In an earlier blog I revealed that only 10.5% of the variation in the price paid for a motor vehicle is explained by net worth. Later a reader asked about the relationship between the income and net worth characteristics among the 1,340 respondents from that study. Only 24% of the variation in net worth was explained by income. What about the other 76%? Much of that can be explained by lifestyle activities and habits. Especially significant is the manner in which one generates income and wealth. Of the thousands of millionaires whom I have studied, the large majority follow the rule as given in The Millionaire Next Door:
To build wealth, minimize your realized (taxable) income and maximize your unrealized income (wealth/capital appreciation without a cash flow).
As an example, let’s consider Malcolm. At age 38 he and his wife just crossed the millionaire threshold. He is a firefighter; his wife is an elementary school teacher. Every other week Malcom works 24-7 as a firefighter. During the other weeks, he buys and refurbishes houses which he rents to college students. He enjoys his “moonlighting” job and originally viewed it as almost a hobby. He and his wife purposely chose to live in a college town that is surrounded by a pristine, natural environment where the median price of an owner occupied home is less than $120,000. They live on 90% of their after tax income from their primary jobs. They invest the balance; plus they purposely generate little or no realized income from their student housing ventures. . . . but maximize their capital appreciation.
Malcolm rides his bicycle to and from the firehouse. In his off hours, he is an avid trailbiker. He and his wife camp, fish, hike and often entertain friends with simple cookouts. . . . None of these activities are expensive.
Malcolm asked me to evaluate his financial position in the context of millionaires. In Stop Acting Rich I indicated that the median age at which a millionaire crosses the 7-figure threshold is 45. Plus the typical millionaire has a realized income (median) that is about 8% of their total net worth. Malcolm’s household is in this category. But for those millionaires who are heavily invested in real estate 3% or less is more common.