Category: books

 

“I drink two kinds of beer—free and Budweiser”—millionaire interviewed in book

The Millionaire Next Door definitely deserves a place near the top of any list of books on personal finance.  Its two authors, Thomas Stanley and William Danko, were two professors who undertook a massive study of America’s millionaires to figure out what made them tick.  How did they get rich? How did they stay rich?  And generally, what are their views on money?

Reading this is almost like watching an archaeological documentary on PBS with Will Lyman narrating: “Americanis Millionairo is a subspecies whose prodigious wealth-building abilities have been studied for centuries.”  Basically, the authors conducted thousands of interviews with millionaires and asked them questions on nearly every subject of personal finance, and the book is those survey results.  Nearly every aspect of millionaires is examined to find common themes—working income, country of origin, education, divorce status, occupation, Rolex-ownership, and a hundred others.

Distilled down to its simplest, the book reaches two conclusions which are really opposite sides of the same coin:

• Frugal spending habits are the single biggest factor to being able to become a millionaire.
• Flashy spending occurs among a small minority of millionaires, and in fact flashy spending tends to be a major factor to not becoming a millionaire.

For those aspiring to be millionaires it’s a wonderful how-to guide on becoming rich the slow-but-steady (and boring) way of spending less than you earn, making luxuries an special indulgence instead of a daily staple, and generally have a grounded view on life and expenditures.  It’s analysis shows that most millionaires get that way by prudent spending and diligent saving; not by having jobs that pay million dollar salaries, not by inheriting the money from rich relatives, and not by “hitting it big” in some venture.   It’s this element of the book that is most powerful—it democratizes millionairehood (I just made that word up).

For those who are already millionaires and became so by leading a life with “sensible spending”, I think it provides comfort that they aren’t alone.  Our society is bombarded with images of what “rich” people should look and act like.  In the 1980s shows like Lifestyles of the Rich and Famous (I must confess a favorite of mine as a kid) celebrated the over-the-top extravagance of the wealthy.  That tradition has continued with a myriad of shows like Platinum Weddings (a favorite of Foxy Lady) and Million Dollar Rooms to name just two.  However, the book does a tremendous job of breaking through those stereotypes to show that the vast majority of America’s wealthy are just normal people who spend their money sensibly or even frugally.

 

In true academic fashion (one of my criticisms of the book is that is reads more like a research paper than a bestseller, but it is a best seller, so what do I know?) the authors break down pretty much every demographic element of millionaires and just as interestingly, those people who make a bunch of money but aren’t millionaires.  Some of the findings are obvious like there are a lot of millionaires who started their own business.  But others are make a ton of sense but wouldn’t have been top of mind as such a determining factor; an example of that is divorce which the authors describe as a millionaire killer (Foxy Lady—have I told you how much I love you?).

They slice and dice things and thousand different ways.  What do you want to know about your average millionaire?  Average age of car (2-3 years), percentage self-made (80%), attended public schools (55%), ancestry (Russian followed by Scottish), percentage who have a JCPenney card (30%), and on and on.

 

Of course, I look at these things through an investing lens, and I was a bit disappointed that the authors spent so little time on this subject.  In a book with almost 300 pages, only about 4 or 5 are dedicated to what millionaires do when investing their money.  And this seems like a major gap considering that investing can be as responsible for building wealth as earning the money in the first place.  They cover the most the millionaires have paid for a suit, a watch, a pair of shoes; but they don’t talk about what type of investments they make?  Seems weird.

The three major takeaways about investing you get from the book are:

• About 80% of millionaires do invest in stocks and other securities. This seems obvious, and actually a little low.  What are the other 20% doing.
• Most use a “buy-and-hold” investing strategy as opposed to actively and frequently trading stocks. I’m glad to see this (this is a topic for another blog post).
• Considerable time is spent discussing how millionaires go about hiring a financial advisor.

If I had my way I would have loved the authors to really dive in here.  If you believe that the point of the authors writing this book is to show the masses how they can become millionaires (and I believe that to be true), then after they adopt the “frugal” spending habits, then it becomes important to know what to do with the money after they’ve saved it.  Here is my list of a few questions I would have loved to know:  What percentage use a financial advisor versus do it themselves?  Do they tend to invest in individual stocks or mutual funds?  How much of their portfolio is in stocks versus bonds?

 

Overall, the book reads a little stiff, and at some times it gets preachy (especially the section on how to discuss money matters with your kids) so that’s a bit of a turn off.  Also, it was written in 1999 and because of that there are a lot of areas that are quite dated and don’t really apply to the world 2015.  But it does provide tremendous insights into their everyday activities of these people and how those have help them accumulate so much wealth.  For all that it gets 2 ½ stocky foxes.

 

As a closing note, I want to thank my coworker who gave me this book as a Christmas gift back in 1999.  You know how you are, and I hope you know how much I enjoyed reading this.

“One ring to rule them all.”  –JRR Tolkien, Lord of the Rings

A Random Walk Down Wall Street by Burton Malkiel literally changed my life.  Back when I was an undergrad at the University of Pittsburgh, and I was showing a budding interest in finance, a professor recommended this book to me.  I ripped through it in about two days.  The concepts were so simple yet so complex.  It made so much sense to me, and a light bulb totally went off in my head, completely shaping the way I have looked at investing for the past 20 years.  If you’re going to read just one book on investing, this is the one you should read.

The book basically talks about two fundamental concepts of investing: what will happen in the future, and why some stocks (or asset classes) have higher returns than others.  Combine these two and you pretty much have an airtight understanding of why the stock market does was it does.

 

Efficient Market Theory

The entire book is based on the concept that stocks follow a random walk which basically means that you can’t predict their movements, especially over the short term.  Some days the market will go up, others down, and that pattern is totally random; in the same day some stocks will go up while others go down, and that is totally random.  Because of the randomness, it’s impossible to predict when the stock market will move up or which individual stocks will perform best, so you might as well invest in an index fund with a buy and hold strategy (much more on this in a future post).

 

The theory rests on two core ideas:

• New information drives stock movements and that new information affects the prices nearly instantly. So if Tesla develops a new battery technology, once that news becomes public, Tesla’s stock will rise to reflect the new value of the information.  A week, a day, an hour, or even a minute later, the market has already digested the information–the news has become old news.
• People only buy or sell stocks for what they think they’re worth. If Apple was trading at $120, but everyone knew it was really worth $140, no one would want to sell it for $120 but instead would only sell it for $140.  If there were people stupid enough to do it, their shares would be bought instantly by people who knew the stock was worth more.  This means that whatever price stocks are trading at is the “right” price.

The efficient market theory makes investing both much simpler and more comfortable.  Simpler because you don’t have to waste countless hours trying to figure out if now is the right time to buy into the market or which stock will do best.  The stock markets are completely unpredictable in the short term so now is as good a time as any.

Comfortable because any price you pay is the right price.  You could buy a stock in a company you’ve never heard of in an industry you know nothing about, and market forces have done you the favor of ensuring it’s the right price.  If the price was too high sellers would have dumped shares and brought it down, while if the price was too low buyers would have snatched up shares and brought it up.  There’s a real load off—Thank you efficient market theory!!!

 

Risk-reward

Everything isn’t totally out of your control, and the book spends a lot of time discussing the one thing that investors can do to impact their returns—take on risk.  If you like “eating well” and want bigger returns, you should purchase stocks that are fundamentally riskier; if you like “sleeping well” and want steadier returns, you should purchase stocks that are fundamentally less risky.

Use the example of Tesla and Wal-mart.  Tesla is a fundamentally riskier stock: its technology is still novel and unproven, it’s entering a market with established competitors, and the legal system works against it (auto dealerships in New Jersey and Texas).  Maybe they “win” and become a dominant auto maker, but maybe they’ll “lose” and go bankrupt.   The downside is very real, so the upside has to be especially sweet to investors to compensate them for taking the risk.  Contrast that with Wal-mart: it’s already the dominant player with enormous economies of scale and a proven strategy that has been consistently successful.  If it “loses” it might be lower sales, but most people don’t expect it to go out of business.  Since the Wal-mart’s downside isn’t nearly as grim as Tesla’s, the upside doesn’t have to be nearly as big.  So over the long-term if you invested in a diversified portfolio of risky companies like Tesla, you would get a higher return than a diversified portfolio of less risky companies like Wal-mart (as always, I’m never predicting future stock movements).

 

Malkiel does an amazing job explaining these concepts (much better than I can in a thousand-word blog) and many others, and then shows how history has proven their accuracy with myriad examples.  My copy is an earlier edition (I bought it used because I’m cheap) published in 1980s, and those concepts apply to today’s stock market just like they did 30 years ago.  Subsequent editions have been updated to include the internet boom and bust of the late 1990s and early 2000s as well as the banking crisis of the late 2000s.  There’s a part of me that almost wishes he wouldn’t come out with new editions (but I get it, republishing is a real cash cow for him) just so he can say, “Look, the things I wrote 40 years ago are exactly apply to what is happening now.”

So as you step into the pool of personal investing, this is an essential guide.  It will undeniably change the way you look at investing (for the better), and it might even change the way you look at life (geez, you’d think I had a man-crush on Burton or something, but the book is that darn good).  I unreservedly give it the maximum four stocky foxes.