How The Millionaire Next Door Got That Way Save. Don't spend. When you do have to spend, be frugal. Then someday you, too, could be a millionaire. Really!
By Andrew Serwer; Tom Stanley

(FORTUNE Magazine) – The Millionaire Next Door looks like another of those self-help, get-rich-quick books you see at airport newsstands. But this bestseller is really different. Instead of tossing out axiomatic fortune cookies, it presents case studies of who's really rich in America and how they got that way. The payoff is that as the authors dissect the behavior and fiscal patterns of these millionaires, they impart the ways and means for you, the reader, to become wealthy too.

Most people think real wealth comes from inheritance, or from striking it rich on Wall Street or in Silicon Valley. This book shows that most millionaires don't fit that stereotype at all. Instead, they are hard-working, hard-saving folks who literally live next door. Their secret, says co-author Tom Stanley, is not so much earning a megasalary as it is saving and not spending. For some lucky people, accumulating wealth is second nature. Fortunately for the rest of us, Stanley says it is behavior that can be learned. I recently dropped by Tom Stanley's house in suburban Atlanta to chat with him about his book and the millionaires next door.

So, Tom, it was Scott Fitzgerald who said the rich "are different from you and me." Turns out that's true, but not in the way most people think.

That's right. They're different in ways that are hard to see. The rich are like the guy I know who owns a pest-control company in Miami. Or the guy who owns a heating and air-conditioning contracting company. He's worth over $5 million. But he lives in a $150,000 house and drives a pickup. He's different all right, in that he has common tastes in terms of consumption, so you'd never know he was rich. He's not throwing his money away on consumer goods that depreciate. Most rich people aren't like the doctor who makes $300,000 a year and lives in a fancy neighborhood. That person often has a lot of income, a lot of clothes, a lot of house, a lot of car, but no real wealth--no money in the bank.

That's a key distinction you make: the difference between income and wealth. Explain.

There is a big difference, and most people don't recognize it. We are so focused on income in this country. But income is not wealth. Wealth is not income. You can't retire on income! Wealth is your assets less your liabilities.

You have that wonderful formula for determining how much wealth you should have.

Your expected wealth should be one-tenth your age times your annual household income. If you make $100,000 and you're 50, take one-tenth of 50, which is five, times $100,000, and you should be worth $500,000. I tell people to do the math on themselves.

And then you take it a step further....

If you have double, or more than double, the expected wealth threshold, you're a prodigious accumulator of wealth, or PAW. That's the category where you can retire and be very comfortable.

So in the previous example, you would need $1 million or more?

Yes. On the other hand, if you're 50 and make $100,000, and you have a net worth less than half the expected threshold, you're an under-accumulator of wealth, or UAW. So in this example, you would have $250,000 or less. These people are going to have a tough time retiring. And let me say this. UAWs are famous for stacking the balance sheet. They'll add in the value of their clothes, the value of their furniture, the value of their dog, the value of everything that has no value. What's interesting about PAWs, or millionaires, is that they consistently underestimate what they're worth. If you ask a guy who owns a business how much it's worth, he'll say, "Aw, don't know, million and a half." But when you really look at it, time and time again, it's worth $4 million. Which is great, because you're much better off thinking, "Hey, I'm not that well off," than saying, "Oh, I don't have to worry about a thing. I'm invincible."

What happens to the UAWs?

They have to keep working. Or they have what we call shock theater, where they live a lot worse off than they thought they would. It's not fun to see. On the other hand, if you're a PAW, you can live for years without ever earning a dollar. The typical millionaire can live somewhere between 12 and 16 years without earning a salary. If you have a big net worth and a relatively low income, you're going to have a wonderful time in retirement.

So what's the actual profile of the millionaire next door?

He's typically a male with a net worth of between $1 million and $5 million. He lives in a house valued at $278,000, which is not extravagant. He's self-employed or owns a business or is a partner in private business, maybe pest control or carpentry, plumbing, air conditioning, or contracting. High tech is overblown. The typical millionaire is frugal. He went to a public school. He inherited nothing. He's been married since his early or mid-20s. His wife is a housewife. They have three children. They drive a three-year-old car. Usually American. The No. 1 car in the group is Ford, particularly the F150 pickup truck. The typical millionaire never spends more than $400 for a suit. He's more likely to be active in a trade association or affinity group related to improving his position than in a country club. He buys stocks. Rarely sells. It's an amazing group of people who mostly got rich in one generation.

And you say these folks clip coupons!

Absolutely. Grocery store coupons. People say that's crazy. But this is a lifestyle. It's about control. When these people go to the store, they are prepared; they aren't just winging it. Other people go without coupons, without any direction, and they wander around spending money. They're impulsive. The millionaires are disciplined. I estimate that upwards of 85% of millionaire households clip coupons.

What about entrepreneurs vs. corporate types?

Building wealth in America is directly a function of having equity in a business. It may be through owning stock in a public business, but more likely it's that you own your own business. I remember a discussion between an entrepreneur and a corporate guy. The corporate guy was complaining that the entrepreneur's business was risky. And the entrepreneur, who happened to be in pest control, said, "I have 1,600 clients. If I lose half of them, I'd have 800 left. You only have one source of income. I have 1,600, and you're telling me I've got a risky deal?"

Too often executives at big companies think they're the company. In fact, they could be put away anytime. They rely too much on the pension plans, etc. Having said this, we do find many, many people who are employees of major companies becoming millionaires. But they took the initiative. They said to themselves, "Hey, I need to do these things: Save money, prepare, organize myself."

But being an entrepreneur goes against the grain.

Sure. In this country, corporate types have the status. Self-employed people have trouble getting health insurance. Wouldn't you rather go around and say, "I work for IBM," as opposed to saying, "Oh, I'm in the exterminating business, or a scrap metal dealer, or a port-a-john dealer?" But the most obscure businesses are the ones that very often produce wealthy people. That's what America is all about. We left the kings and queens in Europe.

What are the biggest mistakes people make trying to become wealthy?

They spend too much. The problem is, Americans are the marketing geniuses of the world. We have convinced people that if their incomes increase, they're superior beings. There's a ratchet effect. If you're a high school graduate, you should be driving a used Chevrolet; if you're a college graduate, a new Chevrolet; if you have an MBA, a BMW. I'm out here the other day washing my car, and two neighbors come by and ask, "When are you going to move?" That was when the book first got on the New York Times bestseller list. But how much bigger a house do I need? It's a four-bedroom house. It's brick. I like it. It's paid for. But that's the way people think. As soon as we have an income change upward, we've been programmed to buy bigger houses, bigger pools, more expensive clothing.

So you're suggesting we don't buy things, which sounds depressingly frugal. Do you have to give up all the finer things in life to become rich?

No, not at all. I know a wonderful physician who's in his mid-50s. He's owned only two cars since he graduated from medical school. Both were Mercedes. Both were used. He said to me, "Tom, these are the finest cars in the world. They should last 200,000 miles, but I don't have to buy them new." The last time he went back to buy one, five years ago, they tried to sell him a new one. He said, "How much is the used one?"--which was three or four years old. It was $20,000 to $30,000 cheaper, so he asked himself if the pride of new ownership was worth $20,000. And he said, "Hell, no." He bought the used one. In fact, according to our surveys, 37% of millionaires buy used cars. By the way, leasing cars is the worst. When you trade your car in, you have no value.

What are concrete steps people can take to become wealthy?

Maximize your unrealized income. Let me explain. Realized income is reportable, taxable income. Unrealized income is when your wealth appreciates, but you don't take it in income. That's the key to becoming wealthy. For example, you might be buying stocks in companies that don't pay dividends. The problem with mutual funds is that every year they've got to declare a dividend, and you're going to pay tax on that. The wisest investors, and the majority of the millionaires we've interviewed, are people who own stocks directly and don't trade much. They're not taking capital gains. They're not taking dividends. They're building a portfolio. Other unrealized income might come from a business. You might have a factory or a company that's growing, and you're putting money back into it. You're not taking it as income, and the business becomes more and more valuable. Or someone owns scrap metal. The more scrap metal he has, the more wealth he has.

How big a salary do you need to become rich?

Most millionaires have realized income of under $100,000 a year. We've interviewed millionaires who make $60,000 a year. If the typical millionaire has a net worth in the $3 million to $4 million range, his total realized income--and that includes wages, salaries, commissions, capital gains, all reported taxable income--is something like 6% to 7% of his wealth.

What about taxes? How should people think about them?

Think about taxes in terms of your net worth, not your income. The typical household makes between $35,000 and $45,000 a year. It pays about 10% of that income in taxes. It just so happens that the typical household is also worth about $40,000. That means it's spending the equivalent of 10% of its wealth every year on taxes. Okay, now let's look at a millionaire who's worth $4 million. He made $200,000 last year, and he's in the 36% bracket, so he pays taxes of about $70,000. Now $70,000 as a percentage of $4 million ain't a lot of money; he's paying about 2% of his total wealth in taxes. A lot of people others might consider rich because they have big incomes spend 20% or 30% or 40% of their net worth every year on taxes. That's because they don't have much net worth. They're what you call "big hat, no cattle." People should look at all their expenses--a new car, an education, a home--as a percentage of net worth rather than just income.

Big question: How much money should you give your kids?

First of all, there are different ways of giving money. One is education. Absolutely wonderful; 43% of millionaire grandparents pay for their grandchildren to go to private grammar schools and high schools. So education, fine. But you have to draw a line. A guy called me the other day. His son makes $30,000 a year. The son wants his father, who's worth $20 million, to buy him a $500,000 house. The father said to me, "Isn't a house a good idea?" Of course it's a good idea. That's not the problem. When you buy a house that costs $500,000, you've got to have a decorator. You've got to have it painted. You're going to live in a neighborhood where kids go to private schools.

But even worse than buying houses for your kids is indiscriminate cash gifts, or what we call economic outpatient care. That has a detrimental effect on the productivity of kids. People between the ages of 30 and 45 who have been given substantial cash gifts have significantly less income and drastically less net worth than kids who haven't gotten anything. What happens is, we end up subsidizing the weak. Let's say you have two kids. One is an entrepreneur. Kicks ass. Quits college. Spits in your face. Does really well. He gets nothing. You've got another kid who's an alcoholic. He's had two illegitimate children. He's had 14 car wrecks, he's been in drug rehab. He will need so much help that eventually he'll end up with the bulk of your estate.

This works against women too. Say you've got a guy who's worth $10 million. He's got six children--three girls, three boys. He thinks the deck is stacked against the girls, so he gives them more, even the unproductive ones. This encourages them to do less. Forty-five percent of women in America who have incomes over $100,000 a year do not work for a living. I mean, this is astonishing. Why? Because they're getting economic outpatient care. Take it a step further: The daughter who is productive, who has the courage to start her own business, is not going to get a whole lot. But the sister who married poorly, who did poorly in school, and who's weak will get the bulk of the estate and squander it. This is why wealth changes hands over time.

So have you been able to turn yourself into a millionaire next door?

Yeah, I have, and it's really not a big deal. I think it's having basic values, not being extravagant, and having an accountant who's a wonderful financial planner. He encouraged me to start my pension plan 20 years ago. I thought he was crazy. But I struggled to put in $1,000 a month, and it's amazing how it's paid off.