Wednesday, December 30, 2009

Lawyers And "The Millionaire Next Door"

The bestselling book The Millionaire Next Door was a real eye-opener for me.  The book is based on a series of surveys set up by the authors who both work in academia and serve as advisors and consultants to businesses that are trying to market products to the rich.  The book provides a lot of great information about the millionaires in America, including generally how they got there, who they are, and how they live. 

The book also mentions lawyers and provides some analysis of how lawyers can become millionaires and why more laywers aren't millionaires.  We will discuss the advice provided by the book as well as some points that the book may have missed after the jump.

Here are some of the most telling statistics - these are as of the time the book was written:
  1. 80% of them are first-generation affluent - That is, 80% are "Self-made".
  2. There are 3.5 millionaire households, but only 8% of millionaire households are headed by a lawyer.
  3. 66% of the millionaires that are working are self-employed and 75% of these consider themselves entrepreneurs.  However, most of their businesses are "dull-normal" - contractors, auctioneers, pest controllers, etc.
  4. Their median income was only $131K/year, but their median net worth was $1.6 million.
  5. They invest/save about 20% of their income per year
The authors identify several factors that they use to explain how the millionaires made their money.  However, the most important factors seem to be:
  1. They live well below their means.
  2.  They believe that financial independence is more important than displaying high social status
This book was a real eye-opener for me because I grew up in a working-class neighborhood and I had internalized the media-driven stereotypes about millionaires.  More specifically, I wrongly assumed that
  1. Most millionaires were "old money" and that only a few were self-made. 
  2. Lawyers received huge salaries and consequently must be mostly millionaires.
  3. Most millionaires made $500K/year - or at least $250K/year.
  4. Millionaires lived a high, "country-club" lifestyle.
  5. Millionaires enjoyed showing their status in order to differentiate themselves from the rest of us and show that they were somehow better.
Boy, was I wrong - and as I read the book, I could see why.

The first thing I came to realize is that no matter how much you earn, you can always spend it all.

I had started to realize that some of the attorneys that I was working with made far more than the $131K/year that the millionaires made, but were so broke that they could not even contribute to their 401k.  These lawyers did not accept that financial independence was more important than owning "status" objects.

This also answered one of my questions with regard to why most millionaires were not "old money".  That is, the children or grandchildren of the millionaire who accumulated the money often felt entitled to the money and were not frugal in spending it.  They typically quickly spent their way out of the millionaire category.  It is really easy to do.

The second aspect that I leaned is that you must have a plan.

I knew people who made 100K who said "If I only made 200K, then I would be rich."  However, they did not have any plan for saving any of the 100K that they made - instead they had a lifestyle where they would just spend whatever came in.  I guess that somehow they thought that their lifestyle would magically change when they started making 200K - that instead of continuing with their current spending non-plan of "spend it as it comes in" they would somehow switch to a new plan where they did not spend it all.  Putting it another way, for those people who were currently spending without thinking about it, why did they think that they would suddenly become more conscious and disciplined just because their income rose?  On the contrary, rising income makes most people feel more "rich" and less like they need to me conscious and disciplined with their spending.  Thus, if these people started earning 200K, they would likely live a higher lifestyle, but they were unlikely to be more discliplined and save more.

This is what I saw with a lot of the lawyers.  They started off without a plan and as they began to earn more money the need for a plan seemed less and less important.  However, at the same time their lifestyle costs were creeping up and up.  It started off with "I deserve it" - the new car, status objects, etc. - and there were usually elements of "there's plenty of time to save for that later."  Then they got hit with big expenses for marriage - which was followed by kids - followed by kid's private school and college - followed by retirement.  Further, in many cases they had spaced their student loan payments out for 30 years to "lower the payment,"  but the student loan payments acted as a drag on their earnings during pretty much their entire careers - until their late 50s.

The third aspect that I learned is that just because you earn big does NOT mean that you have to spend big.

An attorney in a $2,000 suit is not any better of an attorney than one in a $200 suit just based on the suit.  It is the salesman that encourage the belief that if you buy the more expensive suit then clients will respond to you better.  Conversely, (and this is from real-life experience) if a client notices you wearing an expensive suit or an expensive watch, they realize/assume that you made the money to buy if by taking the money from them!  It often really pisses them off.  You can expect them to try to look for discounts on the bill - after all, "you can afford to give back a little."  You really don't want to make any displays of wealth in front of a client.  Let them be the best-dressed person in the room.  Impress them with the value of your services, not the expense of your watch.  Clients usually arent's that shallow - why are you?

Some tips

First, get a plan.  That means having a goal

Second implement the plan.  Do it now.  Even if you can only afford to put away $10/month, it still break you of the habit of spending every dollar that comes in and reinforces the concept that 1) your income and 3) the fraction of your income that you chose to use for current living expenses are two different things.

Third, resist advertising and peer pressure.  The salesmen are there to make money on you and will say and do anything to make the sale.  Your peers buy expensive items to display them to you in an attempt to make you envy them.  However, here's a counter example - assume two associates make the same money and have the same net worth, but one of them goes and buys a $10K watch.  The other associate keeps the $10K in savings.  Which of the associates is really more worthy of envy?

Fourth, set a lifestyle based on your net worth rather than your salary.  This is an aspect where I think that the book falls short.  The book comes up with a formula to determine whether you are "on-track" financially, but the formula is based on a comparison of your salary to your net worth.  In reality, a far, far better comparison would be to compare your total living expenses to your net worth.

Who cares what you make this year, as long as your net worth is sufficient to keep you in your current lifestyle for the rest of your life?  In this regard, several research studies have suggested that a withdrawal rate of 4% adjusted for inflation has a high probability of lasting indefinitely.  Expressed in different terms, that means that a net worth of 25 times your current lifestyle expenses can most likely sustain your current lifestyle forever.  For a lifestyle of $60K, that's $1.5 million.

What does this do for us?  Assume that you make $200K, but just paid off your student loans and consequently have a net worth of zero.  Recognize that you lose about 33% to taxes and thus take home about $132K.  Are you "rich"?  Can you "afford" luxury items?  I would say no.  You have a large current income, but your investments are not self-sustaining.  The actual income provided to you by your investments is zero.

Does this mean that if you only have $100K saved up you should try to live on $4K/year?  No, but it at least provides some sort of counter-argument to spending your entire salary.  Wouldn't you feel a lot more comfortable and confident if you can continue to pay for yourself and your family if you get canned or your clients dry up?  That's a feeling of confidence that you can carry with you every day.  It's much better than buying a $10K watch that you end up selling for $500 when you get canned.

Instead, recognize that it is your net worth - not your salary - that makes you "rich" or not.  More specifically, it's the ratio of your net worth to your living expenses.  If that ratio is low, then I don't care how much your salary is - you aren't rich and you shouldn't live like you are.


  1. Fantastic advice.

    I'm in my early 20s and applying to law schools now--I feel like this should be required reading for everyone my age, not just those thinking about law school. (You should do a post about Roth IRAs! They're great!)

  2. Hi 0L - Thanks for the comment! I agree that reading and thinking about the lessons in the book would be valuable to just about anyone. It was certainly valuable to me.

    With regard to applying to law school right now, I urge you to consider the current market and whether the opportunities for you might be better in a year or two. You may also want to read the post from October about buying a law degree at the height of the bubble. Regardless of your decision, best of luck!

  3. Loved that book. Have you ever read "Your Money Or Your Life" and/or "Rich Dad, Poor Dad"? Have you read any of Dave Ramsey's books?

    I am a doctor, not a lawyer, but I used the same principles to pay of my large med school loans in 5 years.

    Love your blog.

  4. Woops-I meant to write pay "off" not of.

  5. 1:21 - Thanks for the comment! I have read "Rich Dad" and several others. I will be talking about them in posts during the upcoming year. I would be happy for any comments or specific suggestions that you might have!

  6. I recommend this book to all my students. I have found it useful from both a marketing and wealth building prospective.

    Dr. Stanley's blog is also helpful.

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