their expected income to be spent. If it gets cut off, they fall down an economic abyss.

The PAW, on the other hand, is frugal but not cheap. They value the ability to take care of oneself and encourage their children to be independent. Instead of providing material possessions, they spend lavishly on education. Their goal is to give their children the skills to care for themselves and lead a comfortable life. It is rare that they support them in adulthood, and they often achieve post-graduate success without the burden of student debt. To the extent there is help, it is to help in their accumulation of assets, like buying their first house. These children often grow up to be UAWs themselves.

The Marshmallow Test

A famous experiment in the 1970s called the marshmallow test studied the concept of delayed gratification. Kids were offered one marshmallow today or two marshmallows the next day. Predictably, many chose immediate gratification and ate one treat instead of a larger reward the next day. The researchers then followed both groups into adulthood and discovered that those willing to give up the near-term benefits for long-term rewards were more successful in life. Common indicators of this ability include staying in school for longer, eating well (not getting fat), and getting married later. All often lead to brighter futures. They do a better job passing on immediate wants for future success. Much like the PAWs, they were able to see the big picture.

The Wealth Gap

There is a stark difference between looking wealthy and being wealthy. PAWs save their money, invest wisely, and raise productive children who live independently as adults. Despite living modestly, their lifestyle is quite comfortable. Conversely, UAWs might appear to have it all, but many struggle under the weight of excessive mortgage payments, automobile debt, and dependent offspring. It is this difference that explains some of the inequality we see today. Savers grow their assets over time by living below their means. This compounds for most of their life, thus putting them further and further ahead of those who spend every penny. We would do well to remind ourselves of this when watching our investments over time. It might take longer than we want, but waiting for the second marshmallow is worth it. If you don’t believe me, just check out how many people are trying to sell their boats.   

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Photo by David Moffatt on Unsplash