In the Millionaire Money Mentors forums we had an Ask Me Anything sessions with Sarah Fallaw.
She’s a Ph. D., Founder and President of DataPoints LLC, a company that provides scientifically validated, automated behavioral finance tools to the financial services industry, and daughter of Thomas J. Stanley, author of The Millionaire Next Door. She co-authored The Next Millionaire Next Door with him.
In case you missed them, I’ve also featured Sarah and/or her work in various posts here including:
- The Next Millionaire Next Door — My thoughts on the book.
- The Characteristics of Successful Investors — An excerpt from her book.
- Self-Reflection: A Critical Step Before Really Pursuing Financial Independence — A guest post from Sarah.
I relished getting to chat with her directly and ask some specific questions (which the members loved as well based on the interaction).
As we were all talking, we hit upon a very interesting topic — the relative importance of earning, saving, and investing.
In other words, which is most important (and second and third) and how much more important is one than another?
What Determines Financial Success?
We came upon the subject when Sarah made this comment in response to a member’s question:
We ask that the member of the household who is primarily responsible for financial matters respond, which often means that the person responsible for investments responds.
We continue to see differences in who is responsible for general financial management (budgeting, spending) and investment management within households (we collect this data on couples at DataPoints).
We often see that couples will say they are both responsible for general management (or co-manage it), while it is often the case that one person, typically the man, is responsible for investments.
The funny thing is, as we wrote about in a blog on DataPoints, the driver of financial success is not the investing side. My interpretation is that, regardless of gender, the family member who is managing some of what some might call “basic” financial tasks have a greater influence on achieving financial success.
It’s that last sentence that really got my attention!
So I responded:
Wow. That is interesting!
So would this mean that basic tasks like budgeting (or even shopping to save money) would rank higher than earning potential or investment performance in wealth building?
As you can see, I was digging to see what info/data she had on the most important steps in becoming wealthy.
Savings rate can lead to greater success than relying on investment returns.
Earning potential is a little bit of a different ballgame!
Ok, I was starting to zero in on what I wanted but I felt it still wasn’t clear.
For instance, she used “can” (not “does”). So I pressed on with this:
Ok, I’m trying to get to some sort of relative importance here.
My site is about Earning, Saving, and Investing.
I think you’re saying that for most of the millionaires you study that Savings > Investing.
From there, where does earning rate?
Is it Earning > Savings > Investing, Savings > Earning > Investing, Savings > Investing > Earning, or something else?
Or maybe you can’t rate that way and can give me percentages such as…
- 45% of millionaires got there by a savings-based effort
- 35% of millionaires got there by a earnings-based effort
- 20% of millionaires got there by an investing-based effort
Can you give me your thoughts on the relative importance of these three?
Hahaha. I sound kind of obnoxious IMO, but I was on a mission.
I think your order (E, S, I) is correct in that you have to have income in order to save, and you have to earn and earmark some of those earnings (aka save) in order to invest.
I think the breakdown in percentage idea is interesting but I would imagine the percentages differ depending on job type, business owner status, etc.
Ok, so I didn’t get what I wanted (completely) but I did get enough to start a completely new conversation.
What is Most Important and When?
I started a new thread for members and mentors with this:
Sarah generally studies millionaires (not necessarily multi-millionaires).
So to get to the first million in net worth, I can see how saving would be more important than investing.
However, my contention is that for the second million (and beyond that), investing becomes more important due to compounding. I’ve seen people comment (and have had this happen myself) that their investments earn more than they do in their jobs (salaries).
So the summary is, for the first million, saving (combined with earning) is more important. After that, investing is more important.
Here are a few responses to that — first from a mentor:
Very much agree as I crunched the numbers awhile back and 50% of my NW has been from E/S and 50% from investments (I).
My guess is 10 years from now the “I” will move up to 60-70%
This is an interesting topic and one that I personally wondered about. I understand the math about how your net worth will grow faster and faster the bigger it is but its hard to believe until you see it happen.
For us we hit a new worth of 1 million when I was 35 and that felt like it took a long time. We lived on my wife’s income and invested mine for about 10 years to make that happen. Very little of that was gain.
Now I am 38 and we are at approx. 1.8. So I am now starting to see how this snowball can start to pick up a little steam and starts to grow without quite as much effort on my part.
We still make more from working than what my return/gains are but I am starting to see if this trend continues the returns/gains will hopefully outpace our income. When we first started saving and investing that seemed like it would never be the case.
And one more:
I played around with a crude spreadsheet. The intent of the exercise was to assess the impact of a 20% change in income, savings rate, investment return, or an extra year of work on funds available at retirement. There are certainly important interactions that are not included on this crude sheet (e.g., starting savings and/or years to retire on each association).
The crude spreadsheet suggests some “unsurprising” associations. For instance, earnings and savings rate improvements are equivalents. Early decisions have a major impact on retirement capital stock (due to compounding). As one nears retirement, an extra year of work has a significant impact.
While simple, the idea might be useful to others thinking about this topic. It helped me see the tradeoff between another year of work and more focus on my investment returns.
Lots of great conclusions here that we all probably know:
- Earning = Saving in importance. It’s because given a set level of spending, earning more is saving more.
- The impact TIME has on investing. As I’ve said, it’s the most important factor in your investment performance.
- The reason an extra year of work has such a big impact is that it gives your (now sizeable) investments another year to compound.
What Millionaires Say
So we’re all in general agreement with E and S being more important initially and then I being more important at the end.
But there’s one more bit of data to be considered — what millionaires say.
In an update to my millionaire interviews questions I added this:
“What would you say is your greatest strength in the ESI wealth-building model (Earn, Save or Invest) and why would you say it’s tops?”
The results are (FYI, not everyone answered, some answered with two options, and I didn’t start asking the question until the second 100):
- Earn – 28
- Save – 40
- Invest – 11
- All Three – 8
These are results up to interview 200. I’ll compile the numbers up to 250 once we get there.
Anyway, the initial results seem to mesh with Sarah’s findings that earning/saving are generally more important than investing.
I still theorize that it’s this way to $1 million or maybe even $2 million, but after that, investing becomes more important.
What do you think? What are your experiences on this issue?
The Millennial Money Woman says
I thought this interview was phenomenal – thank you for providing so much value and insight. To be honest, I am relieved to hear that earning is not the most important factor to grow your wealth versus saving and investing. Although I always knew that income does not equal wealth, it certainly is comforting to hear the confirmation from Dr. Stanley’s accomplished daughter! (By the way, I read every single book twice from Dr. Stanley and absolutely love them… learned so much valuable information). I liked the analysis too – how saving is more important to reach your first million, and how beyond that the investing component really comes into play.
Thank you so much for taking the time and giving us your input!
Bernd Doss says
As always, provocative questions, which stirs the debate. One must earn in order to save, and savings can, with education, instill a modicum of comfort that is necessary, in my opinion, to investment holdings. Having said all of that, it is, again, my thoughts that the most vital aspect of wealth attainment and continued growth leans more to savings. Over my lifetime, to date, my income steadily rose to a point the allowed full retirement at age 65, which would never have been possible without savings and a modicum of stable investments. I’m not a millionaire, nor will I ever plan to be one, however being debt free, with investment holdings plus savings, will ensure a comfortable and stable balance that maintains my happiness in the remains years, Lastly, vigilance in maintaining a lifestyle that is based upon living within my means is an issue that requires full attention. Thanks for your posting, it resonates within.
It is very true that the priorities shift as you climb the net worth ladder.
I calculated the time it took to get to the first million and then every million thereafter and the amount of days decreased considerably with each milestone.
I do not think my investments will ever approach my W2 income but fortunately I don’t need to have an income that high to live extremely well in retirement.
But for now it seems like it is a self feeding perpetual money making matching I created (all the money the investments make I typically plug back into the system as I still can cash flow with my w2 income)
I have never been a high earner and never will be considering I’m now only 3 years away from retiring at 65. I believe and always will that investing is the way to financial independence. Regardless of how much you earn and regardless of how much you save, your savings has to be invested in something other than a low interest bank-side savings account. I’m a millionaire not because of what I earned or what I saved, but because I invested all of it and watched it over the decades drive my net worth to what it is today.
I would argue that adding an ‘A’ to the ‘ESI’ name would be prudent. ‘A’ for alignment, spousal alignment. Most interviewees directly identify this benefit and other just imply it. many couples differ in spender/saver but still work together if not there is just a major hindrance to financial independence.
I think it’s pretty simple, if you have one dollar as a child, getting a return on that dollar gets easier and easier with time. Until you have that dollar, investing knowledge really doesn’t really help you. So you’re absolutely correct, for most, E&S are absolutely necessary early on, but once you have a sizable nest egg, it becomes more about Investing (and time). I think this correlates to most people’s knowledge growth over time. When young, we work and earn and learn to save. It’s all that most of us know in our youth. We work, and the fortunate learn to save. We typically know little about investing properly, but as we age and grow our assets, we naturally gain more interest in the subject of investing and gain the crucial knowledge of investing. We then apply that knowledge to compound our growth much more rapidly. I think this is a typical progression for most wealthy people. The most fortunate, learn it early and naturally have more time to compound. There are always exceptions like the Gates and Musks who create things and make the exceptional jumps in wealth, but they also must make the investing knowledge jump too or they too would eventually fail. Many bankrupt star athletes and Lotto winners are prime examples of the failure to adapt and gain the investing knowledge. It’s an intriguing subject.
Great interview. Had it not been for Sarah’s father, my financial life would have looked very different. I read the first in 1996 when I turned 30. His second book , “The Millionaire Mind” is likely as good as the first and digs deeper.
There are several metrics/ goals I use as my wealth has increased. At some point I’m sure they were influenced by The Millionaire Series of books.
– Savings / investment – 75% of income
– Salary – 7% of net worth. (Or less)
– Annual investment income should exceed earned income.
– Both sources of income are passive.
By the way – not all of us have spouses. I divorced 20 years ago and never remarried. Perhaps Dr Stanley was right when he said that “choice of spouse “ is critical in building wealth……….
Great read !
Another awesome post. I retired 3 years ago at the age of 56 and I am a multi-millionaire living off of the dividends from my portfolio (no pensions). I would say that working towards a high paying job allowed me the luxury of saving a great deal of my income which I started investing into blue-chip dividend paying companies almost immediately. Once my dividends (which today are more than $250,000 annually) allowed me to live the life I choose, then I knew with certainty that I could retire…and I did. I don’t post to brag…I come from VERY humble beginnings and had to work extremely hard, and make many sacrifices to make it to the big time. But once I did, man did I love to save my money and invest it. Now I am in the wonderful position where I can pay for all of my nieces and nephews education, help out other family members who have fallen on hard times and help to support an Olympic athlete in achieving her goals. There is nothing more wonderful than having enough income that you can spread the happiness around! None of my life today would have been possible though without the big E.
In your early years where NW is low, the relative importance of E vs S is driven by personal circumstance. If your chosen career is say with government, your career and earnings are fairly well mapped so managing expenses and savings is more important. If you’re going to medical school, then going into debt and not saving to capture big earnings is a prudent path. Others may see a balance and trade-off between the two over time. I initially focused on savings as an engineer then shifted to earnings and some debt to attend a full time MBA program which doubled my earnings upon graduation due to a career change. Basically, if the ROI (time and money) can justify sufficient future earnings, earnings is more important than savings.
I agree with the article’s reasoning where Invest is less important until you have roughly $1M+ in investable assets.
I agree with your conclusion that E/S is more important early and I quickly becomes more important. As an anecdote from my life as a 31 year old, I am a government worker and my wife is a teacher. We have earned less than 6 figures combined until relatively recently on the E side, but saved at a high percentage, first to pay off student loans and only recently done a real estate deal that has added a sizable percentage to our income and boosted our NW quickly.
Tom from MD says
jpmkorea, congratulations to you for reading this blog at the age of 31 and “getting it”! I can tell from your post that you have a bright future of FI ahead of you far sooner than most!
If you can keep lifestyle inflation under control (“Your Money or Your Life” gave me a great wakeup call), then the path using ESI is actually pretty straightforward. Kudos!
Thanks! Yeah we had base expenses of roughly $30k for several years (age 25-29 for me, 22-26 for my wife) while doing that first bit. We now feel like we’re living fat and happy around $42k. FI is a strong goal of mine, and while I don’t intend to be a frugal FI person on less than 1m, I feel confident in the plan I have laid out so far.
I think Earn is the most important if your basic needs aren’t being met. But as earning increase to the point that comforts and luxuries can be afforded, Saving becomes the most important and remains the most important as income increases.
Even if you’re at the point when your investment returns are higher than your earned income, you still have to decide to Save those returns and re-invest them.
There have been fabulously rich people that have lost everything because they invested poorly or were wildly undisciplined spenders (often both).
But I think if someone continues to live on less than they earn (including returns from investments), they’ll be better equipped to maintain and grow their wealth.
Its almost a semantical argument because you can only invest what you save and you can only save a portion of what you earn. But it is a great mental exercise. I was a fairly high earner and I really don’t feel like becoming a multimillionaire is anything for me to take pride in. Only an idiot would have failed to max out all his retirement accounts and invest additional money as well. I know there are such people, but if you were blessed with a better than normal income and you did accumulate some wealth the only thing you have to be proud of, is not being that idiot. That’s still something I guess? Awesome post, as usual.
Haha. It’s not just “such (some) people”, it’s MOST people. That’s why having a high income is not correlated with high net worth — most high income earners spend it all.
So, I would say you were good at:
1. Having the talent/smarts/drive/whatever to make a good salary. This alone puts you in a rare class.
2. Having the discipline to save a good portion of what you earned. Again, this is rare.
So, you did two rare things, which is much more significant than doing one. 🙂
Most people who even do #1 don’t do #2, so you end up wealthy while they don’t.
Thanks, and I didn’t mean to imply that other high earners didn’t have a right to be proud of how they handled their money, I do think they do. In my case it was just such an easy and fun path that it is hard to take credit for just doing what you love.
Mark Barker says
When it comes to saving, I think it is helpful (and more realistic) to slowly increase your savings rate over time. If you aren’t saving anything, going to 20% right off the bat is too scary for most people. We started saving around 5% over 20 years ago and gradually built up to a 40% rate this year. Each time I get a raise, I increase my savings 1-2% so I still ‘feel’ the raise in my net paycheck.
That has worked well for us…just my two cents 😉
Charlie @ doginvestor.com says
They’re all important, but I think there’s a dependency of I on first having S. And S is dependent on E.
Without S there is not I. Without E there is no S. So, you first need to focus on E to get it to actually pay for anything and have any savings.
I’ve been tracking how important they each are, and I agree that the first million is mostly about E and S, but only if you’re trying to get there quickly. The more time you have, the more compounding you’ll get. Then, once you have a decent net worth, and say your E is only adding <5% to your savings, then compounding will quickly start to do more than your earnings.
It depends where you are in the accumulation cycle. But you need at least two!
Accidentally Retired says
I feel like we could all go on for days as to which is more important, but I agree that generally E and S start to begin your wealth building, and then it shifts to I. But if you are consistently doing all three, then you will obviously be in the best shape.
So I was thinking about this the last couple weeks and stumbled upon the “Lifetime Wealth Ratio” here: https://www.budgetsaresexy.com/lifetime-wealth-ratio-update/
It’s calculated by taking your Net Worth and dividing it by Total Lifetime Earnings.
This then gets you a true measurement of E, S and I all packaged into one. I went back and calculated out that I was at 25% when I started tracking my net worth and then bounced up to 50%+ when I sold my business and has been steadily growing ever since.
So anyways, by tracking your Lifetime Wealth Ratio, you really can measure how successfully all of your components of E, S and I are working together.
You can see this conversation for the same sort of discussion:
Great post. I think E plays the biggest role in financial success because obviously without earning there can be no saving and investing. Many of the millionaires in your interviews have very large incomes – and that of course allows them to save and invest more, which increases their net worth.
The equalizer with E is time. While you may never have a ‘big’ salary, deciding to save early can result in steady and (eventually) large increases in net worth.
Investing should be simple and boring – hence why most of use index funds. Removing emotions from investing is perhaps the most important trait of a skilled investor.