Property Grunt

Sunday, December 06, 2009

What is the Matrix?

We aspire to be like this.

But the truth is through those aspirations this is what we are achieving.

Below is an interview with Thomas J. Stanley who is the author of the "Millionaire Next Door" which I highly recommend and he just published his latest tome "Stop Acting Rich...and Start Living like a Real Millionaire,". I higly recommend

To Act Like the Rich, Be Frugal

Q: You describe different levels of wealth in the book. There are the glittering rich, the income (statement) affluent and the balance sheet affluent.

A: The glittering rich make up a small fraction of 1 percent of the household population. They have a minimum annual household income of seven figures and a net worth of eight figures and more. They are extremely wealthy people, and they spend accordingly.

But, as I said in "Stop Acting Rich," no matter what they spend their money on, it is just a fraction of their overall net worth. In other words, even the glittering rich spend below their means. There are no more than 80,000 glittering rich households in a nation of more than 115,000,000 households.

3 years ago I did an entry on 740 Park Ave and on the type of people that reside in this building. They should also be considered the glittering rich.

If you watch old episodes of the Apprentice, there are some scenes where the cast meet at Donald Trump's enormous Manhattan apartment and go "Ooh! Ahh! Poppin fresh dough!" over the Fort Knox level of gold displayed in the interior decoration. In his line of work and as memeber of the glittering rich, he needs to be as flashy as possible, he has to show the world that he is a baller. Even though he has declared bankruptcy a number of times. His cost of living is high however, he probably watches his expenses very closely in order to maintain his wealth.

Unless you have their income or financial portfolio, don't even try to be like this group of people. It will only end in disaster.

Professor Stanley also touches upon why people who make a lot of money are not really rich.

The income statement affluent are those with high incomes and relatively low levels of net worth. They are not very productive in transforming their incomes into wealth. Many of the people in this category are highly compensated physicians, attorneys and executives. Many are driven to hyper-consume by their need to display high social status.

Farmers are found in high concentrations among the segment I refer to as balance sheet affluent. The balance sheet affluent are highly productive at transforming their income into wealth

Basically these numbnuts are focused on the perception of being rich rather than putting in the effort in becoming rich, like preparing a strong investment portfolio. Why? I think it is a lot easier to create the impression of being rich rather than doing the work in becoming wealthy. If you are a doctor making 6 figures a year, you buy yourself an expensive car because it is the quickest and easiest way to tell the world that you have money. That status symbol answers the question about your place in society. You can't do that with investing. First of all it is a lot of hard work. It also means exercising a strong sense of frugality which is not as fun as blowing enormous wads of cash on Armani suits. Afterall no one runs around with their financial statement indicating their net worth taped to their chest.

Professor Stanley lays out what the numbers really mean in terms of who is buying into the luxury market.

Q: Who is buying most of the top-shelf brand vodkas, extravagant cars and homes and why?

A: The question of "who" really has two answers.

Status products and homes are more likely purchased by people who have higher incomes. Look at three socioeconomic measures: net worth or wealth, household income and the market value of a home. Which of these variables is best at predicting consumption of the items mentioned? The value of a home ranks first, income ranks second and wealth ranks third.

Again, while it is true that the people at the upper level of these measures have a higher propensity to consume prestige products, it is not necessarily the most significant market.

For example, most prestige makes of cars -- 86 percent -- are driven by nonmillionaires. Yes, people with very high incomes, high levels of wealth are more likely to drive status automobiles. But in sheer numbers, the largest consumer segment for pricey cars, vodkas and homes is not the millionaire population, it is the aspirationals. These are people who think they are acting rich via their adoption of prestige brands, but in most cases they are only acting like each other.

Why do these people act this way? In large part, they are trying to imitate economically successful people. They take their cues from Hollywood and the advertising industry. The problem is that most aspirationals know few, if any, really wealthy to emulate.

It is not what you make but what you keep and you can't keep a lot of if your engaging in a lifestyle perceived as a "luxurious". What I find interesting about the three indicators of predicting consumption is the role real estate plays. It is obvious that this last real estate bubble we experienced was also a consumption bubble. Afterall, once you buy a new house, you need to buy new furniture, you also ned to get a new car and a new wardrobe to match your new lifestyle.

Q: How do you recommend that people become prosperous if they would prefer to get off the consumer treadmill?

A: The simplest way is to live below one's means.

The typical household should be able to put away 5 percent of their annual income while they are in their 30s, 10 percent when they are in their 40s, and 20 percent when they are in their 50s.

This is also related to satisfaction with life overall. There is a highly significant correlation between satisfaction in life and living in a home and neighborhood which are easily affordable.

What is a good rule if you are determined to become wealthy?

The market value of the home you purchase should be less than three times your household's total annual realized income. Also, if you are not yet wealthy, but want to be someday, never purchase a home that requires a mortgage that is more than twice your household's annual realized income.

Frugality is difficult but not impossible to achieve. It is a matter of budgeting and deciding on the value of goods and services and determine their added value. In the end the rewards are enormous. Not just monetarily but it also provides the skill sets that enables me to survive.

Q: Do you have a sense that American consumer values are shifting from aspirational luxury purchases that seemed to be heavily marketed in the early 2000's asset bubble days to more frugal ones?

A: No, I don't think that the values are shifting.

The only reason that people aren't spending as much as they did prior to the current economic meltdown is that they don't have as much money to spend right now. We are a nation of hyper-consumers. We encourage our children to major in consumption and minor in frugality!

The smartest people in the world are in the marketing and advertising industries in this country. How else can you explain that 300 different brands of vodka coexist in our domestic market? In 2009, about 2.3 million American seniors will pass away. What did they do with the more than $2 trillion in income that they earned in their lifetimes?

I estimate that only 2.3 percent will leave behind a gross estate (all assets included) of $1 million or more. What did the other 97.7 percent of the decedents do with all of their income? If they did not save their income, invest it or allocate it to things that appreciate, where did the money go?

Beyond the basic necessities, an awful lot of it was spent on things, many things that now reside in landfills and thrift shops. We are and will continue to be a culture of hyper-consumption.

Speaking of Vodka, I was once informed by a liquor store owner that despite the many brands of Vodka, they are all pretty much the same. The reason why some brands are more popular than others is due to marketing. Which is why liquor stores always have a rotating inventory of Vodkas because they know that sooner or later a popular brand will fall out of favor.

Yet, here we are. We still shell out money for what is perceived as top shelf vodka despite the fact that there is no such thing. Consumption plays a critical role in our society. It makes things move. But when the money runs out and all the credit is tapped out, it all comes to a standstill.

Once this depression ends, the machine will begin to roll, as the advertising and marketing factions of this country implement a new of strategies to emotionally hijack the masses into buying products of aspiration.

The more I learn about economics, I realize how critical consumption is to our economy, yet I am disgusted by it the rising levels of hyper consumption that society indulges in order present the facade that are one of and the same with the glittering rich. Mind you, I am not a communist. I believe in the idea of social status because has human beings we all have the desire to be better than what we truly are. However, this mentality that you can better yourself simply by buying a product or service is twisted. It is akin to people who join McDojos and buy a black belt and are convinced that they can actually hold their own if they are attacked.

Our economy is a Matrix, but my argument is simply that one does not need to be controlled by it but instead be in control of it.