I’ve found myself more interested in personal finance over the past couple months than any other time in my life. I can’t really say why, though I’m sure turning 30 has something to do with it. I’ve already talked about Seven Habits of Highly Effective People. Another book along those lines that I read over vacation and really enjoyed was The Millionaire Next Door (MND).
MND was an eye-opener in how it defines what it really means to be wealthy in America. Right off the bat, the authors define wealth as one’s net worth, rather than annual income. This is important because it underscores one of their main points that frugality is a key to getting rich. They use a football metaphor: one’s annual income is one’s “offense” and one’s ability to live low cost is one’s “defense.” It takes both to be financially successful, but, as in real football, defense wins championships. A person who earns $40k a year and only spends $35k is getting ahead and growing their net worth. A person who earns $100k but spends $110k is falling behind.
There’s a lot of good stuff in MND, and a bunch has been written about it on the web. This blog post, for example, looks at the seven factors common to the truly affluent in America (as defined by net worth) that make up the backbone of the book. But here, I’m going to simplify things and look at the three steps one can take to improve one’s economic situation. First, make a budget. That seems obvious, but it’s amazing how many people don’t do it. You can’t control spending if you don’t know how much you’re spending during the year. That’s poor defense. The authors assert that most millionaires can tell you exactly how much they’ve spent on cars, clothing, and food over the past year. I’m not that precise, but I’ve always been a budgeter, so I’m good on that account.
The second step is save and invest what you have left over. And Wait. I haven’t always been the best at this. While I’ve always budgeted, I didn’t have a real budget line for saving and investing until the past year or so. For me, the trick now is to send money to savings first and automatically, so I don’t even miss it. My goal is to have the proverbial “six months salary” saved in interest-bearing accounts by summer 2008 so I’m ready for anything, including investing in stocks or the inevitable car blowing up (I’m anticipating that in the next 18 months. It’s due.) :).
The third step is forget the Joneses. This is hard hard hard, as there is a social component to spending. If people around you are buying fancy clothes, the latest iThing, or traveling around the world, you’re going to feel pressure to keep up. But not matching others’ purchasing habits (which is often done on over-extended credit anyway — bad defense) is a key trait of the millionaire next door. He doesn’t feel the need to keep up with the neighbors. His net worth is several times theirs, but he lives in a modest house and drives an American car or a pickup truck for work. He doesn’t get a new BMW every two years, and has never spent more than $50 for a watch or $500 for a suit. His belt is tight, so he doesn’t worry about all but the worst economic downturns, unlike his neighbors, who, despite their high income, are living paycheck-to-paycheck to keep up appearances (good offense, bad defense, like the early 2000s St. Louis Rams).
Honestly, this is what I struggle with the most. I’m a single person with a non-profit salary (excellent benefits though) living in the second richest county in the U.S. and among other young adults who make and spend big money. It’s not easy to live beneath your means and feel good about yourself in NoVA (perhaps another reason to move to a crunchy Left Coast or blue collar Midwestern town). One’s productivity and affluence can be faked — just buy BMWs and designer clothes and go into credit card debt. Real net worth, like good character, is one of those traits that is not readily apparent.
How do the millionaires next door get the self confidence to say “screw the Joneses”? How do you get off the never-ending ride of conspicuous consumption? How to you stand out in the singles crowd when you think spending $600 on a new cell phone is the height of insanity? These things I need to learn.