Money Rolls Downhill!
I remember when “The Millionaire Next Door” came out telling people how the authors, who are marketing professors, had come up with a big discovery. They discovered more high net worth (wealthy) people in middle class neighborhoods driving a “beat-up pickup truck” (hey, that’s what I drive!) than in high class neighborhoods.
These were results we have been well aware of as economists for many years. The reason that these marketing professors thought they had stumbled on something new is because many people are confused about the difference between income and net worth. The difference is crucial to your financial health. Income is nothing more than how much cash you bring in on a monthly or yearly basis.
People focus on income a lot because it puts the bling in bling bling! In other words income is hard cold cash coming in each month to buy goodies right now. It also pays the bills but does not get rid of them. Your cash flow tells you how much of your income you get to keep.
Net worth measures what you owe compared to what you own of value. It measures how much you are worth. Passive cash flow tells you how much of your cash flow would come in if you decided to quit going to work. You can see why guys like Robert Kiyosaki emphasize passive cash flow in their wealth building books.
The trick is to figure out how to get to the point where you don’t have to work anymore if you don’t want too. As financial economists we have known for years that living well within your means while saving and wisely investing as much as possible is the road to pumping up both your net worth and passive income so that you sleep-in every morning if you want to.
Let me give you an example of a simple decision my wife and I made that has had an enormous impact on our financial health. When we were married we decided we wanted to live in one of the upscale communities here in San Juan. This gated community is so big it actually has sub gated communities and numerous amenities such as the largest and most modern Olympic pool in the Caribbean.
We decided to purchase a 3 bedroom 2 bath condo that was within our means at 5,000.00. Now that we are wealthier and the condo has increased in value to around 0,000.00 we could sell it and move to a ,000,000.00 house like the ones at the top of the hill our condo is on. We decided to remodel our condo instead and live each day as if we were in a luxury hotel.
Why was this a great decision? By living in a modest priced home we were really able to deck it out. Also, this is really important for you to understand, we are paying only one fifth in property taxes to the local government as compared to what we would if we “moved up” like many people do when their finances improve. Money really does roll down hill because I sure would not want to HAVE to cough up a bunch of cash each year just to pay property taxes!
Another danger people don’t grasp is that local governments rely primarily on property taxes to fund their pork barrel politics. The primary source of revenue for most state governments is property tax! The local Puerto Rican government is now in a deficit. I guarantee that it has been discussed among the bone heads in the local capital that property taxes should be “reformed.” That sure makes an expensive home a financial powder keg doesn’t it!
Why do I suspect that most of the people in the million dollar community up above us are living above their means? Because they are the worst at paying their community fees and have had a lot of their services cut back! Just like they found out in the book “The Millionaire Next Door” many, many households in upscale homes are putting up appearances.
Many of these families are financially unhealthy, and deadbeats when it comes to paying what they owe. These families have less invested in the stock market because they have bigger bills to pay. These families are often less successful in the stock market because the pressure of their high debts focus them no short term stock investing where they are at a disadvantage.
Since we have lower costs in our modest home we are much less at risk if anything changes. Once we cash out the mortgage on our home we could even lose both of our jobs and get buy washing dishes at the local Taco Bell. That is certainly not the case when you have to pay property tax on a million dollar home!
About the Author: Scott Brown, Ph.D. a.k.a. “The Wallet Doctor” holds a doctorate in finance from the University of South Carolina and is a professor of finance at the University of Puerto Rico. Dr. Brown can teach you how saving the daily price of a cup of coffee at Starbucks can make you a millionaire in the stock market through long term stock investing. Dr. Brown's website is: http://www.walletdoctor.com/