When I posted Stop Acting Rich Overview and Thoughts on Wealth, Habits, and Happiness I promised that I would follow up with some thoughts from Stop Acting Rich: …And Start Living Like A Real Millionaire on home ownership and how it impacts a person’s net worth.
This is the fulfillment of that promise. 🙂
There’s lots to share, so let’s get to it.
How an Expensive Home Can Impacts Wealth Negatively
We’ll begin with a general overview of how buying an expensive home can hinder wealth accumulation. Consider these four quotes:
What we don’t realize is that the true cost of living in certain homes and neighborhoods is unseen but truly devastating. I believe the greatest detriment to building wealth is our home/neighborhood environment. If you live in a pricey home and neighborhood, you will act and buy like your neighbors. In other words, human beings have an innate tendency to act and be like those around them — to fit in — and even compete. The type of home we live in and where we choose to live often takes the greatest toll on our financial wealth, and from it, all other perils flow.
The reason why so many homeowners today are having a difficult time making ends meet goes way beyond mortgage payments. When you trade up to a more expensive home, there is pressure for you to spend more on every conceivable product and service. Nothing has a greater impact on your wealth and your consumption than your choice of house and neighborhood. If you live in a pricey home in an exclusive community, you will spend more than you should and your ability to save and build wealth will be compromised.
The more expensive, the more affluent neighborhoods are a vortex of sociological forces. The more affluent the neighborhood, the more its residents spend on almost every conceivable product and service. From cars to haircuts, and from wine to watches, those living in “prestige estates” spend more. We take consumption cues from our neighbors. If many of our neighbors have a much higher level of income and wealth than we do, we will have set ourselves up to lose the war before we have even begun to battle.
My research has found that most people who live in million-dollar homes are not millionaires. They may be high-income producers but, by trying to emulate glittering rich millionaires, they are living a treadmill existence. In the United States, there are three times more millionaires living in homes that have a market value of under $300,000 than there are living in homes valued at $1 million or more.
Lots to unpack here and I’m sure I’ll miss something so you can help me out in the comments.
- Buying and expensive home in a pricey neighborhood is a net worth killer in and of itself. It violates the first two steps on my list of how to buy a home and pay it off in 10 years.
- As if that isn’t enough, buying that type of house then comes with a whole host of higher costs. First there are higher expenses associated with just keeping a pricey home (which is often larger) running: utilities, maintenance, lawn care, taxes, and on and on. Then there are the higher costs that stem from the location (i.e. the local grocery store is more expensive than the Costco across town). And finally there are the “keeping up with the Joneses” expenses like driving a luxury car, private schools for the kids, country club memberships, and so forth. Is it any wonder these people end up accumulating less wealth? The odds are stacked against them!
- The fact that most millionaires live in homes under $300k is both surprising (to the average American who thinks all wealthy people live in million dollar mansions) and not surprising (if you’ve read The Millionaire Next Door: The Surprising Secrets of America’s Wealthy or this blog).
- Depending on where you live, a home worth $300k is not exactly a shack. Yes, in NYC it probably is, but if you live in cities like we have, $300k actually gets you a pretty nice house.
- We never lived in a home worth more than $200k until a couple years ago (though we certainly could have afforded to). And yet our homes had 4-5 bedrooms and 3 bathrooms, were 10-15 years old when we got them, had 3k square feet, and were in decent neighborhoods. There was no need to buy an over-the-top house on a golf course. The homes we had were awesome. And they were quite affordable. This is a HUGE advantage of living in an affordable city.
- Buying homes at this price range allowed us to pay off our mortgage early and forego lots of interest costs through the years. Imagine the other costs we saved on as well! FYI, there was certainly no extra “Joneses” expenses in our neighborhoods — none of the neighbors were trying to impress each other, unless you count that time my next door neighbor got that smoking snow blower! That thing was awesome! But I had a teenage son that moved snow just as well. 🙂
Here’s a related but a bit different comment on why it’s hard for high-status individuals to build wealth:
Why are these high-status groups so bad at accumulating wealth? There are many reasons. Most live in or near high-cost-of-living metropolitan areas. They tend to live in expensive homes situated in or near exclusive neighborhoods. And so they spend accordingly, with little left over for saving and investing.
I wanted to highlight this quote separately because it really hits the cost-of-living of the city. I’ve talked about the facts that living in a low cost-of-living city can help you build your net worth and how where you live has a big impact on your net worth. Considering these I’ve suggested the dreaded idea of moving if you live in a high cost-of-living city. But most people won’t even consider that option.
How to Buy a House for Wealth Creation
Now let’s move to the book’s thoughts on how much someone should spend on a house if they want to grow their wealth:
The most productive accumulators of wealth spend far less than they can afford on homes, cars, clothing, taxes, vacations, food, beverages, and entertainment. As many millionaires see it, living in a pricey neighborhood is a bad idea. Why live in a million-dollar neighborhood when one filled with $300,000 and $400,000 homes will serve the purpose? Real and actual millionaires understand that when you live in a luxury house, you are also buying a luxury lifestyle. Included in this lifestyle are the social pressures to redecorate frequently, join the country club, and send your children to private schools. Your property taxes continue to skyrocket, along with the cost of utilities and insurance. Plus the prices of nearby services tend to be higher, from grocery stores to dry cleaners.
Contrary to popular belief, however, most of the self-made millionaires I have studied have one thing in common: They were able to build wealth precisely because they never lived in a home or neighborhood environment where their domestic overhead made it difficult for them to build wealth. In essence, they ran their households like a productive business. It is not only about how much you make. More important, it is how much you keep. And the “keep” component begins and ends at your home address.
If you want to become wealthy [the way other wealthy people have], live in a neighborhood where your household is among the top income generators. For example, what if your household’s total realized income is in, say, the high five figures? Then live in a neighborhood where the median market value of a home is less than $300,000. Do so, and the chances are that among your neighbors, your household will likely be in the top 20 percent along the income continuum. Then live and consume as though your household’s income was only 80 percent of what it actually generates. Save and invest the rest. Now you are on your way to becoming wealthy.
To enhance your chances of becoming financially independent, you should live in a home and neighborhood environment that has high wealth-building characteristics. You need to be surrounded by neighbors who have lower incomes than your household generates.
Here’s what I have to add:
- For the most part, the suggestion is “don’t buy a pricey home in a pricey neighborhood.” We kinda got it from the first set of quotes, but I wanted to include it again here as they said it in a more positive tone (what to do versus what not to do).
- The quote “they ran their households like a productive business” made me think of the “be your own CFO” e-book that J.D. Roth of Money Boss came up with. In addition, if you think of it, a net worth statement is basically a balance sheet and a cash flow plan/budget is basically an income statement, so why not treat your finances like a business?
- “Live in a neighborhood where your household is among the top income generators.” First of all, it’s difficult to say what the average income by household is in a neighborhood, isn’t it? Can you buy data that tells you this? Second, it’s “Get Wealthy 101” they’re preaching. They are saying to live in a neighborhood where you make more than most people but have the same housing costs. So your income is high but expenses are low. Makes sense, right?
- The example used cites an income near $100k and a house below $300k. So this seems to mean they are saying that you shouldn’t spend more than three times your salary on a home. This gets to our earlier discussion of how much you should spend on a home.
- Then you pile on and only live on 80% of what you make, saving and investing the rest. If you can save 20% of your income, you are well on your way to becoming wealthy. Though based on this early retirement calculator it will still take you 37 years to reach financial independence.
- Summary of this section: A “home and neighborhood environment” with “high wealth-building characteristics” is one where your “neighbors have lower incomes than your household generates”.
How Much Should You Spend on a House?
And now some general guidelines on how much house to buy to encourage wealth accumulation:
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.
If you’re 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.
Some thoughts from me:
- So piece these two together and you should never buy a home that’s more than three times your annual income with a mortgage that’s twice your income. So this implies a 33% down payment at the highest (i.e. a home with a $300k value and taking out a $200k mortgage.) It could be a lot lower though (i.e. a home with a $250k value and a $200k mortgage).
- We discussed all this on my post titled How Much Should You Spend on a House? If you recall, our homes were always between the 0.93 to 1.38 times income valuation. The “experts” had 3.5 times as the high. Looks like 3.0 is the max to build wealth and, I assume, the lower, the better.
I don’t know about you but I found this information very interesting.
Anything you’d like to add or comment on?