FOOL ON THE HILL
Want to Be a Millionaire?

Whitney Tilson analyzes millionaires and shares some ideas on how to become one yourself. It's not as hard as you may think, and if you've been following the Fool's advice over time, you should be well on your way already.

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By Whitney Tilson
December 4, 2002

An article in last week's Wall Street Journal argued, "After inflation, taxes and investment costs, most of us will be lucky to break even, let alone make any serious money."

Jonathan Clements noted, "With stocks still richly valued, many experts are looking for long-run stock returns of around 8% a year. Subtract 2.5 percentage points for inflation, two points for investment costs and 1.5 points for taxes, and you are left earning a paltry 2% a year." Not surprisingly, the numbers are even worse for bonds or money-market funds.

Perhaps these assumptions are a tad pessimistic, but the general point remains valid: The easy days of the 1990s are over. As such, it's critical to have a backup plan for achieving your financial goals (for more on this, see the Fool's Retirement Center). For guidance on what such a plan might look like, let's see what we can learn from people who have already achieved a substantial degree of wealth: millionaires.

Characteristics of millionaires
According to a fascinating book I highly recommend, The Millionaire Next Door (published in 1996, so the statistics are a little dated, but the conclusions aren't), here are some characteristics of millionaires that might surprise you:

  • "More than 80% are ordinary people who have accumulated their wealth in one generation. They did it slowly, steadily, without signing a multimillion-dollar contract with the Yankees..."

  • Fewer than 20% inherited more than 10% of their wealth, and more than half never received a penny of inheritance.

  • They "wear inexpensive suits and drive American-made cars. Only a minority... drive the current-model-year automobile."

  • About half have lived in their current home for 20 years or more.

  • 80% are college grads, and 38% have advanced degrees (which reminds me of the bumper sticker: "If you think education is expensive, try ignorance").

  • 20% are retired. Of those still working, about two-thirds are self-employed -- mostly entrepreneurs, but also self-employed professionals, such as doctors and accountants.

  • On average, they invest nearly 20% of their household realized income each year.

OK, so most millionaires aren't rock stars or scions of wealthy families, but surely they have high incomes, right? Think again. Their median annual income was a mere $131,000. So how did they become millionaires? The answer is so simple it sounds trite: "They live well below their means." 

In short, the book explains most millionaires are "FRUGAL, FRUGAL, FRUGAL... Being frugal is the cornerstone of wealth-building... The affluent tend to answer "yes" to three questions: 1) Were your parents very frugal? 2) Are you frugal? 3) Is your spouse more frugal than you are?"

Yet, fueled by easy credit, we are increasingly becoming a nation of vast consumption rather than frugality. Not only are Americans not living below their means, they're taking on unprecedented amounts of debt so that they can live above their means." Consider the following statistics:

  • Consumer credit plus mortgage debt now equals nearly 40% of personal income, versus only about 30% in the early 1990s and only 27% in the early 1980s.

  • Debt service as a percentage of disposable income was only 12% seven years ago, but has now risen to almost 15%, despite the fact that interest rates have plunged to multi-decade lows. This means the average American family is spending one-seventh of its disposable income simply paying the cost of its debts.

  • It shouldn't be surprising, then, that the net national savings rate fell to a record low of 2% in the second quarter.

These unsustainable trends have alarming implications for the U.S. economy, as consumer spending accounts for roughly two-thirds of the nation's economic activity, as well as for the retirement prospects of most Americans.

Are you wealthy?
The Millionaire Next Door has a simple test to calculate what your net worth should be right now:

"Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by 10. This, less any inherited wealth, is what your net worth should be."

So, if you're 40 years old and earn $95,000 in salary and $5,000 from investments pretax, then your net worth should be $400,000 (40 times 100,000 divided by 10). If this test shows you're an "under accumulator of wealth," then you might want to think hard about making some changes.

Money-saving tips
Assuming that your boss would take a dim view of a demand to immediately increase your salary, and given that job-hopping in this economic climate is unlikely to lead to higher pay, the key lever for increasing your savings is to cut expenses. There are two ways to do this: Consume less or pay less for what you consume. Let me share a few tips on paying less. (This is by no means a comprehensive list; there are countless websites and books dedicated to money-saving ideas.):

  • If your mortgage is more than a couple of years old, look into refinancing to take advantage of mortgage rates that remain near all-time lows. (For more on this, see the Fool's 60-Second Guide to Optimizing Your Mortgage.)

  • Pay off high-interest debt such as credit cards, or at least shift the balance to teaser rates on new cards until you can do so. (More tips in the Fool's Credit Center and on our Credit Cards discussion board.)

  • Long distance and wireless phone rates have plunged, so try calling your provider and threaten to switch unless they give you a better rate. I bet you'll get it.

  • Buy generic rather than branded products. I'll admit that I have my brand loyalties, but in general, why pay for big advertising budgets and fat profit margins? To save 20%, 40%, or even 60%, I'm willing to give a generic product a try -- and more often than not, I find that I'm pleasantly surprised.

  • Buy on eBay (Nasdaq: EBAY). No, I'm not a shareholder trying to promote the stock; nor am I your stereotypical eBay junkie, buying and selling trinkets and collectibles; nor do I have the patience for auctions. Instead, I buy a range of products, almost always new (or at least factory refurbished) and at fixed prices. Over the past year or two, I've purchased a printer, toner cartridges, a LeapPad kids game, a Sony PlayStation (not for me, unfortunately!), a video camera and cassettes, a VCR, a cordless phone system, and an inflatable air mattress. I always shop around and estimate I save 20%, on average, by buying on eBay. There's some risk of unscrupulous sellers, but if you only buy from highly rated sellers, you should be OK.  I've never had a problem.

  • Shop at Costco (Nasdaq: COST). No, I don't own this stock, either, but I agree with Berkshire Hathaway (NYSE: BRK.A) vice chairman and Costco board member Charlie Munger, who once said, "Costco is God's gift to consumers." Consider the gross margins (which reflect a retailer's markup above cost) for various companies: Costco: 12.2%; Wal-Mart (NYSE: WMT): 21.4%; Home Depot (NYSE: HD): 30.5%; Safeway (NYSE: SWY): 31.1%. Not only does Costco have lower markups than just about anyone, but it can generally buy for less by carrying only a limited number of products.

  • If you travel quite a bit, the Web offers amazing bargains. I stopped using a travel agent years ago and instead use Orbitz, Expedia (Nasdaq: EXPE), and Travelocity (Nasdaq: TCTY) regularly, but my favorite travel site is Hotwire, which is like Priceline (Nasdaq: PCLN), but without the annoying auction process. For example, I took a trip to Las Vegas earlier this year and needed to hotel on short notice. Hotwire offered me a room at a five-star hotel on the Strip for $99/night, but -- here's the catch -- I didn't know which one. But for $99, I didn't care! (The Venetian was over the top, by the way.)

Conclusion
The key to accumulating wealth is to consistently spend less than you earn over time. How obvious and simple in concept -- yet difficult in practice!

Guest columnist Whitney Tilson is managing partner of Tilson Capital Partners, LLC, a New York City-based money-management firm. He owned shares of Berkshire Hathaway at the time of publication. Mr. Tilson appreciates your feedback on the Fool on the Hill discussion board or at Tilson@Tilsonfunds.com. The Motley Fool is investors writing for investors.