In a survey of 1284 households that have a net worth of at least $2.5 million, 1232 of the households indicate that their annual spending is less than the income generated by their private business holdings, stock dividends, partnership distributions, and rental income. Given that, at a minimum, this implies passive cash flows of at least $12,000 per month, it may not sound surprising to you that these families can make it work.
But what I find interesting are the reflections from these wealthy individuals about their habits on their journey from a point at which their financial resources were modest to the point that they had accumulated something substantial.
And, in this case, 1063 of the households that spend less than their annual passive income state that they left their investment holdings alone while they were getting rich, and also lived on much less than their annual salary. This means that 82% of households that reach millionaire status leave their compounding engines undisturbed.
In high school, I was on the St. Louis Priory cross country team. I was never a fast runner. My career high for the 3.1 mile race was a final time of 20:32. That was good enough for 54th place at a charming place called Spanish Lake Park. It was a co-ed race, and a group of five girls sprinted past me right before the finish line.
Being my charming self, what did I do? I made excuses! I talked about my ailing leg. I mentioned those girls must have naturally been runners, and that’s why they beat me. Surely it was in their genes.
My coach heard my grumbles and approached me. Hint: He wasn’t coming over to lend a sympathetic ear to my nonsense.
He told me those girls beat me because they out-trained me. They didn’t beat me because God bestowed them with the natural attributes to be runners that could show up anywhere and run three point one miles faster than twenty minutes and thirty-two seconds on a whim. No, it was the act of putting one foot in front of the other, as quickly as they could, on day after day that put them in the position to run faster than me. In other words, it was repeated behavior that made them faster runners.
This applies to nearly everything, including the process of accumulating wealth. Only 13% of people are rich because they inherited it. For the remaining supermajority, it is created by the repetition of behavior. And the chief behavior that trumps everything else is acquiring ownership of a cash-generating asset, and then permitting those profits to aggregate.
Take a look at something like Philip Morris International (PM). Since its spin-off from Altria in 2008, shareholders have received $32.26 in dividends assuming no dividend reinvestment. With dividend reinvestment? Each share generated $41.16.
It traded at $40 per share in 2008. If you needed to use those tobacco dividends to support your lifestyle, then you would only have the capital appreciation today to show for your investment. If you reinvested the $32.26 into something other than Philip Morris, the success of the choice obviously depends upon your alternative investment. But if you reinvested–you would have collected over $10,200 in cash thrown off for every $10,000 you invested in PM. And those are the returns of less than a decade of cash dividends compiling. Spending the proceeds of a cash generator vs. reinvesting them affects your ending medium-term wealth point by a third. It’s the difference between turning every $10,000 you touch into $40,000 instead of $30,000 every decade or so. This is the specific behavior that maximizes the value of your estate.
The distinction that needs to get made is that this is not a decision that was reached upon hitting the wealth point of financial independence. The financial media makes it sound like: “Oh, look there! Where’d that $2.5 million come from? It’s depositing $12,820 in my account each month. I guess I can live off that.”
No, no, no.
That’s not how it happens.
The reality is that these wealthy families go through a three-step process: (1) they identify cash-generating assets; (2) they take cash either from their labor or previously acquired assets to purchase an ownership position in the identified cash-generator; (3) and they then combine the cash proceeds from this new investment, and aggregate it with the cash income from their labor and other investments to repeat the process again.
Even when these wealthy families reach the point of financial independence at which their investment income funds their lifestyle in full, they still don’t spend as much as their passive income permits. When they bring in $12,000 per month, their spending tends to fall in the $7,000-$10,000 monthly range so that they are still retaining part of their monthly cash flow to bulk up their estate. They find it far more enjoyable to continue to build wealth as they go through their retirement years rather than perform 4% rule calculations about maximum withdrawals.