David R. Henderson  

Getting Rich in America

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Sometimes, when the person beside me on an airplane finds out that I'm an economist, he/she will ask, "What's going to happen to the economy?" I answer, "I don't know." If the person is somewhat more sophisticated, he will ask "What's going to happen to interest rates?" I used to answer, "I don't know." I now answer: "They'll fluctuate."

Sometimes the person will ask, "How do I get rich?" I used to answer, "I don't know." But now that I've seen a lot and seen the basic mistakes so many people make, I realize that, compared to a large majority of Americans, I do know. I know how to get rich--slowly.

In 1999, two economists, Dwight R. Lee and Richard B. McKenzie, wrote a book, Getting Rich in America: 8 Simple Rules for Building a Fortune and a Satisfying Life. In my review of the book for the Wall Street Journal, I called it the "how-to guide for becoming the millionaire next door." I realized when reading it that I had been following all 8 rules without ever having written them down.

Here they are:

1. Think of America as a land of choices.
One great quote is from a small successful businessman who said, "If you want your prayers answered, get off your knees and hustle." They point out, "You must do something that will be seen to be of value for others."

Note: When I talk about these rules in class, if I have students from poor countries I give them rule 0: Move to America.

2. Take the power of compound interest seriously--and then save.
Albert Einstein is reputed to have answered, when asked what is the greatest force in nature, "Compound interest." (I don't believe it but it's a great story and makes the point.)
When a friend who had studied saving behavior of various ethnic groups was visiting me almost 20 years ago, I told him that I saved about 20% of my pre-tax income. His eyes widened and he said, "You're Korean." How did I do that? Every time I got a raise, even just an inflation adjustment, I raised my saving rate by 1 or 2 percentage points. Starting from 10% in the mid-1980s, I was at about 20% by 1993.

3. Resist temptation.
This is the hardest rule for most people to follow. I'm really good at it. My wine of choice is two-buck Chuck, I virtually never order alcohol when I eat out, and when I buy cars, I try to hold on to them for at least 10 years. I spend little on clothes. One Starbuck's tall mocha a week is a treat.

4. Get a good education.
"Take professors, not courses," write Lee and McKenzie. I thought this was mine. It wasn't.

5. Get married and stay married.
When I teach this, I point out the following: "50% of American men, when they leave their houses, kiss their wives good-bye. 93% of American men, when they leave their wives, kiss their houses good-bye."
Dwight Lee explained to me that if you follow the other 7 rules, there's no need to get married. But what they have observed--and I've observed it also--is that when you don't get married, you tend not to follow some of the other rules.

6. Take care of yourself.
Don't smoke, do drink moderately, and do exercise. Sickness is expensive and shortens your life, reducing the time over which you can build your fortune.

7. Take prudent risks.
Don't put all your money in what you think will be the next Microsoft. It could just as easily be the next Enron. I invest in Vanguard and much of that is in their total stock market index. The expense ratio is under 0.2%. I also diversify internationally.
Lee and McKenzie write, "Remember, the surest way to get rich in the stock market is slowly--which paradoxically is (unless you are unusually lucky) also the fastest way."

8. Strive for balance.
Have some component of volunteer activity in your life. (This is part of the "satisfying life" part of the sub-title.) The authors recommending "giving back." Most of what people call giving back is not giving back at all. Nor need it be. It's simply giving. And there's nothing wrong with that.


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COMMENTS (32 to date)
Jason Collins writes:

On 5, most marriages are ended by the wife, so that rule is not directly within the husband's control. However, as earning less than the wife, unemployment and low wealth are good predictors of divorce, if you follow the other rules, rule 5 might take care of itself.

Vacslav writes:

On 2: For some people the math-magic of Compound Interest cannot compensate for gradually eroding choices and ability to enjoy life. Also, on 2: the power of Compound Interest is nothing compared with the ability of governments to destroy the value of savings. Prudent savers are supposed to be getting reasonable returns on their savings now, aren't they?

liberty writes:

If I have to do all 8 of these to get rich, I don't think I want to get rich. Maybe this is why I'm not rich, but at least I'm happy.

I take risks, don't save excessively (you never know what might happen, no matter how careful you are to diversify), I don't spend on clothing or fancy cars but I do enjoy my money using it for things that make me happy - holidays, social things, things that enrich my life.

It's not a game to see who dies with the biggest bank account!

Grant Gould writes:

I don't recall when I was given this advice, but it has served me well: "If you can produce more than you consume using capital that costs less than your savings, you are free." It's not a terribly glib or concise rule, but its value is undoubtable. Build skills and save money and eventually you will be rich in freedom.

Joe Cushing writes:

when people think of being rich, they aren't thinking of being the millionaire next door. They want to have a high consumption lifestyle. Being the millionaire next door is better than being the average schmuck, but it is not what people are dreaming of. People want to go out and spend money on whatever their hear desires. We know that's not what the millionaire next door lifestyle is about. The millionaire next door accumulates wealth by not living a rich lifestyle. When people want to be rich, they want a rich lifestyle.

Tracy W writes:

Rule 1:
I don't think that this is specific to the USA.
My rule 1 would be "Choose to live a life in which you have choices". I did a negotiating course, and it's amazing what can be negotiated, when you think that you don't have to accept a deal.

Rule 4: I think I prefer Paul Graham's advice to "sail into the wind" educationally - take the hardest courses you can do. His test for which courses are the hardest is what do people drop out of, and what do they drop into.

Rule 5: I saw a good line: "No woman has ever shot her husband while he was doing the dishes."

R. Jones writes:

On 5, Marriage without a prenuptial agreement seems like an imprudent risk for many in this day and age.

I'd be interested in the libertarian views of the prenup. Many individuals avoid the prenuptial because it's unromantic. It seems like a clear case of irrationality that could be improved by changing the default options. All couples would be required to specify a prenuptial agreement unless they declared otherwise.

Joe Cushing writes:

R. Jones,

The libertarian views on prenups would be that if people want them, they can have them. Actually, I'd say that a marriage is not a marriage without a contract. Vows are a contract. Prenups are a contract. Everybody gets so hung up on the prenup's purpose of how to dissolve the marriage but it can also spell out the terms of a marriage. A prenup is vows binding. It's what a wedding should be. For the non-religious the prenup is the marriage. The state should have no roll in marriage at all.

Glen Smith writes:

This is more a list about the properties of a wealthy man than a description of actions to take.

Hadur writes:

I think there is something to be added along the line of "know your limits".

Among my demographic (young males who recently graduated from top schools and make enough money to have some left over for savings/investment) there seems to be a trend of showing off your investment prowess. People brag about the latest stock tip they acted or or the latest side business they attempted to start, the way that male lizards sometimes show off bright dewlaps on the underside of their necks. The implication appears to be that if you are not putting your money to active use by that, you are either stupid or a sucker.

I, on the other hand, acknowledge the fact that I can't possibly pick stocks as well as professionals can (if even professionals can pick stocks well!) and that starting side businesses takes time and skills I may not have.

I'm sure that at least a portion of my friends will become rich through their self-directed investment. What I'm betting on, though, is that many more of them will fail to outperform my strategy of just socking money away in diversified funds managed by somebody else.

Jesper writes:

The 5 is somewhat reasonable, as marriage gives economies of scale and increased social acceptance. However, it needs to be pointed out that your spouse must follow the rules as well.

At least in my own Sweden, a fair amount of growing wealth and income disparities seems to be due to smart, disciplined, highly educated people marrying each other instead of just tossing a coin.

It would be interesting to live forever and see what this trend does to our society, the gene pool and so on in 10-20 generations. But perhaps (likely) genetic engineering will make it irrelevant.

Yancey Ward writes:

Glen Smith wrote:

This is more a list about the properties of a wealthy man than a description of actions to take.

I am confused. Every single one was a suggested action to take, get, or strive for.

'Find a need, and fill it.'

Andrew writes:

Bryan probably would have titled this as "8 steps to avoid poverty"

cthorm writes:

If you're going to hold investments for a long period of time, especially in a tax sheltered account like an IRA or 401k, you're better off allocating the majority of the funds to investments with some dividend or interest yield. A stock index fund will give you good diversification and exposure, but you won't get the benefits of compound interest.

Daublin writes:

Kudos, David. Your list of items would be a better introduction to successfully living the American dream than anything currently taught in kindergarten classes.

I would quibble with "resist temptation". There is a balancing act between how much work you want to do and how much consumption it allows. If your work is pleasant, then I see no reason to defer consumption and live an ascetic life. A more carefully phrased rule would say something about, consume little enough that your savings can keep growing.

@cthorm: I don't follow, unless you are quibbling on terms. If your index fund reinvests profits, then don't you still get exponential growth? Perhaps you could say it's not "interest" you are earning.

Joe Teicher writes:

I always worry about thrifty people. I think they will not have the drive to push to get to the next level of income because they won't really enjoy the extra income if they get it. My perspective is that you should spend as much as possible and load up on fixed costs and responsibilities. Then you will have the motivation to work your ass off to get to a high income. I think that people who just work their ass off and get to a high income end up a lot richer than thrifty people who don't work that hard. There is just a lot more scope to increase income than there is to decrease expenses. Plus, you might get hit by a bus tomorrow. Wouldn't you have rather lived as rich as life a possible rather than saving for a future that never ended up happening?

Mike W writes:

All good rules for living a "satisfying life", but that is not the same as "building a fortune". The marketing of the financial services industry (and books like the one you reference) equates the two in the public perception. While it is a prudent way to create a retirement nestegg long term, nobody is going to build a fortune by relying on the power of compound interest and making annual contributions to the Vanguard Total Stock Index Fund.

Building a fortune requires swinging for the fences not prudent risk taking. Those folks really are different. If more people focused on the risk rather than the reward in their saving they would lose less and, while they would not have "a fortune" they could have a richer life.

collin writes:

It should be mentioned you need to marry the RIGHT person as opposed to you should get and stay married. That probably makes a big difference as the consequences of bad marriages are seen everyday on mid-day TV.

CR

Thomas Boyle writes:

If you follow the other rules, then by getting married, you are selling an option, "picking up pennies in front of a steamroller". Sure, as long as you pick up the pennies you're better off - which is why the "stay married" is so important. Trouble is, that's an option you've sold, so you don't control it. It's true that most marriages are ended by the wife, and surprisingly often simply because they have "outgrown the relationship".

I also observe that husbands, at least, who follow the other rules, will find their wives' activities increasingly biased toward the emotionally satisfying but not necessarily remunerative. Thus, the pennies the men pick up at the start will also be frittered away over time.

For poor people, being single is a luxury (because it offers no sharing of expenses). But, for affluent men, being married is a luxury - one with a hidden (and probabilistic) cost. If you love being married, then that's fine: it's a luxury; treat it as one. But understand that the cost of a divorce is embedded: treat that money as already lost, and know that you can't rely on it being there in the future. All too often, men think of the total family net worth as "theirs" because they earned it; but their wives think of roughly 110% of it (50% of current family net worth, plus alimony into the future) as wages earned, and theirs to take if and when they feel inclined - and the wives have the better grasp of the law. Most married men, if you subtract the present value of their potential divorce liability from the family net worth, have substantial, negative net worth themselves.

Doesn't sound like a path to riches, to me.

Peter writes:

@R. Jones writes:

"On 5, Marriage without a prenuptial agreement seems like an imprudent risk for many in this day and age."

The problem is, IMHO, is most men (and maybe women) aren't thinking about this when they decide to get married, especially when you are young and low worth. Eighteen year old trailor trash who just knocked up his girlfriend who, for a variety of reasons isn't covered by welfare, and has to marry her so insurance covers the prentatal care isn't thinking about pre-nups.

It's why I'm partial to civil unions in contractual form as it forces you to read the small print. My marriage license was a half pager that asked for name, DOB, and where you plan to get married. It didn't come with a thousand pages of "what these means in the legal context once you sign and what this means when you split up twenty years later"

Jason Malloy writes:

On 5, most marriages are ended by the wife, so that rule is not directly within the husband's control


Well, some of those divorces are due to groomly misconducts, no? When you factor in fault, women and men seem to be about equally accountable for marriage dissolution.

Of course it's not totally within your control, but all prudent choices are only probabilistically related to success (refraining from cigarettes doesn't guarantee you won't get lung cancer). As illustrated recently by Coming Apart, divorce and marital dissatisfaction remain low among professional workers. So choose your spouse from a pool of people less likely to divorce, and make choices that make you less divorceable.

Phil writes:

Joe wrote:

I always worry about thrifty people. I think they will not have the drive to push to get to the next level of income because they won't really enjoy the extra income if they get it.
I think you are confusing income with wealth. While a high income can make wealth accumulation easier, most of the high income people I know are not wealthy and all the wealthy people I know are hardworking and thrifty.

Another good read is Stanley and Danko's 1998 book The Millionaire Next Door (ISBN 978-0671015206) in which they interviewed and profiled folks with a net worth over $1 million. They found the characteristics of the typical millionaire in the U.S. looks more like the average guy next door than the guy in the Italian suit and German car.

Joe Cushing writes:

Phil,

I think you missed my comment above. How does the average person define rich? With the exception of accumulating some slowly consumed durable goods, Income is more important than wealth. The whole purpose of accumulating wealth is so that it can produce high income. If you have high income, then the wealth isn't needed to be rich. Also, as you said, it becomes easy to accumulate wealth if you have high income, so that your current source of high income becomes less important over time. Think of a dentist who buys apartment buildings and then become a part time dentist.

In the millionaire next door, nobody becomes rich until late in life.

thomas boyle writes:

Jason,

Curiously, because - as you say - there actually are things men can do to affect the odds of their wives exercising the divorce option, they may actually be worse off, because the wives end up in a very powerful position to demand concessions within the marriage itself. Essentially, the wives can extract a portion of the value of a divorce, without divorcing.

From what I've observed, the behavior that most affluent men adopt, to make themselves less divorceable, is to do whatever their wives tell them to do. Always. Without argument. Without regard to the cost. I wouldn't be surprised if that is primarily what accounts for the low divorce rates among the affluent! (As for the "happily married" survey results, as a psychologist once told me, "we feel the way we need to feel, to do the things we need to do".)

To slightly correct the article, "93% of men, when their wives leave them, kiss their house - and their retirement, and their ability to retire - goodbye". It's educational to work in Human Resources for a while. You'll see someone working their butt off in a top 5% income job, "getting by" in a shared apartment while their ex-wife lives in the house they're still paying for. It's sobering, when - as I was - you are involved in administering an early retirement offer, to have men tell you "I'd love to take the offer, I'm exhausted, and I know the offer is now or never, but I can't - I'm only 59 and the judge won't lower my alimony just because I want to retire". I once worked with a semi-retired executive in his late 70s, a delightful man, who was still making substantial alimony payments to a woman who had left him more than 30 years before.

And so, the more men have to lose, the more they say "how high?" when their wives say "jump". It's somewhere between sad, and downright frightening to watch even powerful executives cower like beaten puppies.

It's amazing what you'll do when someone could pauper you with a signature.

Matt Raft writes:

Thank you so much for this post. I've been giving the exact same advice to young adults, whose jaws often drop when they realize that the appearance of money does not necessarily indicate wealth.

Also, as you mention in #3, I only buy used cars (tip: rental car businesses like Enterprise and Hertz often sell inexpensive, used small cars). Most people have no idea how a car, even a used one, drains their paycheck. When you're done tabulating insurance (tip: get the "MedPay" and towing options, and if you have comprehensive insurance, get uninsured motorist coverage), maintenance, gas, sales tax, and loan interest (if you don't buy with cash), you're spending far more than the car's actual utility.

IMHO, the best way to help the poor (and reduce expenses for everyone else) is effective public transportation. When I represented discharged employees, in many cases, the lack of immediate income (aside from unemployment insurance benefits) would cause them to lose their car, which would make job-hunting and overall punctuality extremely complicated, especially for single parents. In fact, in some cases, the employee would be terminated b/c of car problems, which had caused him/her to be late to work. In short, I am surprised more people, including economists, do not mention the overall benefits of efficient public transportation systems, such as the ones in D.C. (Metro) and Singapore (MRT).

RL ExtraCredit writes:

I feel like this is more a list that talks about avoiding poverty rather than being rich. The reason I feel so is because the most important point in order for someone (specially an entrepreneur) to become truly wealthy has been skipped. In my opinion this point is about taking action which is RESULT ORIENTED. Tycoons make things happen. They are driven by results. Planning for success is as important as achieving success. You need to know exactly how you got there so your success can be duplicated, scaled up and multiplied, else you would remain stuck in this stage of avoiding poverty.

Silas Barta writes:

I agree with Vacslav. Compound interest is a lot less powerful when savings interest rates are ~0.02%.

Heck, it's pretty impotent in terms of wealth accumulation through prudence even at about 5% *real*.

Phil writes:

@ Joe Cushing. I should have been more clear as the quote I cite was not yours but the other Joe's (Joe Teicher). That said, the statement that "those who want to be rich want a rich lifestyle" is not universally true. There are a great many of us who want to be rich to first have a sense of security, and second the option of having a rich lifestyle. Those who become rich through frugal means may never exercise that option, but there is a sense of fulfillment and joy from simply having it.

Shimen Krek writes:

Marriage is a good one. The median net worth of married couple households in a Census Bureau wealth study 4x higher than that of a single man and 5x higher than that of a single woman. Married couples' wealth increases at a faster pace by double. "While men come out slightly ahead, divorce destroys wealth dramatically for both sexes," wrote Jay Zagorsky. Your net worth will likely be higher than that of a single or divorced person. Also, its been known that married couples not only make more money and faster but manage their money better. Not only that, but the longer a couple stays married the more assets they build.

Alexa W. writes:

Many of these rules for becoming wealthy are indeed applicable to everyday life. I would like to highlight two of these points, in particular.

In response to #3, more and more young adults are taking the college route after graduating from high school. Statistics have shown that people are paid higher wages after attending and graduating from a university. Studies have also shown that college acceptances of applicants is becoming more competitive each year; students are needing higher GPA's and test scores just to be accepted into a respected university.

I also agree with #8. While learning more about economics, it was strongly emphasized how everything is connected. The wide variety of skills people have are related to the different careers they have which are connected to the diverse products being sold. Everything people do in this economy has an effect on those around them. If more people gave back, levels of positivity and productivity in the economy would consequently increase.

Are you frustrated and wondering why you are earning peanuts while the "heavy hitters" are earning all the money easily?

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