In my last column, I talked about my recent visit to my son David’s seventh-grade class to explain why the American Dream is still alive and well – and how ordinary citizens of this country could still achieve financial freedom.
I did emphasize that it is the American Dream, not the American Guarantee.[ad#Google Adsense 336×280-IA]Fortunately, we have a very good understanding of what is required to achieve financial independence.
For starters, there is a near-perfect correlation between educational attainment and income.
Generally speaking, high school graduates earn more than high school dropouts.
College graduates earn more than high school graduates.
Those with a master’s degree earn more still.
And those with a doctorate generally earn the most. (Excluding entrepreneurs and other risk-takers, a category I’ll cover in a moment.)
Your formal education is not the sole determinant of your income, of course. It is also about your chosen vocation, your years of experience, your ability to learn and adapt, your work ethic, your social skills, your talent, competence and professionalism, your ability to organize, lead and inspire your co-workers and your ambition to rise in the organization.
And I pointed out to David’s class that economic success isn’t just about maximizing income. It’s also about minimizing outgo. (As the old saying goes, when your outgo exceeds your income, your upkeep becomes your downfall.)
Real financial independence – a key component of the American Dream for most of us – isn’t just about how much you earn and spend. It’s also about saving and investing.
High net worth individuals tend to save religiously and compound their investments over a long period of time, often decades.
However, I forewarned my young audience that the temptation to spend is irresistible for many – and that expenses have a way of rising to meet the income available.
Millionaires generally fight that trend.
We know this thanks to the work of Dr. Thomas Stanley, author of The Millionaire Next Door, The Millionaire Mind and other books. Dr. Stanley, who died in a car accident last year, was the country’s foremost authority on the habits and characteristics of America’s wealthy. Many of his findings were counterintuitive.
For example, we tend to think of the rich as owning mansions, sailing yachts, collecting cars and buying expensive bling. Yet Stanley found the majority of millionaires in this country – individuals with a net worth of $1 million or more – enjoy a fairly modest lifestyle. The vast majority:
- Live in houses that cost less than $400,000
- Do not own a second home
- Have never owned a boat
- Are more likely to wear a Timex than a Rolex
- Do not collect wine and generally pay less than $15 for a bottle
- Are far more likely to drive a Toyota than a BMW
- Have never paid more than $400 for a suit
- Spend very little on prestige brands and luxury items.
Frugality is the general rule. Investment begins with saving. And that means not spending everything you make.
This is an uncomfortably high bar for many Americans. And that’s unfortunate since it really takes so little, especially if you start young.
For example, over the last 200 years a diversified portfolio of U.S. stocks – with dividends reinvested – has delivered a 10% average annual return.
If you save $190 a month and earn nothing more than the market’s long-term average return, it turns into $1,017,710 in 40 years. Or more than $1.65 million in 45 years.
Could most Americans save $190 a month? You be the judge.
According to the U.S. Census Bureau, our median household income is $51,939. That means you would need to save just 4% of your pretax income (or approximately 5% of your after-tax income in this bracket). The later you start, of course, the more you need to save to reach this goal.
What keeps so many from achieving the American Dream?
Some are born into unfortunate circumstances that they are unable to surmount. Others have mental or physical handicaps. Still others suffer tragic accidents or setbacks.
But for many – and perhaps most Americans – it is ignorance of the laws of economic and investment success, poor choices, bad habits, and/or negative thinking.
Am I being too harsh? Is it really just a matter of planning, patience and discipline?
It is. But first – like the 12-year-olds in my audience – you have to understand the great secret behind our amazing free market system.
And I’ll reveal that in my next column.
Source: Investment U