Monday, May 16, 2011

Wealth Is What You Save, Not What You Spend

Source:http://financiallyfit.yahoo.com/finance/article-112550-9317-5-what-millionaires-have-in-common
Want to be a millionaire? Don't overspend and use debt wisely.

We all may not be millionaires but there are plenty of financial and life-planning secrets we can learn from the well-heeled.

Most people know that wealth in the U.S. is in the hands of a small percentage of the total population. And, today, most of those folks with a net worth of $1 million or more have earned it themselves.

They're mostly entrepreneurs who create everything from high-speed networks to garbage haulers. They dig ditches and build houses and grow corn and make jewelry. They deal stamps or coins or artwork and control pests and cut lawns. They also cure people and give them new teeth. Others will defend their neighbors or even feed them.

And they're not big spenders. In fact, most of those with big bucks live well under their means -- think about Warren Buffett still living in that modest Omaha home -- and they put their money instead toward investments that help them stockpile more wealth.

"Wealth is what you accumulate, not what you spend," according to Thomas Stanley and William Danko, the authors of the seminal tome on America's wealthy "The Millionaire Next Door," first published in 1996.

"It is seldom luck or inheritance or advanced degrees or even intelligence that enables people to amass fortunes," the authors wrote. "Wealth is more often the result of a lifestyle of hard work, perseverance, planning, and, most of all, self discipline."

Wealth is defined in many ways, though it's generally determined as the value of everything you own minus debts. But there's a difference between marketable assets -- things you own that could be liquidated rather quickly, like stocks, bonds, real estate -- and possessions like cars, clothing and household items that you use regularly and aren't likely to sell.

Income alone does not make one rich. It helps, of course, to build wealth, but the financially independent look to their salaries as a means to an end, which is that pile of cash.

"The wealthy don't spend their wealth on discretionary purchases," said Pam Danziger, founder of Unity Marketing, a consumer market-research firm specializing in luxury goods and experiences. "They get rich by maximizing the value of their investments."

That doesn't mean they don't pay big bucks for pretty shoes or outfits, but that most choose those items carefully and shop for value and quality. "They truly evaluate the purchase as an investment, not an expense," Danziger said.

What they do though is diversify those investments, which gives them more flexibility to ride out difficult times. "The wealthiest clients have very, very diversified portfolios that go way beyond just stocks and bonds into hedge funds, currencies, commodities and emerging markets," said Leslie Lassiter, managing director of the JPMorgan Private Wealth Management.

"There are many, many mutual funds out there that will allow you to get exposure to those types of asset classes," Lassiter said.

Among the biggest differences between those flush with cash and those wishing they were is in how they pay for things. Millionaires tend to use cash for most of their purchases, including cars, homes and boats.

For the average wage earner, of course, that's not always an option but it still holds this lesson: Don't look to debt to fund your lifestyle.

Most wealthy people use debt for investment purposes and are careful not to over-leverage themselves. "A prudent use of debt is an appropriate thing for anyone," Lassiter said.

They also plan very well and spend a lot of time at it. Many are compulsive savers and investors who often say the journey to riches was far more fun than the reaching the goal.

And they're patient, willing to invest in the long term and wait it out. "They stick with their investments and are more likely to have a financial plan," said Sanjiv Mirchandani, president of National Financial, a subsidiary of Fidelity Investments.

Many take the long-term approach to investing because they're working at being financial independent. When they retire, for example, many will know exactly how much they need to live on, to give away and to leave as a legacy.

"The best ones really understand how much liquidity they need to cover their expenses and make sure they have that much cash on hand," Lassiter said. "That's something the average person should do as well."

At the same time, she said most are very careful about leveraging debt. "The wealthy tend to balance between the two," she said.

Recommendations for accumulating wealth:

Live below your means: People with high incomes who spend all that money are not rich; they're just stupid.

Plan: That means plan for today, tomorrow and 30 years after retirement. Take time doing it too and spend time monitoring it every day. Use budgets and stick to them.

Diversify: As Lassiter said, look for mutual funds that allow you exposure to asset classes that aren't related to each other.

Reduce use of credit and turn to cash: It's easier, of course, for a prosperous person to pay for a house in cash than it might be for most folks, but credit-card debt for luxury purchases or extravagant vacations will never pave a road to riches.

Have access to cash: While the rich keep much of their wealth invested, they can get cash when they need it. "Have some kind of line of credit available, like a HELOC (home-equity line of credit) that you never use," Lassiter said. "It's a safety valve." She suggests a year's worth of cash to cover expenses; Danziger thinks three years worth is a better bet.

Spread cash around: When the wealthy pulled money out of the equities markets two and three years ago, they opened a bevy of bank accounts, all guaranteed up to $250,000 of deposits by the Federal Deposit Insurance Corp.

Bring your children into the mix, and remember the importance of estate planning: The affluent can go to great lengths to teach their children about money and how to manage it -- something every family should do. Though talking about money with children consistently ranks as one of the most dreaded conversations, it's important that your heirs know where all the bank accounts and safe-deposit boxes are -- even that their names are on them, too -- who the attorney is, where the will and trusts are filed.

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