Getting into Financial Shape with the Decamillionaire Next Door

The following guest post is by Roshawn Watson from Watson Inc. Learn more about Roshawn immediately following the post.

During a time of rampant pessimism and economic turmoil, a record number of Americans cannot even contemplate becoming a millionaire in the next 10 years. It may appear a little untimely to write about wealth; after all, many are just trying to stay afloat. However, I submit to you that there is no time like the present to get into financial shape. That’s because although the Great Recession exposed the vulnerabilities of many families, some families have also gained a heightened awareness of opportunities and resolve to strengthen their finances. One of the best ways to achieve this is to learn from people who have successfully managed their money.

Today, we’ll delve into key lessons from the Tiger 21, a club for decamillionaires. I recently read an account from one of their meetings suggesting that the typical American family can get into better financial shape by employing three simple steps.

1. Maintaining Adequate Liquidity

Liquidity is essential in today’s challenging economic times; more importantly, during your own personal economic crisis, whether it be a job layoff or a gigantic car repair bill, having liquidity can give you a peace that too few experience. At a minimum, consider maintaining an emergency fund of at least 8 months worth of expenses AFTER you are debt-free excluding the house. Admittedly, this IS risk-adverse, but it is also a NECESSARY precaution because: a) job security is an illusion, b) most real estate values have seen significantly better days, c) it’s hard to convince yourself to sell equities in an emergency (especially if the market happens to be down at the time of said emergency), and d) it may be hard to obtain loans from banks when you need them the most (instead banks may close your credit line if they aren’t certain they will be paid back or may demand the balance of your loans if you default).

Liquidity is not trivial. In terms of emergencies, Money magazine reported that 78 percent of families WILL have a major unexpected event within the next ten years. In other words, LIFE WILL HAPPEN, but whether or not you are prepared is up to you. Moreover, liquidity is not just for emergencies. According to the Millionaire Next Door, most millionaires can survive for more than 12 years without working. I’m not suggesting that all of that is in cash or near cash-equivalents, but the point is that having liquidity mitigates some risks. That’s the very reason businesses deleveraged back in 2008. Liquidity decreases our absolute dependency on our income.

Indeed, it may be your best defense after eliminating your consumer debts WHEN life happens.

2.Are You Insured?

Typically, we hate insurance until we need it. Purchasing adequate insurance also reduces our financial risks.

a) Long-term disability insurance is important because it replaces your income in the event you become disabled. Still, it is one of the most underinsured areas. The Senate Finance Committee reported that 70% of people between the ages of 35 and 65 will become disabled for three months or longer, and 90% of these disabilities will occur “off the job”. Don’t think Social Security will necessarily pick up the slack either. Many people with legitimate claims are rejected on a daily basis. Fortunately, some employers offer long-term disability insurance, so check with your benefits coordinator to see if you are covered. Otherwise, purchase an individual policy. Although an individual policy is more expensive, the peace of mind is well worth it.

b) Adequate life insurance is also critical so that the death of a loved one does not financially ruin a family. It seems morbid to talk about death, but if one has dependents, life insurance is critical. Many who have life-insurance do not have an adequate amount of coverage. One should have between 10-12 times his annual wage in insurance. For example, if a household’s income is $50,000 annually, a $500,000 life-insurance policy should suffice. Let’s crunch the numbers. A 10% annualized return on $500,000 would generate $50,000 per year; thus, the income has just been replaced. Do not let an untimely death devastate your family financially as well as emotionally. Lastly, go with a good term-life policy. You can obtain these for pennies on the dollar, especially compared to whole life.

c) Health Care insurance is an obvious must. Medical bills consistently rank among the number one cause of bankruptcy. Even a major medical insurance plan with a high deductible would represent an adequate start, especially if your family is relatively healthy. Also, consider a Health Savings Account (HSA) or obtaining coverage through an association (sometimes you can get significant discounts) if your job doesn’t provide you insurance as a benefit or if you are self-employed.

3. The Person in The Mirror

Most of us can get wealthy if we learn how to control the person in the mirror. According to the Tiger 21 club, it’s not a matter of “what can I afford to spend” as much as “what do I need to spend?

Did you know decamillionaire households are more likely to accurately an answer to the following: my grocery expenses are “X” and my clothing expenses are “Y” than the typical American family. Consider the implications of the following statements:

  1. More than two-thirds of grocery store shoppers in America today are impulse buyers.
  2. Two-thirds of millionaires surveyed (62.4 percent) know how much their family spends each year for food, clothing, and shelter.
  3. For every 100 millionaires who don’t budget, there are about 120 who do.
  4. Moreover, greater than half of the nonbudgeting millionaires invest first and then spend the balance of their income. In other words, before they purchase clothes, housing, food, etc., they pay themselves first a minimum of 15% of their annual income. Even without a budget, they are clearly controlling their income.

In short, those with more means are more likely to control their expenses(i.e., groceries, clothes, etc.) through budgeting than those with lesser means. If this is counterintuitive, remember that IT TAKES WORK TO BUILD WEALTH! Forget the media images of celebrities and Wall Street whiz-kids, most people who build considerable wealth may never get a substantially large pay check.

Frugality is the cornerstone of wealth-building. A good defense is critical to your wealth equation. Who better than decamillionaires to have internalized this lesson? If you consistently practice fiscal restraint and invest wisely, your money will eventually work harder than you.  Contemplate living off of just a small fraction of your wealth. The typical millionaire household lives on just 7% of its wealth.  That’s the kind of restraint I’m referring to.

The Income Myth and Parting Thoughts

Let me reiterate that it’s not about income as much as the media seems to represent. That’s because regardless of whether you make $50,000 or $500,000, you can still be broke! It is infinitely easier to earn a high income than it is to build substantial wealth.

  • Fewer than five thousand of the nearly 100 million US household will earn $5 million in a single year.
  • The majority of millionaires earn a small fraction of $5 million in a year.
  • Few could even become millionaires and support a high-consumption lifestyle simultaneously

Consequently, regardless of your income, I believe there is something to be gained from running an economically-productive household. By maintaining adequate liquidity, protecting your household with the appropriate levels of  insurance, and exercising fiscal restraint, you can build a financial house that is not easily destroyed by unexpected tragedy and lay the foundation to build extraordinary wealth. That’s financial peace that no flat screen, Gucci bag, or Lexus can even touch.

About the Author

Roshawn writes at Watson Inc. on eliminating debt,investing money, and building wealth. Get his free eBook Your Foundation to Wealth by signing up for his email updates (no spam I promise). Get his RSS feed and connect with him on Twitter @roshawnwatson too.

Comments

  1. I personally found some of the statistics you share about millionaires intriguing. I had no idea about the habits of most real millionaires until I read Millionaire Next Door. This post is along that same vein. Good post.

  2. One benefit of working at a decent company is that you get good benefit. For me, all the insurances listed in this post are covered by my company. Long term disability and life insurance ($200k worth) is free and health insurance is covered 80% by the company. It really helps to have a good benefit or else I would be paying much more for these extra insurance. What’s your benefit like?

    • Just a word of warning on company provided insurance. Don’t count on it! Leave the company for any reason (layoff or by choice) and you need to reapply at your next job. In addition to being older than when you qualified at your last job, you are in all likelyhood less healthy or at least have more medical history. You may not qualify for the same coverage, or at least not at the same rates.

      We learned this the hard way. My husband was laid off after 25 years with the company he joined out of college. As a 21 year old he had qualified for the maximum life insurance coverage available $500k, and fully covered by the company. When he was laid off at 46, he was now a middle aged man who’d had a stroke at 41 (not after affects but it’s still on your “record”. He new employer’s health benefit provider declined to cover him for anything more than an amount equal to one year’s salary, which is their basic coverage. He’s now considered too risky. We’ve instead taken out private life insurance to make up the difference, at a cost of over $200/month.

      Consider any “free” insurance you get from your company as a bonus but don’t rely on it. Get private insurance when you are young and healthy so you never need to be reassessed later when you aren’t as appealing to them.

  3. Grr, I hit a key and my comment disappeared.

    Anyway, great, great post Shawn. I know that I need a great emergency fund than we have, but then again, I don’t know if I will ever feel like I have enough. All I know is I didn’t like the statistic about the percentage of people that will have an unexepected event happen in the next ten years. (Good events are welcomed though!)

    I was just talking with someone who only has 50k in life insurance, yet he has 2 little kids and his wife doesn’t work. He said he can’t afford it. To me, some things are not an option, and insurance is one of them.

    Enjoyed your article!

    • Yes, I agree Kris. I tend to be risk-adverse although it doesn’t always come naturally. I get it from other people, which is a good counterbalance for me personally. Anyway, the risk of having an emergency in the next 10 years is high, so being adequately prepared is a great way to manage that risk. I think a well-funded EF should be large enough to catch the majority of problems. However, once you become a millionaire, you actually have a much larger EF called wealth :) The average millionaire can survive for at least 12 years without working. Just imagine what you could do when you become a decamillionaire!

      BTW, only having $50K in life insurance with three dependents is not going to do much at all. His famnily can’t afford NOT to have insurance IMHO. Thanks so much for the kind compliment; I’m so glad you liked it. Cheers!

  4. Excellent words and posts. My wife and I are multi-millionairres after years and years of applying disciplined spending, saving, and investing. We picked up a copy of The Millionairre Next Door and realized it described us, almost exactly. Our friends tease us for driving a Toyota Solara and a ’93 Ford Explorer…to which my response is “and how much do you owe on your depreciating asset?” What we see so prevalent in society is that people define their wealth by a fancy car that they make HUGE payments on. We make no payments and don’t define ourselves by the paint color or interior material of our road device that takes us from place to place. Don’t get us wrong, our cars are comfortable, however average they are. Being wealthy is as much about knowing when to spend as when not to spend. We have spent 100′s of thousands of $$ investing in our businesses (which are tax friendly and produce positive passive income). As my Dad said “I’ve been rich and I’ve been poor….I like rich better”. My dad is the most frugal guy I know…and he’s a decamillionairre. Cheers, Fred

    • Hi Fred,
      Your priorities sound so right on! I wish more people would celebrate your family’s example. Your dad established a wonderful legacy. Fortunately, it is one that you were able to incorporate into your own family’s finances with very fruitful results. Congratulations! I absolutely LOVE hearing stories like this!

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