The Third Pig: In Defense of Frugal: Are You A Millionaire?

source: Thing One Taylor

Recently I began reading investment manager Michael Farr’s book, A Million Is Not Enough. The title strongly suggests what the book’s subject is all about as all strong titles should. And I will probe that subject in a subsequent post. In the meantime, the book has reminded me of a question I get every now and again:

“Ben, are you a millionaire?”

I am sure because of the business I am in (it certainly isn’t my lifestyle) curiosity about this topic is inevitable. Sometimes the question comes in the form of “Ben, how much money do you have?” or “Ben, are you rich?” (For our purposes, rich and wealthy will be used interchangeably.) For most people, it isn’t that they’re all that interested in my finances per se. Basically, they are asking, “Ben, how can I get rich?” Knowing no answer will satisfy all, using myself as the example, I usually come up with some form of non-answer which typically sounds like:

“I am not as financially successful as I would like to be. I have had some financial hiccups along the way. But by most standards, I have done ‘ok’.”

It is not that I am trying be evasive but I realize one’s person’s millionaire is another person’s poor man. “Rich” is often in the eye of the beholder. To paraphrase comedian Chris Rock, “If Bill Gates woke up with Oprah’s money, he’d jump out of a [expletive] window.” Some are actually satisfied with my non-answer answer. Most however, are more curious than they were prior to the initial question. What does “ok” mean? What “standards” are you referring to?

Lately, this question has been asked more than usual. I’m not sure why. Nonetheless, it has prompted me to start a series of posts in answering the “are you rich” or “how can I get rich” questions using clients/friends (with names and specifics changed) and myself as examples. The reason I have decided to title this series, “In Defense of Frugal”, instead of “How To Get Rich” is because frugality is the cornerstone of wealth building. Frugality is how one gets rich. Ironically, one doesn’t get rich by making a high-income. Although helpful, one doesn’t get rich by getting outsized returns in investments. [It would be great if I could say that since I run an investment management business.] And it certainly won’t come from showing rich before one is rich.

The fact is, most every American mistake folks who show rich - driving fancy cars, wearing designer clothes and spending lavishly on themselves and others - as actually being rich. It’s not! Showing rich too soon will absolutely undermine being/getting rich. Statistically speaking, most who show rich, especially if you’re say less than 50 years of age, have very little capital. Typically, these folks are high-income earners but they are highly inefficient at converting those dollars into real wealth. They are many times cowboys with big hats and no cattle. Paradoxically, moderate-income earners are more likely to become wealthy than high-income earners. High-income seems to inspire high consumption – the wealth killer.

Lucky for me, I learned this lesson earlier than most. However, the curious look at my lifestyle and are thoroughly unimpressed. I drive a beat up 10 year old car, I live in a small house on a busy street and with the exception of some dressier garments my clothes are typically purchased from Walmart, Target and the outlets of high end retialers. None of this is sexy, I know. But this lifestyle has allowed me to weather those “financial hiccups”. And I am now on the threshold of reaping the rewards.

It is not always easy to stick to a frugal lifestyle. I like shiny things as much as the next guy. And I want those things! It takes a lot of discipline not to succumb to hyper-consumerism. But I have been pretty good at not putting the cart before the horse. However, I am now at a point in my life where I can be more “spendy” and less “thrifty”. Most non-wealthy people spend in anticipation of wealth. As a consequence, they never arrive. On the other hand, most wealthy people, and those who are likely to be, allow their consumption habits to expand in conjunction with or at a pace just a tad slower than the expansion of their wealth. This is the road I have chosen.

A point regarding the above should be made. Frugal doesn’t mean missing out on the good things in life. Frugal people wear couture but may get their items from the Junior League shop. Frugal people drive luxury European cars but they may purchase them used and hold onto them. Frugal people travel, just less often and don’t mind connecting flights or hotels with less than five stars. Frugal people attend Broadways plays, but may acquire the tickets through some barter arrangement with a friend. Frugal people buy fine furniture but keep it a long time and have it reupholstered when needed. And frugal people do all of this in moderation. Generally, frugal people curb costly habits, suppress instant gratification, seek efficiency and defy expensive social norms. Frugal people leverage their resources so they can enjoy life more and their lifestyle allows them to allocate capital to where it will work for them and not against them.

Has all this frugality made me rich, which is our original question? Well, first we need to define rich. Wealth means a store of capital resources. This is highly distinguishable from income. Income can be defined as a flow of capital resources. Income is not wealth, and wealth is not income. Income passes through. Wealth sticks around for a while. Although both are important to one’s financial health it is wealth that changes lives and affects one’s opportunities. Income is a poor substitute to wealth in its life altering/affecting power.

But that is the qualitative definition of wealth. What is the quantitative definition? Although, as I mentioned earlier, wealth is relative many people continue to see $1,000,000 net worth watermark as rich. Being able to say you’re a millionaire still has some cachet even if $1,000,000 is not what it used to be. So “Ben, are you a millionaire?” For all practical purposes, give or take a few thousand, yes I am.

source: Money.com

You may or may not be impressed by this. I personally know some of you have much more. But that isn’t the point of this post. It is simply to answer a question often asked and to show how I got there. The median (50^th percentile) net worth for my age (40 years old) is just over $50,000. According to the latest Survey of Consumer Finances (SCF, 2007) median income and net worth for my age is closer to $86,600. (Click here to find out where you stand.) However, my net worth puts me in the top 5% - 10% of wealth for all households and very likely the top 1% -5% for my age group. And most of those households have two income earners, which I do not. This is how frugality has served me. I have no debt to speak of and I live a low burden lifestyle. My net worth consists of three things, 1) equity in my home, 2) investments and 3) my business value. Although I have had financial hiccups, I have been able to allocate my personal capital better than those who have far out-earned me.

All that said, being a millionaire is cool and all, but as Farr’s book says $1,000,000 is not enough. My case is a perfect example of this. A good percentage of my assets are illiquid. So it’s not like I can go out and buy the first Benz with spinning rims I see. Even if I were 100% liquid, $1,000,000 in financial assets conservatively generates only $40,000 per year so retirement in Aruba is out. So in my opinion, a $1,000,000 net worth or even in net financial assets is not what I would define as rich.

So how would I define rich? I have two measures.

One is like a barometer, predicting where you should be in wealth in terms of your age and income cohort. It also predicts where you might end up in the future.
And the other is more like a thermometer of wealth. This measure is really the true definition of wealth. It measures whether you’ve actually arrived or not.

I will tackle both of these measures in follow up posts.