Getting into Financial Shape with the Decamillionaire Next Door

The following guest post is by Roshawn Watson from Watson Inc. Learn more about Roshawn immediately following the post.

During a time of rampant pessimism and economic turmoil, a record number of Americans cannot even contemplate becoming a millionaire in the next 10 years. It may appear a little untimely to write about wealth; after all, many are just trying to stay afloat. However, I submit to you that there is no time like the present to get into financial shape. That’s because although the Great Recession exposed the vulnerabilities of many families, some families have also gained a heightened awareness of opportunities and resolve to strengthen their finances. One of the best ways to achieve this is to learn from people who have successfully managed their money.

Today, we’ll delve into key lessons from the Tiger 21, a club for decamillionaires. I recently read an account from one of their meetings suggesting that the typical American family can get into better financial shape by employing three simple steps.

1. Maintaining Adequate Liquidity

Liquidity is essential in today’s challenging economic times; more importantly, during your own personal economic crisis, whether it be a job layoff or a gigantic car repair bill, having liquidity can give you a peace that too few experience. At a minimum, consider maintaining an emergency fund of at least 8 months worth of expenses AFTER you are debt-free excluding the house. Admittedly, this IS risk-adverse, but it is also a NECESSARY precaution because: a) job security is an illusion, b) most real estate values have seen significantly better days, c) it’s hard to convince yourself to sell equities in an emergency (especially if the market happens to be down at the time of said emergency), and d) it may be hard to obtain loans from banks when you need them the most (instead banks may close your credit line if they aren’t certain they will be paid back or may demand the balance of your loans if you default).

Liquidity is not trivial. In terms of emergencies, Money magazine reported that 78 percent of families WILL have a major unexpected event within the next ten years. In other words, LIFE WILL HAPPEN, but whether or not you are prepared is up to you. Moreover, liquidity is not just for emergencies. According to the Millionaire Next Door, most millionaires can survive for more than 12 years without working. I’m not suggesting that all of that is in cash or near cash-equivalents, but the point is that having liquidity mitigates some risks. That’s the very reason businesses deleveraged back in 2008. Liquidity decreases our absolute dependency on our income.

Indeed, it may be your best defense after eliminating your consumer debts WHEN life happens.

2.Are You Insured?

Typically, we hate insurance until we need it. Purchasing adequate insurance also reduces our financial risks.

a) Long-term disability insurance is important because it replaces your income in the event you become disabled. Still, it is one of the most underinsured areas. The Senate Finance Committee reported that 70% of people between the ages of 35 and 65 will become disabled for three months or longer, and 90% of these disabilities will occur “off the job”. Don’t think Social Security will necessarily pick up the slack either. Many people with legitimate claims are rejected on a daily basis. Fortunately, some employers offer long-term disability insurance, so check with your benefits coordinator to see if you are covered. Otherwise, purchase an individual policy. Although an individual policy is more expensive, the peace of mind is well worth it.

b) Adequate life insurance is also critical so that the death of a loved one does not financially ruin a family. It seems morbid to talk about death, but if one has dependents, life insurance is critical. Many who have life-insurance do not have an adequate amount of coverage. One should have between 10-12 times his annual wage in insurance. For example, if a household’s income is $50,000 annually, a $500,000 life-insurance policy should suffice. Let’s crunch the numbers. A 10% annualized return on $500,000 would generate $50,000 per year; thus, the income has just been replaced. Do not let an untimely death devastate your family financially as well as emotionally. Lastly, go with a good term-life policy. You can obtain these for pennies on the dollar, especially compared to whole life.

c) Health Care insurance is an obvious must. Medical bills consistently rank among the number one cause of bankruptcy. Even a major medical insurance plan with a high deductible would represent an adequate start, especially if your family is relatively healthy. Also, consider a Health Savings Account (HSA) or obtaining coverage through an association (sometimes you can get significant discounts) if your job doesn’t provide you insurance as a benefit or if you are self-employed.

3. The Person in The Mirror

Most of us can get wealthy if we learn how to control the person in the mirror. According to the Tiger 21 club, it’s not a matter of “what can I afford to spend” as much as “what do I need to spend?

Did you know decamillionaire households are more likely to accurately an answer to the following: my grocery expenses are “X” and my clothing expenses are “Y” than the typical American family. Consider the implications of the following statements:

  1. More than two-thirds of grocery store shoppers in America today are impulse buyers.
  2. Two-thirds of millionaires surveyed (62.4 percent) know how much their family spends each year for food, clothing, and shelter.
  3. For every 100 millionaires who don’t budget, there are about 120 who do.
  4. Moreover, greater than half of the nonbudgeting millionaires invest first and then spend the balance of their income. In other words, before they purchase clothes, housing, food, etc., they pay themselves first a minimum of 15% of their annual income. Even without a budget, they are clearly controlling their income.

In short, those with more means are more likely to control their expenses(i.e., groceries, clothes, etc.) through budgeting than those with lesser means. If this is counterintuitive, remember that IT TAKES WORK TO BUILD WEALTH! Forget the media images of celebrities and Wall Street whiz-kids, most people who build considerable wealth may never get a substantially large pay check.

Frugality is the cornerstone of wealth-building. A good defense is critical to your wealth equation. Who better than decamillionaires to have internalized this lesson? If you consistently practice fiscal restraint and invest wisely, your money will eventually work harder than you.  Contemplate living off of just a small fraction of your wealth. The typical millionaire household lives on just 7% of its wealth.  That’s the kind of restraint I’m referring to.

The Income Myth and Parting Thoughts

Let me reiterate that it’s not about income as much as the media seems to represent. That’s because regardless of whether you make $50,000 or $500,000, you can still be broke! It is infinitely easier to earn a high income than it is to build substantial wealth.

  • Fewer than five thousand of the nearly 100 million US household will earn $5 million in a single year.
  • The majority of millionaires earn a small fraction of $5 million in a year.
  • Few could even become millionaires and support a high-consumption lifestyle simultaneously

Consequently, regardless of your income, I believe there is something to be gained from running an economically-productive household. By maintaining adequate liquidity, protecting your household with the appropriate levels of  insurance, and exercising fiscal restraint, you can build a financial house that is not easily destroyed by unexpected tragedy and lay the foundation to build extraordinary wealth. That’s financial peace that no flat screen, Gucci bag, or Lexus can even touch.

About the Author

Roshawn writes at Watson Inc. on eliminating debt,investing money, and building wealth. Get his free eBook Your Foundation to Wealth by signing up for his email updates (no spam I promise). Get his RSS feed and connect with him on Twitter @roshawnwatson too.

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