A lot of this is wrong. For example, no one
rich would "leverage their home equity to finance purchases."
And though rich people often have assistants, they're not drawn from a special guild of "concierges" with connections for getting restaurant
reservations. Nor would anyone rich rent handbags or Ferraris.
The parts that aren't false read like a description of
someone who made money from e.g. developing shopping malls.
People who get rich from technology are less likely to be B students, less likely to try to
cheat the IRS by routing their personal expenses through their
companies, and more likely to be "nice guys."
But, as a percentage, what subset of all rich people actually earned their money through technology? Either way, if those people aren't leveraging their home equity, than they don't know much about finance, truth be told. Assume you have good credit and a steady income or assets; there is absolutely no reason to own your house outright. Bill Gates, for example, has a mortgage on his house. The easier way to think about it is that if you're paying 5% interest on your mortgage, but could get 7% return on money elsewhere, you should take all the money out of your house and earn the 2%. Either way, you also get the value increase (or decrease on the equity as whole). This is the same reason that many wealthy college students take out college loans, because with their low interest rate, there is no reason not to have the 40k sitting somewhere else making more money.
I don't know what evidence, other than opinion, you have that rich people don't have a special guild of concierges, or rent handbags or Ferraris. I know several people of the private jet sort who do have an assistant that is not just someone who just takes down their schedule, but rather is someone who can solve problems anywhere, work the network to get a dinner reservation where ever you want, etc. Further, most fabulously wealthy people are very smart with their money, even if they do have ten houses and two yachts, and although they could buy $2000 bags and throw them away in two months, why would they? They could buy a fancy sports car, an asset that radically depreciates and that you can’t drive all the time, or they could rent one whenever they want?
I didn't say that rich people don't have mortgages, but that that they wouldn't borrow against their house to finance purchases. There may be some tax advantage to having a mortgage, but it wouldn't make sense to borrow against one's house to buy stuff that was going to depreciate in value.
Where did you hear that Bill Gates has a mortgage on his house? It seems very unlikely. You can only deduct the interest on the first million of mortgage debt, so it wouldn't seem worth the trouble.
As for the handbag question, try giving a woman the choice of buying a new handbag or renting a used one, and see what she says.
Ya, I would agree with your comment about financing purchases, and I read that slightly incorrectly. My point, even for bill gates, is that if your rate of return on capital, or expected rate of return, is higher than the rate at which you can borrow capital, than you should borrow. That differential is what's important, with the tax break being icing on the cake.
And on the handbag question, haha, I think you're likely correct.
I am less sure about cars, since if you are going to buy and dump a car, it seems like you should lease it, no? I don't know...
I think the other important thing to realize is that the rich aren't, like any large group, unified in their behavior, which is something that article like this always avoid. There is no one way to become a millionaire and there certainly isn't one set of behaviors they exhibit.
On the last point, the same applies for cars. The market for used 1 or 2 year old BMWs is very strong. Rich people buy new ones, and dump slightly used ones.
Well, there are very few risk free returns, obviously. I guess the standard would be US treasury bonds, which don't pay more than mortgages, obviously. But the S&P has an annual rate of return of almost 10% over the last forty years, so if you're risk averse (aren't we all) a good index fund will likely beat your mortgage rate.
I wouldn't say I'm rich, but my accountant is creative when it comes to tax, and rightly so.
I completely agree on the handbags thing, Ferraris are a different matter - if you have a means of moving that cost from being a taxable depreciating asset to a tax writeoff then go for the latter. I know an entrepeneur who leases high end sports cars through his companies as a means of reducing tax liability. YMMV though (pun intended, sorry)
I have been dating someone in the PR biz and these "top 10" style articles are a new PR vehicle. You can pack 10 or more client mentions into one article.
* For example, no one rich would "leverage their home equity to finance purchases."*
Is this because rich people don't borrow, or have the found a source of income even lower than a subsidized loan with tax advantages? If someone's home is a small fraction of his net worth, taking a mortgage and using it to invest in a business would probably be a sensible arbitrage.
I've dated the very well off, and I know at the lower levels, they are using those services. American Express operates one, and I knew someone who made a decent living as a personal concierge in Manhattan.
It all depends on the circle, though. Doctors and lawyers seem to be more likely to use these services, while entreprenuers seem to be used to doing things themselves.
If you've ever spent time in Newport, RI, and seen what the old money in this country drives... it's Honda's and Toyota's. You don't see so many Bentley's, Ferrari's or Bugatti's.
Money on the east coast is less concerned with flashy cars. Your more likely to see their money invested quietly in their homes and families.
West coast/the South is all about your image, I saw more 6 figure cars in the poorest sections of Miami than I've seen in the richest places in New England.
I lived in Providence, and this is partially true. Yes, there are many old money that drive cars like this, but if you spend time out in Newport during the summer, you do see many six figure cars.
How very very true that is. I have friends that make less than half what I do. Once upon a time, I would have thought that my current income would mean I'd "made it". But somehow, here I am, still occasionally concerned about being overdrawn, still trying to be frugal, still feeling like I don't make enough to do all the things I want to do. By world standards, I was fantastically wealthy when I was peddling vacuums.
Some things are more a function of the human condition than anything else. People in San Diego complain about the weather.
Annual income twenty pounds, annual expenditure nineteen six,
result happiness.
Annual income twenty pounds, annual expenditure twenty pound ought and six,
result misery.
I thought that was a fairly inane point. While I have no doubt that Joe Millionaire feels like he's not rich if he can't buy a new Lotus without blinking, that's pretty much irrelevant to any practical discussion of wealth.
When your income places you well into the top 1% of earners and you're still hurting for cash, that's your problem. Learn to live within your means.
I think the clearest line between rich and not is whether you have to work to earn a living. In my book, if you're an "earner" at all, you're not rich yet.
Sure, whether you need to work to earn a living depends on the standard of living and risk level you're comfortable with. But I think it's possible to set a reasonable upper bound. Say, around the point where your interest income at a typical risk-free rate, after reinvestment to keep pace with inflation, would put you among the highest earners in the world if it were ordinary income. Defining "highest earners" as those in the top two US tax brackets, that amount is currently around $8-10M, or on the order of 2^23 present-day dollars.
Personally I think on the order of 2^22 dollars reasonably qualifies as well. Maybe that's because of the standard of living I'm used to. Certainly if you have 2^24 dollars and you don't think you're rich, you have a definition of wealth that ignores a major qualitative difference in what a person can afford to do. Above 2^23 dollars, I think additional wealth begins to put you more in the realm of the low-level aristocracy and rulers than the merely rich.
That's just begging the question -- if your income is in the top 1% of all earners, and you still "have to work for a living", then you're pretty clearly not living within your means.
It's quite obvious that the definition of the word "rich" is relative, and subjectively defined. Yet everyone seems to focus on that relativity as if it's some huge, meaningful insight. It isn't. At the end of the day, if you're earning more than 99% of everyone around you, and you still can't pay your bills? That means that you're doing it wrong.
I don't think its a matter of "hurting for cash." Its the thought that you could lose it all just as easily as gaining it all (or actually much, much easier). And as you get older and accumulate responsibilities, the overhead of families, good schools, retirement, all weigh on you making that thought all the more horrific.
Entrepreneurs are probably much more vulnerable to these kinds of worries, because that's what they worried about (losing it all) on the way up.
all things are relative. You can be the smartest person in your state, but not the country. You can be the smartest person in the country, but not the world. Same thing with wealth, you may be a millionaire but there are MILLIONS other people who are richer than you.
This reminds me of what someone taught me about being the relative best. Sometimes it is good enough to be the best in your environment. For example, it is easier to be the most popular guy in a room (e.g. throw a party/be a host/invite lots of people) than the most popular guy in a club. Big fish in a small pond. Local maximums (City Council member) are more realistic and achievable than global maximums (global maximum = U.S. President).
Well at that point I guess you can strive to be the smartest person ever. But its a finite measure, at some point there is always that 1 person who is the richest/smartest.
Wealth isn't like that though.
If I have X Peso's (Or Dollars, etc) and you have X + Y then you are richer (for any positive value of Y).
The only 2 limits to comparison that I can see is:
* Liquidity - (ie - Bill Gates can't sell all his MSFT stock without the price crashing significantly)
* Historical Data - How do BillyG/Buffet/Slim compare to Rockefellar and King Soloman?
Actually it is the same. As you point out, the formula for converting all of the forms of wealth into the same units is subjective. In order to determine the richest person in the world this is just as important as defining the right way to measure the smartest person.
Everything is relative. No matter what you have, there is always someone with more. If you have $1 million, there's someone with $10. If you have $10 million, there's someone with $100. If you have $100 million, there are billionaires. And if you're the richest of the billionaires, there will still be people who are better looking, healthier, younger, and happier whom you can feel inferior to.
it's impossible to be happy if you're always comparing yourself to others. there will always be someone smarter, better looking, richer, and with a bigger ____ than you :p
True happiness is contentment, contentment comes from financial security. I laugh at those millionaires who, as the article said, are squeaking by on 400k a year. The biggest key to financial security isn't making more money. It's reducing your living expenses. If you're making 90k a year but socking away half of that, you're buying a year of retirement for every year you work. (assuming your investments only keep you even with inflation and dont make you any additional money).
also: one of the best pieces of advice in the article is always have a mortgage. as soon as you finish paying off your first house it's time to make a down payment on a new one and rent it out to pay for the mortgage. assets>cash, plus it's tax advantaged.
I've never really liked that reasoning. Let's assume that someone is in the 30% tax bracket (paying 30% on all qualified income). Let's say this person makes $100,000/yr. They pay $30,000/yr in taxes.
Let's say they also have a $100,000 mortgage at 5% APY. They're paying $5,000/yr in interest. That interest is deducted from their income of $100,000 leaving $95,000 taxable income. Assuming they didn't move down a bracket, they're paying $28,500/yr instead of $30,000/yr, saving them $1500/yr in taxes. Remember though that they're paying $5,000 in interest. It doesn't make financial sense in that respect.
They are paying $3500 more per year than if they paid off their mortgage.
It's seems like a way for people to live in nicer houses (or have more of them) and get a "deal" or "discount" on taxes, though in the end they are paying more.
This doesn't take into account housing prices, cash flow issues, or alternative investments. The rational I've seen in people who could pay off their houses but decide not to is either:
A: I can use this as leverage and sell later when the price is higher, making me money (risky, if the market drops)
B: I can use the money that I could use to pay off my mortgage to invest in other things (also risky, given the nature of any investments)
or C: It's a tax deduction (which from my math doesn't make sense. Maybe someone can show me a situation where the math works out better by keeping the mortgage)
I'll show you the situation. If your mortgage is at 6% (I think mine is just below that) and you're in the 30% bracket (I am around there) you're effectively saving 1.8% in deductions (30% of the 6%) and therefore paying 4.2% interest right? A C.D. now pays over 5.25%.
So to clarify the math, you borrow $200k, pay $12k in interest, but get to deduct it and therefore save $3.6k, thus really paying $8.4k in interest (or 4.2% of the $200k).
Therefore if you mortgage the house (as opposed to buying it outright) and buy into a CD at 5.25% you're effectively gaining 1.05% interest for free. You're making about $2k a year. Also you're increasing your credit score, which saves you a lot of money in the long run.
In your above scenario the guy was saving 30% of 5% (1.5%, or 1500) which would put him at 3.5%. He'd be borderline retarded to pay for the house outright.
Much more intelligent (especially for someone my age, who has a good 30 years to worry about retirement, thus reducing the volatility) is to put that $200k into the market, which will probably average somewhere between 7-10% in that time. Suddenly that $200k mortgage turns into a shit ton of money in my retirement account.
Also, there's the fact that the mortgage costs only slightly more than renting a similar place (if homes as nice as mine were available for rent, which they generally aren't here) yet in 30 years I have a free and clear home I can sell.
In summation, mortgages FTW. That's why very wealthy people who could afford not to still damn near always get them.
So, in essence you're in favor of option B (use the money to invest in something that will net you more in the end), specifically in CDs, or possibly a money market account. Thanks for bringing that up. The CDs are FDIC insured and are a strong case for not paying off the mortgage.
In your example, $5000/year interest is under the standard deduction. Unless you already have other deductions to itemize, you are getting no tax write-off for the $5000.
For instance, in 2008, the standard deduction for singles is $5450. Lets assume that you have $2000 in other itemized deductions. So, the first $3450 of your mortgage interest simply offsets the write off you would get with the standard deduction. Therefore, only $1550 would get you an additional deduction.
Now, if you're married, the standard deduction is $10900. In my situation, my mortgage interest is just barely greater than that amount.
The tax deduction on mortgage interest just means you cut the interest rate by the tax bracket, eg. if you're in a 33% tax bracket and have a 6% mortgage, the effective interest rate is 4%. Makes the math easy.
In addition, it seems to me that a lot of middle-class homeowners who use this argument would be just as well off (or very close to it) with the standard deduction.
I've never owned a house. Am I missing something?
EDIT: I live in the Midwest where 2000 sqft in a nice neighborhood is very often less than $200k. This is probably a factor.
there will always be someone smarter, better looking, richer, and with a bigger ____ than you
Oh, come on, nazgulnarsil, where's your spirit? You can do it!
Bart: You make me sick, Homer. You're the one who told me I could do anything if I just put my mind to it!
Homer: Well, now that you're a little bit older, I can tell you that's a crock! No matter how good you are at something, there's always about a million people better than you.
my extreme pragmatism depresses most people. I always hear hope for the best but plan for the worst and I think it is unnecessarily pessimistic. Hope for the best, plan for the averages, have a backup plan for the worst.
But the bottom line is that we're already incredibly wealthy by historical standards. I am in the bottom quintile by income in the U.S. (poor college student) and yet i enjoy a standard of living that is probably in the top 1% of all humans who've ever lived.
P.S. assuming you are Mr. Yudkowsky your posts at overcoming bias singlehandedly turned me from an empiricist into a rationalist.
I am also skeptical of the conventional wisdom of home ownership. I think a mortgage is simply a way to force yourself to save money. If people save with the same commitment as mortgage payments, even while paying rent, they should end up doing just fine.
(heavily adapted/paraphrased/quoted from 28 Feb 2006 Berkshire Hathaway Chairman Letter by Warren E. Buffett)
The explanation begins with a fundamental truth: With unimportant exceptions, such as foreclosures (in which some of a seller's losses are borne by creditors) the most that a real estate investor, in aggregate, can earn between now and Judgment Day is what the market, in aggregate, earns.
True, by buying and selling clever or lucky, investor A may take more than his share of the pie at the expense of investor B. And, yes, all investors feel richer when prices soar. But an owner can exit only by having someone take his place. If one investor sells high, another must buy high. For owners as a whole, there is simply no magic-- no shower of money from outer space-- that will enable them to extract wealth from their homes beyond that created by the markets themselves.
Indeed, owners must earn less than their markets earn because of "frictional" costs. And that's my point: These costs are now being incurred in amounts that will cause homeowners to earn far less than they historically have.
Work it out. Play with unknown factors (future rent, interest & house prices) and see what you come up with.
Mostly it's about even.
But just as you say a lot of human elements come into play. People choosing a rental or a purchase choose radically different properties so usually saying 'I would be paying this rent' is meaningless since you would be living somewhere completely different paying different rent. And saying 'I would be saving X' is also meaningless because you probably wouldn't be.
I think these usually outweigh the pure financials. many people purchase houses that would have never saved a dime. But of course, that's beatable.
That's not even remotely true. The interest rate for a mortgage right now is a few % points below what the stock market has returned, on average, over the last 50 years. That's not even counting the tax deduction for the interest.
A mortgage is basically borrowing money with which to make more money. Your mortgage payment on a place is generally not much more than your rent payment would be, and it's tax deductible and, over time, builds equity.
You can't save with the same commitment while paying rent because you have to pay rent.
> Your mortgage payment on a place is generally not much more than your rent payment would be
This is not true in most of the formerly booming real estate markets in the U.S. My coworker just bought a condo for $500K in Boston. At 6%, his interest payments are $30K/year, or $2500/month. My friends are renting a similar place for $2200/month.
I've heard it's worse in California, eg. people paying $3500/month in mortgage payments for houses that rent for $2000 or so. The recent Businessweek article on Merced mentioned homes with $3400/month that the owners walked away from, then out-of-state speculators bought it at a foreclosure auction and are now renting it back to the original owners for $1200/month.
> The interest rate for a mortgage right now is a few % points below what the stock market has returned, on average, over the last 50 years.
First rule of finance: any truly risk-free profit opportunities will be arbitraged away as soon as large numbers of people become aware of them.
That's exactly what happened in the 1990s. People suddenly realized that the stock market, on average, returned higher rates than a 30-year mortgage, so they took out mortgages and invested it in the stock market. As a result, the stock market quadrupled between 1995 and 2000. Then they pulled it out of the stock market and back into real estate between between 2001 and 2005.
It's highly unlikely that stock market returns over the next 50 years will match those of the previous 50 years, even with the cratering of the real-estate market.
True. However stock market returns have averaged about 10-12% a year going all the back to 1830. Furthermore, they've beaten real estate, bonds, gold and every other asset class over any given 15-year period. Even people who bought the day before the great crash in 1929, came out ahead of those who put the same money into real estate... as long as they didn't panic and sell at the bottom as most people did.
Of course we can't expect every decade to be like the 90's, but I think it is a reasonable expectation that the 200-year trend will continue barring a kurzweillian singularity or other freakish phenomena.
> It's highly unlikely that stock market returns over the next 50 years will match those of the previous 50 years, even with the cratering of the real-estate market.
Why? Stock market rises tend to be linked to technological advances. We are pretty close to some significant technological breakthroughs and these will only accelerate over the next 50 years.
Consider, for example, that within 15 years, it should be cheap and practical to use solar panels for almost everything. Consider robotics and the way robots will radicalize many industries as much as industrial robots have revolutionized factories, etc.
If it's an investment property the tax advantages are very nice. Deductions for interest, depreciation, insurance and maintenance can seriously add up. Add rent to that and the yearly cost compared to the medium-long term capital gains turns out to be quite nice.
Of course it depends on the state of the market, but if it's a long term investment, and you don't buy out in hicksville, that shouldn't be to much of an issue.
As for owning and occupying a home you're paying a mortgage on... well that's more of a lifestyle choice. I would agree that it's not really the best investment.
Note that I live in Australia, so much of this may not apply to other regions.
You just spelled out the problem: you still need to pay your rent. Why paying rent when you could be paying yourself? In the long run, owning the place you live is smarter.
I think your example is more realistic if the numbers are more like 3000/mo to buy and 1500/mo to rent. If rental prices were as close to mortgage rates as 2000/1500, then not only would buying be obvious, it would not even be a much larger financial commitment. The extreme case is when rent equals mortgage.
If you have a new mortgage, then somewhere between $1000-1800 is spent on interest, NOT saved, and it is GONE (well, it's a little less because of the tax advantage for mortgage interest).
He said mortgages were a good investment, not houses. In terms of EV they're pretty high up the list, especially compared to the alternatives (buying the house outright or renting).
Nothing always goes up, but over time real estate does pretty well. Plus the tax deduction on the interest rate, and the fact that the APR is lower than what you could get with the money if invested well in other stuff make mortgages so well-worth it that even people who could buy outright almost always take them.
Because mortgages remain a great leverage instrument. Find a bank who will lend you 4X your initial deposit with a low fixed (or not...) interest rate, without margin calls, in any other investment vehicles?
putting money into a house that maintains its value or even drops slightly is better than paying rent. rent money is gone forever. a mortgage is building equity that you can draw on. plus I don't get how people don't realize that renting out a house to pay its mortgage is basically free money. Someone else is building equity in a house for you and all you have to do is pay the down payment and manage tenants.
My personal plan is to buy a house that has something that can be turned into a studio, live in the studio and rent out the main house. I have a feeling this type of situation doesn't go on the market too often for obvious reasons though.
Duplexes sell fairly frequently. For mine, the rent of each unit is greater than the mortgage...
As a note, though, home ownership (esp. rental ownership) is more expensive than just the mortgage (and taxes, and utilities). Like any business, there is time and attention required. Like any other depreciating asset, there is also ongoing maintenance costs. And they are not smooth like the income stream. If your rent is $1000 and your monthly payment (mortgage + escrow) is $800, you may be netting $200/mo. Great! But then you have to scramble to find the $10k to replace the roof. Or it takes two months to replace the tenants (there goes 8 months' profits). In the long term, it should work out. Your mortgage + tax payments should increase slower than the monthly rent payment. But renting out a house is not free money.
as close to free money as you can get without lucking out I would say.
Of course it requires attention and time but it beats pissing money away on rent, especially in silicon valley where rents are more than twice as much as the national average.
I think you're overlooking the interest payments, which are gone forever as well. If you have a 300k mortgage at 6%, you are paying 18k year (1500 month) in interest alone. Yes, there are tax advantages but I think this is negated by property taxes, PMI insurance, etc. Your mortgage payments aren't buying equity in your house.
and viewing houses as just another investment is amazingly persistent and is the attitude that got us into our present problem in the first place.
a mortgage is building equity in a physical asset, stocks are gambling to try to get 10% returns in paper money.
How are stocks 'gambling'? Buying a stock is buying a fraction of a business. Is all business ownership gambling? A business is just a group formed to do something too complex for individuals -- are the constituent individuals also a gamble?
This is really about how to get upper-middle class wealth. The psychology of these millionaires is very different from the mentality of big startup founders -- sure, half run businesses, but these are lifestyle-type companies with no ability to scale.
Just because a business isn't suited for investment by VCs doesn't mean it's not a great investment for its owners nor that they necessarily possess lesser business ability or some kind of inferior mentality.
I didn't intend to imply anything about inferiority.
The people described here have a different mentality. They get rich by avoiding risks and cutting costs. It is a slow and systematic process with guaranteed results.
Startup people get rich by taking big risks and working hard to increase their top-line productivity and wealth-creation. It is relatively fast and chaotic process with unpredictable results.
Actually, it does. If they had businesses that scaled, they'd be well above the million-dollar mark and in the even-tinier minority.
But I'll go one further and suggest there's a causal link in play here: The half that are business owners are people who make their money precisely in businesses that don't scale. They own and operate local businesses which are natural geographic monopolies and they don't get crushed by large multinational competitors because of that fact. For example, these are businesses like landscaping companies, local shops, construction contractors, and services businesses.
Also note that a chunk of the 50% that don't own businesses are well-paid, sometimes independent professionals such as doctors, lawyers, architects and engineers. Again, their source of income does not scale, so they get rich by cutting costs.
10 Million households have $1 million+. There are an estimated 111,162,259 households in the US...
This is upper class wealth...just not completely elite levels of wealth. I think the point of the article is that people with upper class levels of wealth tend to have upper-middle class lifestyles.
This is really an argument of semantics of "upper-middle-class" vs. "upper-class." Maybe there's standard definition I don't know about. My personal definition is that upper class is "don't need to work ever again."
You're right that upper middle class people have the same lifestyles as upper class. The difference isn't in material goods, it's in freedom.
But not having to work again is tied directly to consumption along with income.
The interesting component of the article was that the average income of somebody with $1 million of net worth was approaching $400,000. This implies a poor savings rate and not very much savings at all.
If freedom is the goal, it seems the key component is a modest lifestyle.
Upper class is second-generation. To be truly upper class you'd have had to have gone to an elite boarding school, for example, and bonded socially with the rest of the upper class. Self-made people can never be more than upper-middle regardless of how much cash they have.
When people start affording more with larger incomes, their assets turn into overhead that must be managed. It's a cliche, but the TCO of most things is more than their face value. On the other hand of that, there is an amount of dollars one can earn to build a framework and make their money be self-supporting. I.e. the returns on investment covers taxes and expenses and actually has non-negative growth.
While I agree that contentment is /a/ key to happiness, it won't exactly motivate you to strive for things completely out of reach. Just the chase of your goals can result in happiness.
The parts that aren't false read like a description of someone who made money from e.g. developing shopping malls. People who get rich from technology are less likely to be B students, less likely to try to cheat the IRS by routing their personal expenses through their companies, and more likely to be "nice guys."