When you drive through a fancy neighborhood where every home is a mini-mansion with a Mercedes or BMW in the garage, you probably think these people are wealthy.
Some of them are -- but many aren’t, precisely because they spend so much. To me, wealth isn’t the money you earn and spend. It’s the money you keep by not spending it, and then investing it to make it grow.
I see affluence as what you spend, while wealth is what you keep and invest. But in this materialistic culture, that’s not how most people view wealth. Instead, we confuse it with status symbols and high-consumption lifestyle that can be acquired with high incomes.
As a guest lecturer for a college course, I can see how students tend to confuse the outward trappings of wealth – spending – with wealth itself. People with huge houses must be wealthy, they assume. The irony is that, in many cases, the compulsion to consume – to acquire status symbols -- prevents even people with high incomes from acquiring wealth.
Though conspicuous consumption is common elsewhere on the planet, it dominates here in the United States, where the savings rate is relatively low worldwide. Over the past few years, U.S. households, on average, have saved from about 4 to 5 percent of their disposable incomes -- only about one-third or one-half as much as households in some European countries.
The contrast between American spenders and savers is well documented in the 1996 book “The Millionaire Next Door: The Surprising Secrets of America's Wealthy,” by Thomas J. Stanley and William D. Danko. The authors present statistics and scenarios that reveal the contrasting mentalities of typical savers, who acquire wealth, and typical spenders, who don’t.
They explore the reasons why many savers don’t care about status or appearing wealthy, a mentality that enables them to spend less and acquire much more wealth than many spenders. So unbeknownst to you, your next-door neighbor of seemingly modest means might actually be wealthy while the folks with palatial homes may not be.
If you’re truly wealthy, this means you’ve put aside a considerable amount relative to what you earn. People who are truly wealthy are those whose assets can kick in to replace their working income. If they stopped working tomorrow, the income stream from their invested assets would replace what they’re earning now on their jobs or businesses.
If you’re not spending a tremendous amount, it’s easier to achieve a level of wealth in a relative sense, having an asset base that generates income or earnings, replacing what you spend. (This last figure, of course, should be significantly less than your working income.)
You’re wealthy when the combination of your annual dividends and the growth on your investments fully finances your cost of living. People who get to this station in life without inheritance have put aside a considerable amount relative to what they earn. If they stopped working tomorrow, the income stream from their invested assets would replace what they’re earning now from their jobs or businesses. Getting to this point not only requires a good income, but also steadfast discipline to not overspend.
How can you develop the capacity to spend during your retirement what you spend now, without eroding your principal? Consider:
- Rearranging some mental furniture to change your mentality about wealth. Instead of focusing on what you have materially now, concentrate on what you’ll need to live comfortably in the future and how far you are along toward that goal.
- Changing your view of spending from a perception of wealth to one focusing on its role as the enemy of wealth. That means shunning big-ticket items such as luxury cars and boats, which cost a lot to maintain and depreciate rapidly. The prestige people pay for that Beamer they can’t really afford may be costing them plenty down the road. The main reason an old saying about boats – there are two good days when you own a boat: the day you buy it and the day you sell it – has become a classic is that they are money pits because of the expenses: purchase price, gas, maintenance, dockage fees and insurance premiums. Well-considered investments in houses are another matter entirely, as they often appreciate (as opposed to boats and cars, which depreciate). And when you come home at the end of the work day to a nice (though affordable) house, you feel good – especially if it’s rising in value.
- Adjusting your behavior to match this new spending mentality. If you don’t have one already, set a realistic budget to spend less and work on sticking to it. Invest the money you have left over after expenses each month by maxing out your 401(k) contributions at work (if you aren’t already), thus getting the maximum employer matching money (if this is offered). Work on managing your 401(k) account for better returns.
Once you’ve done this, if you’ll still need money to reach a realistic retirement savings number, tighten your budget belt and use the freed-up cash to set up a brokerage account that draws directly from your checking account so you can automatically set aside money for further investment. With strict budgeting and sufficient income, it’s possible to do this while still funding your kids’ college educations, paying for vacations and generally enjoying a good lifestyle. The key to all this is planning and steadfast discipline to stick to the plan.
Any opinions expressed here are solely those of the author.
Gary Droz is managing director of MainLine Private Wealth in Pittsburgh and Wynnewood, Pennsylvania, and has worked in financial services for more than 30 years. He previously served as president and managing director of Innovest Financial Management, and co-founded the Senior Insurance Institute, which presented educational symposia throughout southeast Florida with the goal of educating seniors and addressing advanced life insurance issues. Droz has a BA in communications from the University of Pittsburgh. He has been a guest lecturer at the Tepper School of Business at Carnegie Mellon University, where he discusses the discipline of investment management.