Do you really need $2M to retire?!?

Posted on November 28, 2011 by Doug Nordman

 

 

(Today’s post was suggested by my daughter, who keeps an eye on Gen Y financial issues…)

Shortly after Hallowe’en, MSN put up a scary article about Generation Y needing to save (spoken, of course, in a creepy Dr. Evil voice) two million dollars for retirement. And if that’s not frightening enough people, the article also claims that Gen X will need almost as much.  In other words, most of today’s workers need at least that much to retire.

Seriously?!? Where do these scary articles (and numbers) come from?

First, there’s plenty of (not retired) journalists and bloggers trying to make their article’s filing deadline. (He claimed as he typed ever faster, nervously eyeing the clock.) Under that pressure, it’s tempting to spout any statistic as long as it inspires controversy. Truth is preferred but facts are negotiable. It’s even better if the information is sensational instead of boring. “GenY should be OK for retirement” is not a headline. “GenY has to find $2M or keep working!!” is better.

In this case the article’s headline was drawn from a survey of 226 registered investment advisers hired by Scottrade.

Second, did they come up with the numbers to calculate a $2M figure? Well, they really didn’t. They used “average expenses” for GenY and GenX, and then assumed that they’d keep working until “around age 70”. A different study used multiples of average salaries.

I can play sensational deadline-journalism games and pull my numbers out of survey averages, too. But I don’t have to, and neither do you:  we can use real math for your real life.  Is the article even worth reading? Let’s summarize their advice, and then see if it’s useful or worthless:

  • Set a worthy goal.
  • Take advantage of employer help.
  • Control costs.
  • Get a Roth IRA or 401(k).
  • Maximize Social Security.
  • Don’t plan on retiring at 65.
  • Don’t get hung up on the number.

What’s a “worthy goal”? This part of the article’s advice is worthless. For starters, the goal is not an “average expense” or a multiple of your income. It’s not even a percentage of your salary or your annual expenses. Thumbrules don’t work for everyone. There’s really only one way to figure it out, it’s different for every individual, and it doesn’t inspire scary headlines.

Here it is: track your expenses, make an annual budget based on your values and those expenses, and then save at least 25x that budget. When you get to that number then stay invested in a diversified portfolio of equities and other assets. Withdraw 4% the first year of retirement. Raise each following year’s withdrawals for inflation. If you want to spend more occasionally then you probably can, but you’ll need to do more analysis and maybe have an annuity provide some of your income in case the markets turn against you.  Of course if you’re earning a military retirement check then the answer is almost always “Yes!“, but even if you only complete one enlistment then you can still make the math work for you.

Employer help is the match of your 401(k) contributions: “free money” in your retirement account. Good advice. Some of your salary contributions to your retirement 401(k) account are matched by your employer’s funds, up to a certain maximum. Although many 401(k) programs are burdened with high expenses, extra fees, and poor investment choices– the employer match makes it worth the effort. If you’re in the military you don’t have an employer match (only the Thrift Savings Plan) but you should still try to maximize your contributions every year. The earlier you contribute the funds, the longer they’ll be able to compound before you need to use them. The more you put in (up to the max employer match) then the more you’ll have compounding.

Control costs. You might not have much control over your earnings, but you can certainly reduce your expenses. The less you pay to manage your investments then the more money you’ll be able to invest. Good advice. Financial planner (and military veteran) Rick Ferri puts numbers on this concept in a “worst case” study of a retirement as the markets peaked in 2000.  (Thanks to reader Ted for suggesting the link!) Ferri’s analysis shows the erosive effects of high expenses and adviser’s fees. Another example is the typical investment adviser’s annual 1% fee. When you’re withdrawing 4% every year from a retirement portfolio, do you really want to hand over a quarter of that withdrawal to an adviser?

Another way to control costs is to invest more of your savings in tax-free accounts like a Roth IRA or a Roth 401(k). Good advice. You won’t get a tax deduction but you won’t pay taxes on the earnings, either. Today’s taxes probably won’t go much lower but future taxes may be much higher, and a Roth will avoid that taxation. You should still get the maximum employer’s match to your 401(k), and you should still try to maximize your TSP contribution when you’re on active duty, but after those hurdles are met you should try to maximize your Roth savings. The more you can save, the sooner you’ll reach financial independence. It typically takes 10-20 years of military & civilian employment, but a few can do it in less time.

Social Security is a great example of a retirement annuity that usually kicks in no earlier than age 62. If you maximize your earnings for 35 years and delay Social Security withdrawals until you’re 70 years old then you’ll extract the maximum benefit from the system. If you’re not interested in working for 35 years or waiting until age 70, then keep track of your estimated benefits and factor them into your savings goal. If you retire straight out of a military active-duty career then you’ll only have 20 years of Social Security earnings. However, if you’ve saved aggressively then you may already be financially independent, even though your Social Security benefits would be lower. Not good advice, but not worthless. If you don’t save then this is society’s safety net.

Should you plan to keep working until age 65? Should you work even longer? Worthless advice— work that long only if you want to! If you design your spending plan around your values, save aggressively and control your investment expenses, then you’ll be financially independent as early as your 40s. Of course a 20-year military retirement makes that even easier, but that’s just one way to maximize the math. Low expenses and a high savings rate are another approach, along with part-time employment or side income from other sources (like a website or a rental property). I hope you find a career that’s fascinating, fulfilling, and lets you live the life you want to have– but when you’re financially independent then you can work on your terms.

Ironically the article concludes with its best advice: don’t get hung up on the number. $2M can be very discouraging if you don’t assess the context behind it, and your number will probably be a lot lower.

Is that number even possible, let alone realistic? How much money can one human be expected to earn during their life? Well, my daughter suggested this article, so let’s look at her salary. When she’s commissioned she’ll start pulling down a righteous O-1 paycheck. The military will raise her pay every year, but if they want to retain her then they’ll make those raises keep up with inflation. If we assume that military pay keeps up with inflation then we can use the Department of Defense 2011 pay tables for 20 years of income.  Even during a drawdown, if she stays on active duty for 20 years and promotes to O-4 she’ll earn nearly $1.35 million. In addition she’ll earn a minimum of another $300K in subsistence and housing allowances. Add in sea pay(!), specialty pay, and bonus pay and she’ll earn $2M before she turns 42 years old. If she promotes to O-5 then it happens even faster.

You can earn $2M during your life even if you’re not a military officer. You don’t even have to retire from the military if you’re willing to pursue a civilian bridge career. But if you want to be financially independent in your 40s then you’ll have to decide what’s important to your lifestyle and save as much money as you can. You’re earning it. Now you have to figure out how to keep it!

 

Related articles:
Is the 4% withdrawal rate really safe?
How many years does it take to become financially independent?

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Posted in Financial Independence, Military Retirement | Leave a comment

Geriatric financial management

Posted on November 9, 2011 by Doug Nordman

Many of us Boomers are caring for aging parents, but nobody seems to talk about it. Maybe we don’t like to contemplate the foreshadowing of our own mortality, or maybe society deems it to be selfish complaining. Yet if the subject happens to come up in a Boomer conversation, then everyone has their story. Some of them are happy, a few are sad, and all of them share our frustrations.

I wish it was easier for us to talk about it. If we could all feel more comfortable about sharing a little of what we’ve learned, then maybe it’ll be less frustrating for the next person who starts this journey.

In my case, I’ve learned that there’s a reason when my “just write it“  is harder than usual. Most weeks the posts leap off the keyboard and I’ll have three or four in the hopper. Some weeks I’m barely ahead of my self-imposed deadline. Usually when the words aren’t flowing, my brain is still working on a problem. The mechanics of writing– drafting, organizing, cutting, and formatting– help me clarify my thinking and figure out what problem I should try to solve.

Yet there are still times when I’m just tinkering on the margins: tweaking the peripheral issues because I can’t solve the main problem. But at least I can write about it. Here we go.

My Dad’s health has taken a turn for the worse. After several weeks of invasive tests, he’s been diagnosed with “low-grade lymphoma consistent with Waldenström’s macroglobulinemia”. That means his body’s making too many white blood cells and not enough red blood cells. It’s also creating too much immunoglobulin, which makes the blood very viscous and leads to other complications.

WM lymphoma is rare, but the oncologist seems pretty confident in the diagnosis. The biopsy shows exactly what types of cells are present and what condition they’re in. Only 1500 cases are found every year, but the techniques are getting better and there may be more cases out there. One of the first problems we’ve encountered is that there’s not much on the Internet, and patients tend to be highly dependent on what little experience the doctor has accumulated from these rare occurrences. If you or a family member have dealt with WM lymphoma then I’d appreciate learning more about how you handled it. And if you’re a website entrepreneur then let me know when your “WM lymphoma discussion board” is ready for my post.

Dad’s main symptoms are anemia and fatigue. There’s also enough pain for this tough guy (who never even takes ibuprofen) to need a Vicodin prescription. Alzheimer’s makes it much more difficult for him to handle the situation. There’s no cure, but it’s a slow disease that can be “controlled”. Treatment starts with least six sessions of chemotherapy at three-week intervals using cyclophosphamide and rituximab. Dad’s nearly 78 years old so he’s not a candidate for other procedures. After the chemotherapy they’ll keep monitoring his blood parameters, because the doctors can only tinker around the margins of the real problem without solving it.

The fatigue & pain must be pretty severe, because Dad has always avoided doctors and he hates being a “lab rat”. However, the short-term trauma of chemotherapy may slow the cancer’s long-term progress enough for him to “feel better”.  After he and my brother had a long discussion with the oncologist, Dad agreed to try the chemotherapy. However, Alzheimer’s patients aren’t always capable of giving informed consent, and Dad may change his mind after the first infusion. My brother and I will help him cross that bridge if he comes to it. Dad’s medical directive is clear and it should be straightforward to carry it out.

I’m 4000 miles away from Dad while my brother is just down the street, which is why I’m handling the finances while my brother tackles the daily life issues. (Frankly, it takes a family. The whole challenge of caring for an elder is too much for one person– even if one of the caregivers is retired– and at times the emotional burdens are just too much for anybody.) I know better than to second-guess the front-line decisions from my rear echelon, and I help my brother carry out the plans after he and Dad have made their choices. Ironically, however, I tend to get the caregiver phone calls because most of the questions involve money.

Thankfully Medicare and health insurance have treated Dad very well. His emergency ulcer surgery (over $50,000) was completely covered by Medicare (and his supplemental insurance). Medicare and his insurance have also completely covered his physical rehab at a skilled nursing facility (~$9000). Prescriptions are Medicare D coverage but amazingly, Dad’s retiree benefits include Medco insurance. (His blood-pressure medication only costs him a $4/month copayment.) Our biggest “financial problem” (aside from the long-term care insurance claim) has been tracking down all the policy numbers and getting them to the right people. After my first month of flailing around it’s been taking care of itself.

But chemotherapy is a new situation. When Dad and my brother made the decision, the oncologist said he’d set up the first infusion. They’re still waiting to hear the date. However, the lab started getting ready, and their first step is a prescription for an anti-nausea medication. Dad will take three capsules– one on the day of the infusion and the next two over the next two days.

Each one of these capsules is rumored to cost $250.

Chemotherapy pharmacies have no financial sense of humor. Their customers are always in a hurry but their products are hugely expensive. The pharmacy won’t ship today and invoice next month. They may trust Medco but we have to pay up front, and a three-capsule Emend prescription has a $180 copayment.

The “problem” is that we’ve let Dad’s credit cards expire while we pursue conservatorship and guardianship. (I’m not sure that a credit-card company would keep Dad’s accounts open anyway.) He’s been paying all his bills through a Web service, but small businesses (like pharmacies) usually don’t handle electronic transfers. It takes a week for a Web billpay service to snail-mail a paper check to a pharmacy, and the pharmacy won’t ship until the check clears.

So once again, to keep things moving I ponied up my credit card. The probate court’s “Conservators Manual” frowns on conservators reimbursing themselves from their ward’s accounts, and they require written reports to show where the money’s been going. In this situation, however, I’d rather bicker with the probate court than the chemo pharmacy. At least once the chemotherapy schedule is set up I can keep $180 on deposit with the pharmacy.

Meanwhile, after eight months our lawyer has finally filed the guardianship & conservatorship petitions. (That process is a subject for another entire post.) The court’s independent evaluator has visited our Dad and heard the right answers to his questions. We hope to have the (uncontested) hearing before the end of the year. We still don’t know if I’ll have to be personally present for it, but the options of Skype or a pre-recorded phone call were mentioned. Hopefully I’ll be able to phone it in and receive the legal authority of an appointment letter before 2012.

Until then I don’t have any solutions to the copayment cashflow issue. I’m not posting this for help or pity. But if you’re expecting to care for an elderly parent then you’d better have the financial arrangements in place. If you don’t have joint accounts or powers of attorney, then you should have at least a $5000 “emergency” fund standing by while the legal process grinds away.

There may be other financial issues. One effect of lymphoma is amyloidosis  — the excess buildup of proteins in the body. It’s possible that this may contribute to Alzheimer’s, which is a buildup of proteins in the brain. This correlation is speculative and years of research will be needed to confirm it, let alone figure out if it can be treated. But if Alzheimer’s is ever found to be caused by a medical syndrome like cancer, then it could become a pre-existing condition which would not be covered by long-term care insurance. My father’s care facility charges $214/day and will probably raise their prices by at least 5%/year. They’ve earned it, too– we’re hugely grateful for their experience and alertness at finding this problem in the first place. If Dad was still trying to live independently, even with in-home assistance, then the lymphoma may never have been discovered. But the care facility might be unaffordable without insurance.

Another speculation is that lymphoma may have an inherited genetic trait. If this ever becomes subject to identification through DNA testing then families can be ready for it, but they probably won’t be able to buy insurance for it. Of course genetics is just a loaded gun and the environment (or lifestyle) pulls the trigger, but I doubt that insurance companies are willing to take the bet.

Thanks for reading this, and a big thanks to everyone who’s already written me. I hope this helps someone who’s confronting their own elder-care situation, and I’ll keep sharing what we’ve learned. If you have any lessons to pass on about lymphoma with Waldenström’s macroglobulinemia then I’d love to hear from you.

Related articles:
Financial lessons learned from caring for an elderly parent
More on caring for an elder’s finances

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Posted in Military Life & Family, Money Management & Personal Finance | 2 Comments

Book review: 1001 Things to Love About Military Life

Posted on November 7, 2011 by Doug Nordman

Yeah, I know, you’re skeptical, especially if you’re on active duty.  1001 things?!?  I’ll bet you can’t even come up with 10.

Luckily this isn’t a retention pitch– it’s a book title.

Tara Crooks (co-founder of ArmyWifeNetwork.com and producer of Army Wife Talk Radio) has reached out to military spouses for over six years through the Web and on bases. One day she and her co-founder (Star Henderson) began their list, and soon they had over 500 items. They reached out to their mentors, and the four of them turned their lists into a manuscript.

This is a book for everyone in the military, not just for spouses & families. Two of the authors are veterans as well as military spouses, and the four of them have nearly a century of collective military experience with deployments, transfers, families, bases, and the whole culture. There may be plenty of things to love about military life, but there are even more of them to laugh about (in some cases I’d hasten to add “once they’re over“).

The book is literally a numbered list. Some of the items are accompanied by photos or comics, others by essays. (A few items need no explanation.) It’s organized by the perspective of the servicemember, the spouse, the family, all our jargon, and our traditions. My favorite section is “Outside Looking In”, describing all the ways that civilians learn about and honor the military.

I also enjoyed learning about the history of spouse organizations and conferences. We have a lot of military spouses to thank for today’s support organizations and educational programs that we tend to take for granted. Tara and her partners are continuing the tradition over the Internet and in person!

One of the book’s best features is the occasional page for you to record your own experiences and memories— your holiday ornaments (collected from duty stations around the world), the bumper stickers on your vehicle, your favorite military-related songs, where you met your spouse, and your favorite ways to stay connected during deployments. After you’ve filled in these pages you can share the book with your (perhaps deployed) spouse or send it to another loved one for them to add their own.

Here’s just a few of the items that started conversations at Hale Nords:

  • #240: Familygrams. My spouse (who composed far more than her fair share of the darn things during the Cold War) says that they are not at all something to love about the military. But I loved reading every one of them, so I guess it all depends on the perspective.
  • #372: Finding moving stickers of different colors on your furniture years after retiring from the military. Yep. It’s been over nine years and we still find them just about every time we move furniture or clean out the garage/attic.
  • #514: United Through Reading.  This is a fantastic program for deployed parents to keep in touch with their kids. Mom or Dad record their video of them reading their kids’ favorite books, and then the kids can share the DVD at home with their own copy of the book. I wish I’d known about this when I was on active duty!

I’ve told our daughter most (*ahem*) of my sea stories, but “1001 Things” is a great way to pass on the rest of your family-friendly memories. It’s going on her reading pile, and I’m sure we’ll have many other conversations starting with “Hey, Dad, did you ever…”

You can read more about the book at LoveMilitaryLife.com. By the way, that’s Pearl Harbor survivor Herb Weatherwax pictured on their website. He’s 94 years old and volunteers at the USS ARIZONA Memorial Visitor’s Center to talk with people, tell his stories, and sign autographs. He even does videoteleconferences with school children around the world (including Japan). Some of these survivors have volunteered there three times a week for over a quarter-century. (That’s longer than my entire military career.) I’d say they’ve found many things to love about their military service, despite the horrific events that they had to survive. There’s a life lesson for the rest of us.

Related articles:
Jeff Rose’s interview with co-author Tara Crooks
United Through Reading: READ! Our Blog
Bloggers at the USAA Blogger Event

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Posted in Reviews | 7 Comments

Problems with retirement calculators

Posted on October 27, 2011 by Doug Nordman

It’s been a while since I’ve discussed their weaknesses and the options. There are a few updates to existing programs along with a new kid on the block from USAA. Before I start naming programs and websites, though, let’s look at the concepts behind the various choices. Maybe by the time we’re done with this post you won’t trust calculators.

Why use a retirement calculator? (If you find a career that you truly enjoy, retirement is irrelevant!) The best reason is so that you know when you’re financially independent. A calculator helps you decide when you can stop working for money. Another important reason to use a retirement calculator is to appreciate how your investment decisions will affect your portfolio, and how your spending plans will be limited by it. The answer to “Am I financially independent?” depends on how much you’re planning to spend and how much you have to support it. Those parameters have a lot of flexibility, and your plans might change during the rest of your life.

Most retirement calculators fall into two broad classes: historical data and simulated data. The former attempt to tell you how your retirement assets and plans would stack up against years of historical data. The software assumes that you’d retired during a certain year and then applies the subsequent historical data against your portfolio and your planned withdrawals. At the end of the run, the calculator starts over and assumes that you’d retired one year later. The runs continue until the calculator reaches the end of its historical data.

Simulated data uses assumptions about market volatility, historical performance, and asset classes to generate sequences of returns. The returns aren’t the actual performance data but rather just a number of sequences that could have occurred within those assumptions. The calculator does as many runs as necessary to generate a statistical analysis of your portfolio’s performance. A popular type of this simulation is called “Monte Carlo” for the methods used by casinos to optimize the probabilities of their gambling games.

Both types of calculators have significant problems. For example, the historical calculator uses roughly 130 years of stock-market data for popular indexes like the Dow-Jones Industrial Average.  However, a retirement can easily last 40 years, which means that there are fewer than 100 sequences of data running for 40-year periods.  There’s even less data for recently created asset classes like small-cap value stocks, international stocks, and Treasury I bonds. It’s hard to pile up a convincing set of statistically valid results from these “small” sample sizes. We’re not going to build up a thousand years of stock-market data, either.

A major drawback to the historical calculators is the assumption that the future will be no worse (and no better!) than the past. Sure, we’ve seen two world wars and a number of other global changes during the 20th century, but “this time is different” happens every day. The calculators don’t handle very high volatility or new asset classes. They don’t account for changes in correlations between asset classes over time.

Simulated data also has problems with the sequences of returns. Markets can steadily rise or fall across the years of bull or bear markets, but simulated data runs choose the years randomly without accounting for this persistence. Simulations suffer from sparse data on new asset classes or may put arbitrary limits on volatility. (They can’t create much variation with only a few decades of history on which to base the their limits.) They also don’t account for changing correlations between asset classes.

Simulated data struggles with catastrophes like the extremes of the Great Depression or the 2008 freeze of the credit markets because the markets are random series of events. Sure, they tend to go up more than they go down, and they usually change within certain limits, but they’re still random events that could just as easily decline over a number of years (1966-82) or drop a thousand points in a day.  However, the first assumption made by every simulation retirement calculator is that the performance of stock markets fits into a bell curve. That allows the calculator to apply probability and statistical techniques of analyzing the bell curve, even though the “real” stock market can still exceed those parameters. The calculator’s assumptions may handle 99.994% of the possibilities, but that’s not much comfort if your retirement happens to stumble across one of the .006% realities.

Both types of calculators assume that retirement spending is constant (even if it’s adjusted for inflation with “constant dollars”). Yet retiree spending varies. When the market is down, we all tend to defer spending in some categories. When the market is up, we tend to spend more money in almost all categories. Investor psychology has identified and analyzed those behaviors, but retirement calculators don’t do a very good job of simulating them.

A few retirement analyzers attempt to sidestep these drawbacks by iteration. Instead of simulating an entire retirement, retirees use their methods to assess a portfolio’s performance each year and decide how much spending the portfolio can handle next year. When the markets are down, they’ll recommend spending cutbacks. When the markets are up, they’ll support a full spending budget but suggest that some excess be set aside for a potential future bear market. The system is similar to “negative feedback” used in cruise controls and autopilots. However, it’s not much help in predicting when you’ll be financially independent.

After decades of perpetual debate about the “best” retirement calculators, what retirees really want is some sort of insurance against the (very few) situations that nobody could predict. What if you don’t want to trust your life to a retirement calculator, let alone attempt to explain it to your spouse? What happens when the calculator doesn’t predict the right future? What’s your “Plan B”?

One extreme plan would be to work until you have too much money to spend. Groucho Marx famously claimed that he invested all of his retirement money in Treasuries. When a reporter said “Nobody can live on Treasuries!”, Groucho’s answer was “You can if you have enough of them.” But if you’re working until you join the asset ranks of Warren Buffett or Oprah Winfrey, then you’re probably not reading a blog about financial independence. You’re having too much fun to ever retire. If you find yourself in that situation then keep on doing it!

Another option is “Oh, well, I’ll get a job”, even if it’s a Wal-Mart greeter or neighborhood handyman. This is a great assumption for early retirees in their 30s or 40s. The reality is more difficult for retirees in their 50s, especially after they’ve been out of the job market for a few years. It’s even less appealing for retirees in their 60s or 70s who could have very real physical limitations.

Another choice is a “bare bones” budget for bad times. Again you’ll assume that the worst is unlikely to happen, but you’ll have a contingency plan. This might be a reserve fund that you set aside from your portfolio to tap into once a decade. It might be severe spending cutbacks to the point where you’re sharing group housing with several roommates and growing your own food. It might be attempting to live within your Social Security annuity, or purchasing additional annuities before retirement to guarantee an absolute minimum level of income… as long as the insurance company (and the federal government) pay out.

One popular compromise is “living off the portfolio”. This is a plan to spend only the dividends without ever touching the principal. This works quite well for private universities and inherited family wealth, where each generation is just a custodian of the assets while living off their income. Of course those situations aren’t much help to workers who’d like to know the earliest date they’re eligible to join this club.

Portfolios have survived for centuries and you can’t lose your wealth if you’re only limited to spending the dividends. However, your spending limits can be quite volatile unless you pick the right diversified combination of dividends. Another “worst case” is when inflation eats into your dividend returns. A final issue is that (like Groucho’s portfolio) today’s dividends aren’t as good as they used to be. Even broad equity indexes are only returning about 2% in dividends, and dividend funds (or individual dividend stocks) may achieve higher rates only with much higher volatility and risk of loss. This historical deviation has only been around for a few decades so it might not be a trend, but this is scant comfort if you’re only going to be around for a few more decades.

With all these flaws, why use a calculator at all? Well, some of us investors enjoy the analysis process almost as much as the results. (Guilty!) If you’re worried about your retirement, then plugging numbers into a calculator helps you worry constructively. A few investors try to figure out whether they can maintain their lifestyle or whether they need to make major changes– either to get to retirement or to stay there. Best of all, a calculator acts as a warning system: you’re reassured that you’ve covering all the bases, or you learn that you need to reconsider your plan.

In a future post I’ll discuss the most popular calculators– and the most useful ones. If you can’t wait to dive in, though, consider a good hard workout of the free FIRECalc.com, a paid subscription to FinancialEngines.com, and an overview of Bud Hebeler’s “Analyze Now!” system.

Related articles:
That retirement calculator may be lying to you
Details of the 4% Safe Withdrawal Rate
“Present value” estimate of a military pension
Effect of inflation on a dollar
During retirement: take small financial steps (part 1 of 2)
How many years does it take to become financially independent?
Retiring on multiple streams of income
Military retirement: how much can I really spend?
Military retirement spending: how much will I need?

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Posted in Military Retirement | Leave a comment

Book review: Stop Acting Rich

Posted on October 26, 2011 by Doug Nordman

 

 

 

 

I’ve been a Dr. Stanley fan since “The Millionaire Next Door” in 1996  . He’s made an entire career out of studying the lifestyles and buying habits of the rich and the not-so-rich. Thanks to his research, my family has been able to figure out what’s important in our lives and what’s worth the money. Thanks also to his research we’ve become nearly immune to the miracles of modern consumer marketing.

“Millionaire Mind”  has also been a big help with raising our daughter. We couldn’t just dump the books on her pillow with a “Read these!” note, but we could talk about some of his stories and compare them to her “earning”, “shopping”, and “owning” experiences. It even helped her decide what classes she wanted to take in high school and what she wanted to study in college. And of course “Millionaire Women Next Door”  taught her how to dream big.

“Stop Acting Rich”  has been out for a couple of years, and its latest edition is repeating the same best-seller trajectory followed by his other books. It’s not as startlingly novel as TMND, but it’s the same voyeuristic pleasure (and even schadenfreude) of learning how to be (and not to be) rich.

Stanley divides his subjects into four categories: the “glittering rich”, the “balance sheet affluent”, the “income affluent”, and the “aspiring rich”. The glitterati are over $20M and so rich that they don’t even bother to budget. They can spend as if they’re truly rich, because they are! Some of them became that way through inherited wealth, but the majority of Stanley’s subjects did it the old-fashioned way: through earning a high salary (and saving it) or by growing their entrepreneurial businesses. Now that they’ve arrived, they can spend their income as they please. Note that the spending didn’t start until after they’d arrived.

“Glittering rich” is a critical difference from the other three categories, because these people will probably not be able to spend it before they die. (Notwithstanding a few celebrity examples to the contrary.) Even if they’re no longer working full time, the vast majority are still growing their businesses. They’re not worried about their annual six-figure spending because they’re earning seven or even eight figures each year. For them, wealth is more a means of keeping score than a threshold of financial independence.

The “balance sheet affluent” are Stanley’s true millionaires next door. They’re typically business owners, although a few of them were high-income earners who managed to continue a frugal lifestyle. These are the people you’d never expect to discover are worth seven figures. They drive older mid-size cars (or pickup trucks), buy suits on sale, drink cheaper brands of beer & alcohol, and don’t wear status badges. Their spouses are exceptionally frugal because that’s how they started out in their marriage, and they continued those habits even as their wealth accumulated.

The “income affluent” and the “aspiring rich” tend to be lumped together when Stanley’s describing their behavior. The former are earning plenty of money and spending nearly all in pursuit of lifestyle upgrades. If they lose their job or take on too much debt then they’re immediately in financial jeopardy. The aspiring rich are in trouble from the start: they’re not earning very much and either have a negligible net worth or are heavily in debt to the lifestyle that they feel obligated to be living. Although they’re every bit as discerning in their expensive tastes as their glitterati counterparts, they haven’t earned the fortune (or built their own business) to support their spending.

These last two categories are the focus of “Stop Acting Rich”. Stanley points out that they’re merely acting rich in the image that the media has created for us. Luxury marketers and high-end retailers want them to drive the rich cars, wear the rich clothes, and drink the rich beverages. The world’s advertising and marketing campaigns are very good at selling this image– but it’s not the way that real millionaires live.

Stanley debunks each aspect of this carefully crafted image. His surveys and his research compare the public perception of millionaire shoes, watches, cars, wine, liquor, and other accessories to the actual brands favored by the real millionaires. His best chapter describes “premium vodka”. Americans can choose among nearly 300 brands, and most of the vodka distributors don’t even distill their own– they buy thousands of gallons of alcohol in railroad tank cars or tanker trucks from agricultural producers like Archer-Daniels-Midland. A little extra flavoring, a special bottle, a few million dollars of image grooming, and voilà: a premium vodka is born.

If you’re an oenophile (or if you think you are) then you should just skip Stanley’s wine research. He repeatedly makes the point that conspicuous symbols of wealth (homes, cars, clothing, beverages) are better indicators of the owner’s credit-card use than the size of their investment portfolio.

So how do you start living like a real millionaire? First, live below your means. Don’t aspire to be rich by chasing the costly symbols that the marketers would have you believe are “used by rich people”. Read Stanley’s survey data to learn what lifestyles and brands are truly valued by the rich, and choose the aspects that suit your values. If you’re living the lifestyle of the aspiring rich, then perhaps it’s time to change your values before your money runs out.

Next, save your income and invest it for financial independence. If you’re “income affluent” then it’ll happen faster, but your goal is to become “balance sheet affluent”. (Note: Land is an asset. The house built on it is a rapidly depreciating asset, and its taxes & maintenance costs are a liability.) Don’t feel obligated to compete with the rest of society in displaying the trappings of wealth. Instead try to have your values reflected in your assets, not your income or your spending or your liabilities.

Finally, if you still must spend, then don’t start spending like the glittering rich until you actually are glittering rich. Too many “aspiring rich” and “income affluent” are spending their income with the assumption that their possessions (or their looks) will help them make it to the big time. The reality is that most millionaires plowed their income and their hard work back into growing their businesses until they could live off the profits.

If you’ve been reading Dr. Stanley since TMND then you’ll enjoy a pleasant stroll down the familiar paths of his research. If you’re new to the genre, however, you’ll have your eyes opened to amazing new vistas of how to behave like a real millionaire.

This book will be on our daughter’s reading pile soon!

You’ll find more advice at Dr. Stanley’s blog.

Related articles:
Book report: Dilemmas of Family Wealth
Book Review: “Get Rich Click!”
Book review: Eric Tyson’s “Personal Finance in Your 20s For Dummies”
Book review: The Complete Idiot’s Guide to Social Security and Medicare
Book Review: Liz Weston’s “The 10 Commandments of Money”

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