Friday, March 20, 1998
by Al Levit
Glendale, CA (Mar. 20, 1998) -- It's Friday, that day each week when we aim to offer a useful financial lesson. On Fridays over the past six weeks we've covered: 1) the nightmare of credit-card debt; 2) an example of a large consumer franchise that didn't make the Cash-King cut; 3) a list of financial books worth reading; 4) why we don't think Microsoft's business is overpriced for long-term investors with its stock trading here at 50x earnings; 5) how to manage your personal Flow Ratio (the analysis tool that we outlined in Step 7 of our portfolio guidelines); and 6) why we selected Pfizer over Johnson & Johnson. For a look at all past Cash-King columns, click here: "Past Reports."
This week, I'm going to imitate item #3 above by focusing on a financial book that I think provides some interesting data for individual investors. By now, most readers should know that Cash-King investing is not a minute-by-minute or even daily challenge. We write columns every day here because we like to learn as we try to teach some of the fundamentals of long-term business investing. Even if, like us, you're keeping up with and contributing to the 2,600 or so messages on the Cash-King Web message board on a daily basis, you know that providing hot timely tips isn't one of our calling cards. Hopefully, you're here to learn and profit financially, intellectually, and yea verily, even in spirit if Foolishness moves you.
Given all that, we Cash-King investors design a life where we have some extra time to read an occasional book. We happen to enjoy reading a really good book more than flipping channels between the Jerry Springer Show and the E! Network (but it has to be a REALLY good book!). So, every once in a while we'll devote a column to a review of bound thoughts that you may find of interest.
Since I assume that you've already read all three Gardner books, and that you've bought copies for yourself, your spouse, your parents, your kids, and every other passing acquaintance, I'd like to turn to another slot on the business bookshelves today. Which one? The one that houses The Millionaire Next Door, by Thomas J. Stanley and William D. Danko.
The book has sold pretty well, so you may have heard of it. If not, The Millionaire Next Door is a study of more than five hundred millionaires conducted between May 1996 and January 1996. Much of the information is startling. The hundreds of millionaires described are consistently not particularly glamorous. In fact, they're surprisingly difficult to distinguish from most middle-class Americans. Their clothes come from J.C. Penney, not Saks; their cars are Explorers, not Jaguars; they go to work each week rather than lying around in a gooey puddle of baby oil and zinc oxide.
Who woulda thunk it?
Early on, the book posits the following definition of how much wealth a person (or family) should have accumulated at a given stage of life:
(Age x pre-tax annual income) / 10
The authors direct you to exclude any income or wealth resulting from inheritances from the calculation.
This equation is pretty powerful, since it promotes the idea that more wealth is acquired as we age. It's a fairly cruel lesson for anyone seeking substantial wealth when young (hey, have we reversed the aging of cells yet?). But for the rest of us, it's a great reminder of the benefits of compounded growth and patience. The book makes it pretty clear that wealth does not automatically travel along with high income. You'll note that the above equation does include investment returns -- so while your pile of savings expands at an average of 11% per year over the next thirty years, well, there's a darned good chance that your salary isn't going to grow at the same rate. Nope, savings, investing, and time seem to play much more consequential roles than annual income.
The book then goes on to subdivide the population into three classes:
PAWs (prodigious accumulators of wealth) -- those who have at least twice the average from the above calculation.
AAWs (average accumulators of wealth) -- those who have between half and twice the average of the final tallyfrom the equation above.
UAWs (under accumulators of wealth) -- those who have less than half the average from above.
Most of the rest of the book deals with what makes one person a dominating PAW and another a less prodigious UAW. It wasn't very surprising to learn that many of the traits that make one a Fool also seem to make one a PAW. Take a look at them:
Most PAWs select their own investments.
Most PAWs operate on a well-thought annual family budget
Most PAWs dedicate more time to planning their financial future than they do shopping for cars and furniture.
Most PAWs intentionally live a bit below their means.
The latter chapters of the book are important for Fools to read (since we tend to be early PAWs!) because these chapters discuss the passing of wealth between generations. Unfortunately, the evidence in the book suggests that offspring of PAWs tend to be UAWs. Why? Usually because the parents don't want life to be as hard for their children as it was for themselves. A downside of that aim, though, is that many PAW parents neglect to teach their children the basics of saving, investing, and the miracle of compounded growth.
Because that instruction doesn't come from the parents, the typical result is that inheritance fosters a reliance on the gifts as a source of income for the younger generation. They step up to the cash bin periodically, grab some loot, and spend it -- without understanding how to budget, how to invest it, how to transfer stock to charities, how to add more savings to the pile, etc. They have little understanding of how to put the tool of money to work for them, not ag'in 'em.
And over time, not understanding this tool does have negative consequences. The inheritors extend their lifestyle accordingly. Expenses expand to absorb the new income, and soon the young adults are no better off on the wealth scale than they were at the start. Then, real trouble can result if the parents withdraw or materially restrict their "offerings" and the children are ill-equipped for the future.
Inheritance without education and training is more dangerous than you might think.
The book proposes that there seems to be one type of major monetary gift by parents that has very positive consequences. That exception, as you might guess, is college tuition, which falls into the "teach a man to fish for life" category. The authors seem to propose that this is the only exception. Not even helping the kids with an initial down payment for a house is immune from the "expansion of expenses" syndrome noted above. Education has to travel with the gift for it to provide long-term stability.
After reading through the hundreds of accounts, I did conclude, though, that there were a few gaping holes in the book. There was not a single word about stock options. I wondered what happened to the thousands of millionaires in Redmond, Washington who've worked for Microsoft for the last ten years. Similarly, we know that there are thousands more who are millionaires the same way in Silicon Valley. Not a word was said about them either.
Also, I found it hard to believe that none of these very frugal millionaires, who make their own investment decisions, had ever heard of discount stock brokers. There was no mention of cutting costs when investing, even though the interviews were conducted during the later half of 1995, while discounting was in full swing.
Moreover, there was no mention of technology as an aid in budgeting or tax planning. I found this curious in a study of people who were so obviously successful at achieving their financial goals. I have to believe that many of the millionaires in the study are computer-literate, using the latest technology to organize the present and plan for the future.
For me, the biggest hole in the book was the lack of any mention of the Internet as a source for savings and investment research and advice. This might be the result of the 30-month gap between the interviews and today, but still I found myself wondering why the free information on the Web wasn't mentioned. Instead of discount brokers and low-cost research online, the book suggested developing a list of carefully selected investment advisers. Maybe future editions of the book will include a mention of technology.
I found The Millionaire Next Door to be a good supplement to much of what we have already learned throughout Fooldom, with a few interesting insights. I'd call it a valuable way to use up several hours when you choose not to be in front of your television.
That's it for me for this week. Rob will be here on Monday with a review of the performance of and news from our companies. Until then...
Fool on and see you in the Cash-King message folder,
Stock Change Bid ---------------- CHV +3 1/16 86.88 KO +2 15/16 77.50 EK + 5/16 62.75 XON +2 5/16 67.13 GM + 11/16 70.75 INTC -1 1/2 75.75 MSFT - 3/16 81.75 PFE +2 7/16 92.50 TROW - 3/4 72.50
Day Month Year History C-K +0.91% 1.00% 2.78% 2.78% S&P: +0.86% 4.75% 9.77% 9.77% NASDAQ: -0.60% 1.05% 8.24% 8.24% Rec'd # Security In At Now Change 2/3/98 22 Pfizer 82.30 92.50 12.39% 2/27/98 27 Coca-Cola 69.11 77.50 12.14% 2/6/98 28 T. Rowe Pr 67.35 72.50 7.65% 2/3/98 24 Microsoft 78.27 81.75 4.45% 3/12/98 20 Exxon 64.34 67.13 4.34% 3/12/98 15 Chevron 83.34 86.88 4.24% 3/12/98 20 Eastman Ko 63.15 62.75 -0.63% 3/12/98 17 General Mo 72.41 70.75 -2.29% 2/13/98 22 Intel 84.67 75.75 -10.54% Rec'd # Security In At Value Change 2/27/98 27 Coca-Cola 1865.89 2092.50 $226.61 2/3/98 22 Pfizer 1810.58 2035.00 $224.42 2/6/98 28 T. Rowe Pr 1885.70 2030.00 $144.30 2/3/98 24 Microsoft 1878.45 1962.00 $83.55 3/12/98 20 Exxon 1286.70 1342.50 $55.80 3/12/98 15 Chevron 1250.14 1303.13 $52.98 3/12/98 20 Eastman Ko 1262.95 1255.00 -$7.95 3/12/98 17 General Mo 1230.89 1202.75 -$28.14 2/13/98 22 Intel 1862.83 1666.50 -$196.33 CASH $5666.26 TOTAL $20555.64 *The year for the S&P and Nasdaq will be as of 02/03/98