Why the Rich Will Never Be Wealthy

One of the most exciting books I read when I was younger, was called “The Millionaire Next Door.” When you say millionaire, many people will likely have visions of people that live in mansions, drive fancy cars, own yachts, dine on the finest food and wine as well as jetting around the world on private jets.

If you thought that, you would be dead wrong. The book focused on first-generation millionaires, meaning they didn’t become wealthy through inheritance. You would find that many of them own their businesses, drive modest vehicles (A Ford F150 was the most popular), live in modest houses that many times were decades old, and some still clipped coupons!

The book was appropriately titled when it included “Next Door” in the title, meaning you would never know these people were millionaires because they lived next door to mostly non-millionaires. The people who were not millionaires lived in the same neighborhood, drove similar cars, and had many similar habits but didn’t make the grade for wealth accumulation.

The Faux Rich

According to the book, we have, in essence, camouflaged millionaires living in modest houses and driving modest cars around us every day. What is the opposite of that? It would be people you look at and think are millionaires based purely on outward appearances but are in fact not rich or wealthy.

Suppose you pass someone driving a Mercedes that lives in a magnificent home in a prestigious development and is wearing a fine suit, Rolex watch, and Gucci shoes. In that case, you might think you are looking at a millionaire. As a society, we get conditioned to believe these outward appearances of wealth as proof of prestige and success. Corporations and their marketing teams work hard to make us think that.

When you see a person with a high income or worse, a moderate income, and a mountain of debt that appear to be rich, you are looking at the faux rich. If you read The Millionaire Next Door, you would realize that most millionaires don’t do any of these things.

High Income Doesn’t Equal Wealth

Someone who has a high income isn’t necessarily wealthy despite their outward appearances. They might drive a nice car, live in an expensive home, wear all the right clothes and jewelry, but support all of it with a mountain of debt. The debt is serviced with their income, but they have almost no net worth. If the income stops the debt will sweep over them like a tsunami. The outward appearance of wealth can, and probably is, deceiving. The faux rich are nothing like The Millionaire Next Door.

Think of high income as a faucet with water coming out and pouring into a sink with the drain open at the bottom; if you shut off the tap, the water stops, and the sink empties. That is the definition of far too many “rich” people we see all around us. They have many trappings of wealth, but what they have is a large income flowing into their lives like the faucet pouring out water. Just like the faucet, shut off the income, and their “wealthy lifestyle” drains away.

To make matters worse the faux rich will often increase their lifestyle the second their income goes up. They get a new job, promotion, or raise and immediately decide that they need new clothes, more jewelry, a bigger house, or a newer car. Of course, because they don’t have the cash to pay for this upcoming expansion they will borrow more money with more interest.

The higher level of income might cover these additional and increased monthly payments and they appear to be even more “rich” than they were before, but their financial position has actually deteriorated. This practice happens at all income levels. It happens with people that make $70K per year and it happens with people that make $300K per year. The phenomena is the same at all income levels, but the numbers and level of “richness” change a bit.

The Taxman Loves Rich People

If you fall into our category of faux rich and earn a high income through a salary of some type, your income is what the IRS calls W2 income. I have said it before, but it bears repeating, W2 income is the most expensive income you can earn.

W2 income, especially a high one, pays some of the highest taxes possible. You receive almost no tax deductions. There is very little to nothing you can do to influence the amount of taxes you will pay at the end of the year. You receive a W2 statement at the end of year to give to your CPA. Your taxes were already subtracted directly from your check throughout the year and sent to the IRS. Thank you for your contribution. Here is a quote from a recent Wall Street Journal article about taxes and the IRS on April 28, 2021

“When the government has independent information about income—such as W-2 forms with wage data—compliance rates are nearly 100%. Where it doesn’t have such information—much of business income—estimated compliance rates are often about half that level.”

Once your taxes are filed you will either owe more money or get a check back from the IRS. If you get a check back, it just means you gave an interest-free loan to the government for the past year. If you are lucky, you might qualify for a few deductions and credits for such things as your home mortgage interest, child tax credit, charitable contributions, and a few other minor things, but you can’t do much to influence the amount of taxes you will pay in this scenario. The deductions, such as they are, don’t lower your taxes much. They are rigid and give almost no flexibility.

I once attended a financial principles seminar and as part of the exercises, we took an example person that made a mere $53K in income per year. The exercise involved 4 different scenarios for how they earned this income. The first was a person that made all of their income working a W2 job. In the second scenario, the person had a small business and earned their income by being self-employed. The third scenario was that the person generated their income through portfolio income generated by stocks, bonds, interest, and annuities. The final scenario was this income was generated from rents (investment properties) and interest income. In all 4 cases, it was assumed the person made the same amount of money.

What changed in each scenario was how they made that income. Care to guess which one paid the most taxes? If you guessed the W2 job you would be right. The lowest taxes paid was in the 4th scenario of income being generated via rents and interest. The examples were simplified for the sake of time and there were some structures and strategies that the self-employed and portfolio income earners could do to lower their taxes considerably, but there was nothing the W2 scenario person could do. If the different tax liabilities for the different scenarios are a surprise you have a lot to learn about the U.S. tax code. You might be tempted to say “that can’t be legal!” I assure you it is, but it takes education, planning, and making different choices in life.

The quote above from the Wall Street Journal is a bit misleading. It implies that people with business or alternative income outside of W2 income cheat and don’t pay the taxes they are supposed to pay. That is not true. There are different tax systems for the different ways you can earn your income and the structures that you use. Simply put there are different legal rules for people that earn their income in ways that are different from a straight W2 job. That is the important point here.

Bankers Love Rich People

Many of the faux rich can’t purchase the luxuries of life in cash. Instead, they finance the luxury car, large house, boat, fancy wardrobe, and Rolex. That financing isn’t free. You pay a lot of interest to the bank for all those loans and use your high income to cover the payments. The bankers love this arrangement because they are raking interest in on debts from all these “rich” people paying all those finance charges.

You need a high income to cover all the payments on all that debt. That high income pushes you into a higher tax bracket and the interest you pay is like a second tax. It becomes a vicious cycle where every expansion of your lifestyle requires a higher income to support more debt, pay more interest, and create higher taxes. If you keep your income rolling in the dance can continue, but if the income stops…

No Time to be Rich

Earning a high income takes a lot of time. Nobody makes $300K per year by working 40 hours per week. Even if you happen to be in a profession where your hourly rate is staggering, i.e., attorney or doctor, they still work a lot more than 40 hours per week, ditto for senior executives and other high earners. Yes, they make a lot of income, but they put in a lot of time to do it. In the end, many of them don’t have time to enjoy a lot of the trappings of wealth they are paying so dearly for in interest and taxes.

A Rich Illusion

This appearance of being rich is an illusion. If that income came to an end suddenly, these rich people would quickly find themselves in a bad position. Think of a professional athlete that can’t play any longer due to an injury. A surgeon involved in a car accident and can’t use their hands for surgery. An attorney that falls off a ladder and gets a traumatic brain injury and can no longer practice law. All the things that make these people “rich” are based on them being able to continue to trade time for a high income and utilize credit and debt to finance an affluent lifestyle.

A Tragic Real Story of the Faux Rich

My then-girlfriend, now wife, worked for a family as a nanny for about six months during college. The wife owned a print shop, and the husband owned a roofing company. They had the entrepreneurship piece down, but that is where the intelligent decisions stopped.

They had a giant house in an exclusive neighborhood, and at any given time, they had people remodeling and landscaping it. They had a large boat, that the bank really owned and spent many a weekend out on the islands partying with friends. It was not uncommon for a given weekend to cost them a couple of thousand bucks between babysitting, fuel for the boat, food, drinks, and entertaining.

One year they decided their current boat wasn’t good enough, so they sold it (at a loss) and bought one that was 10 feet longer! They belonged to a yacht club and worked like hell to keep up appearances that they had made it and were wealthy. They lived paycheck to paycheck and didn’t have a nickel in savings or cash reserves. The wife once said, “you know people really think we are rich, but we are just barely making it!” Gee, I wonder why they thought that!

By the time she stopped working for them, the husband had been accused of stealing money from the yacht club. His roofing business was taking a hit due to the accusations. The wife had decided to close one of her “unprofitable” print shop locations. She said the husband and wife were fighting all the time over money, and they both drank a lot.

This is dysfunctional at a whole new level. These people were not rich; they were faux rich. On the outside, they looked like successful entrepreneurs, but they were anything but. They lived in terror that their much more affluent “friends” in the yacht club would discover their fraudulent lifestyle. I am not sure how their story ultimately ended, but I know that all the print shops eventually closed. I know most of the roofing contractors in the area, and I have never heard of his roofing company, so I imagine not well.  

Become Wealthy Not Rich

The wealthy are a different breed. These are often like the people profiled in The Millionaire Next Door. They live a modest outward-appearing lifestyle but have a high net worth. Their income is high enough to cover a comfortable lifestyle with a lot of free time. They can afford to give to charity and rarely stress about money issues. A wealthy person thinks more about saving and investing than spending. They have a consistent capital accumulation plan and plow that capital into purchasing more cash flowing assets that produce income rather than the trappings of wealth everyone thinks of, i.e., nice homes, expensive cars, boats, etc.

Depending on how you accumulate and hold that wealth, you may pay very little in taxes. You may still earn an income doing a profession of some kind, but passive earnings from your wealth often augment your income. Further, your wealth begins to compound and grow over time on its own. Think appreciation of assets combined with the reduction of debt and an increase in passive income. In other words, their net worth and passive cash flow grows year after year.

Wealthy individuals often have other types of wealth besides just financial wealth. Because part or even all their income is earned through passive cash flows, they have the wealth of free time. They stop exclusively trading their hours for dollars.

The truly wealthy have a lot more financial security. They have multiple streams of income that is unlikely to end all at once, like a person who derives their income from a single job. These income sources are often derived from rents, interest, investments, royalties, and self-employment, structured the right way of course for privacy, asset protection, and maximum tax efficiency, i.e., low taxes.

Case Studies in Wealth

Here are some real case studies of individuals that are wealthy with varying degrees of income. Each of them is a real person that I know personally and have interviewed. I changed the names and a few other minor details to protect their privacy. The core facts are all real and accurate.

Case Study: Jane M.

Jane is a real estate agent and a single mom with three adult children. She earns self-employment income via sales commissions. Using this as a base to begin building wealth, she decided to invest in real estate instead of just selling it. Using her knowledge of the local market and real estate, she acquired rental properties, eventually reaching 65 rental properties. Due to the fantastic benefits of real estate, most of her investment income is shielded from taxation.

She started a contracting business and held various professional licenses such as, a general contractor, plumber, and HVAC. She manages the crews and no longer does the physical work herself. Despite having six different businesses and having 65 cash-flowing rental properties, she says she has legally been in the 0% tax bracket for years!

If you met her on the street, you would not think of her as “rich.” She drives an old minivan with almost 200,000 miles on it. She brags that her minivan “is just getting broke in!” She lives in a modest house in a middle-class neighborhood. She dresses plainly and doesn’t wear expensive jewelry or flaunt her wealth in any way. She takes multiple vacations each year, cruises are her favorite, and she could write a check to cover just about any expense that would ever arise in her life.

While she is busy running her businesses and managing her investments, she still controls her schedule and has a lot of freedom.  She has an incredible net worth and high passive cash flow combined with her self-employment income. In case you haven’t guessed it, Jane is a millionaire and personifies The Millionaire Next Door.

Case Study: John H.

John worked in sales and earned a decent income. He started buying old beat-up houses at a discount and fixing them up, eventually turning them into rentals. Using a combination of creative financing, private lenders, and savings, he ultimately acquired 100 cash-flowing rental properties.

John enjoyed working, so he allowed his cash flow from his growing investment portfolio to purchase more properties. Using his excess cash flow, he started a private lending business. John would lend money to other real estate investors and earn an excellent return on his excess cash. At his peak, he earned $80,000 per year with just his lending business. He would also do many of these loans inside a self-directed Roth IRA and never pay taxes on that income.

When I met John, he had already quit working in sales and managed his investments, lending business, and rental properties. Due to the way he structured his business activities, he also legally paid almost no taxes.

John was very unassuming in his appearance, preferring jeans and a flannel shirt. He drove a pickup truck and looked plain and ordinary. You would never know by his appearance or lifestyle that he was a millionaire. If you knew him well, he would occasionally refer to himself as the “blue jeans millionaire.” He had an enviable lifestyle with a nice income, high net worth, and freedom.

Case Study: Eric S.

Eric chose the entrepreneurial route while still in college. He set up a small business, silk screening clothing apparel. While other college students were eating Ramen Noodles and racking up thousands of dollars in student loans, Eric had a modest apartment, no student loan debt, and an $80K per year income! After college, he sold his apparel business for $130K and used the money to start an ISP (Internet Service Provider) and ran that successfully for a few years.

While he was running his ISP, he learned website design and digital marketing. Eventually, he sold his ISP to a global telecom for $300K. Using this windfall, he started an Internet marketing business. One of the first sites he built was a community site where he posted daily events, news, and advertising for local companies.

Later he came across some interesting-looking glasses at a local outlet and negotiated a deal to purchase the glassware in bulk at a discount. He set up an eCommerce site and began selling these glasses all over the world. He eventually hired a part-time person to check and fulfill orders daily, and before long, the website was earning $600K in annual sales with very little of his time involved. He eventually added more eCommerce sites into his portfolio and had several income-producing web properties.

He eventually ventured into real estate. He focused on commercial real estate by purchasing a small office building and warehouses. He bought these properties to house his businesses but eventually started renting out his excess space to other companies. He kept buying commercial properties after that purely for investment purposes.

His real estate and entrepreneurial activities provide many tax advantages, and he can structure his affairs in a way where he pays very little in taxes. He has semi-passive income flowing in from his businesses and real estate, so he has a lot of control over his daily time. He loves starting new companies and defines himself as a “serial entrepreneur.”

He has a nice but not ostentatious house and drives a modest car that doesn’t stand out and dresses casually. He does spend money to travel and enjoys outdoor pursuits like skiing, but overall has a modest lifestyle. If you met him on the street from all outward appearances, you would say he is an average upper-middle-class guy. You would not guess he was a multi-millionaire.

Case Study: Joe P.

Joe is an entrepreneur and has started and sold a few small businesses over the years. He started investing in real estate back in the early 1980s in southern California and still invests there. Today he would describe himself as “primarily a note investor.” A note investor buys real estate (or other assets) and sells it to other people on installment sales, creating a note in the process. In industry jargon, they “deal in paper” by buying, selling, creating, and trading notes for a profit. The income generated from notes is interest income with some capital gains depending on how it is structured.

Joe has several rental properties that provide income and substantial tax savings. He is a creative real estate investor who can put some fantastic deals together in any market. He is a big fan of using Roth IRA funds for his investments, which means they will be tax-free forever. Today, due to the sky-high price of real estate in California, he primarily buys mobile homes. He can still buy these at substantial discounts and resell them by creating notes. Joe is a student of finance and has a high skill level with a financial calculator.

He has a small handyman business to provide active income so he can still contribute to his solo 401(k) plan and Roth IRA. He wouldn’t be able to do this if he only had passive income from investments, rent, or a pension. He provides this handyman service to other real estate investors and people that own Air BNB properties in the area.

Joe is also a lifelong learner. He reads a lot and has been attending classes in real estate investing since the 1980s. He says a lot of his day is spent simply thinking. Joe actively networks with other real estate investors both in California and around the country via Zoom, email, and phone. His office, which is in his house, has books, papers, notebooks, and boxes of stuff stacked everywhere.

Joe lives a very modest lifestyle. On any given day, he wears jeans and a T-shirt. He drives a 20-year-old pickup truck, and except for a beat-up, watch wears no jewelry. He pays a lot of his daily expenses in cash. His house is very modest and is even a bit dated by today’s standards, but he doesn’t care. Joe said he lives by the “70-10-10 budget,” where he lives on 70% of his income, invests 10%, and gives 10% to charity.

If you met Joe on the street, you would never guess that he is a millionaire. If you spent an hour talking to him, you might figure out, he is a brilliant guy but probably still wouldn’t guess his net worth. He enjoys living “below the radar,” as he says, and has a lot of free time to manage his investments and learn new things. He has been financially independent for decades and shows no sign of slowing down despite being 60. He says he loves what he does and will probably never stop.

Common Threads of Success & Freedom

The four people outlined in the case studies all had some common threads that ran through their lives and businesses. They exemplify the millionaire next door profile. Here are some of the common threads I want you to see:

Entrepreneurs: All of them have their own businesses. Those businesses may be small such as Joe P. with a handyman business, or larger enterprises like Eric S. and his online businesses. Over time I learned that all of them had held traditional jobs early in their lives, earning W2 income, but eventually left those to pursue self-employment or entrepreneurship. As I have said before, self-employment is a key to the Money Outlaw lifestyle. It gives you an incredible amount of personal freedom, income, tax savings, and satisfaction. If you aren’t there today, you can always get there with focused effort and determination.

Real Estate: Every one of them used real estate in their wealth-building journey. The incredible power of real estate to build wealth, income, and provide excellent tax benefits is unequaled by any other investment class. Real estate allows you to use leverage, creativity, and tax laws to grow wealth in ways that investing in traditional Wall Street vehicles like stocks and bonds will never give. You also have a fantastic amount of personal control over the value and management of your real estate investments. Over time if you do it right, you will begin to accumulate a significant net worth and passive income that can fund more investments and your lifestyle while providing a lot of personal freedom.

Lifelong Learning: Each of the people above would classify themselves as lifelong learners. They read books, attend seminars, utilize mentors, and actively learn new skills regularly. None of them stopped learning once they graduated from school. Graduation began their lifelong learning journey; it didn’t end it. Each one would tell you that they kept uncovering new opportunities for entrepreneurship and investment by constantly learning. They learned strategies to minimize taxes and build wealth on their terms.

Taxes: None of the people I profiled were fond of taxes. By utilizing the rules and vehicles created by our own government, they pay very low taxes. They don’t cheat on their taxes because the laws provide them plenty of legal ways to reduce their taxes. They earn their active income in small businesses that offer a lot of tax advantages. Real estate and notes create incredible tax savings if you know what you are doing. There isn’t ONE tax system in the U.S.; there are many. Anyone with the proper knowledge, creativity, and business structures can legally lower their tax burden to levels that W2 income earning people will never reach.

Modest Lifestyle: All of them had a very modest lifestyle when compared to their wealth and income. Depending on which person you met, you might think they had a very modest income, or at best, middle-class income based on all outward appearances. They live in modest homes, dress in plain, unassuming clothing, drive old or modest vehicles, and never flaunt their wealth. Most of them would proudly proclaim how cheap they were. Please understand when I say “cheap,” it is in no way a derogatory statement. I am not suggesting they don’t ever enjoy life, like Scrooge from Charles Dickens:  A Christmas Carol. They value personal freedom and financial security over the lifestyle of the faux rich. They would tell you it is simply a matter of priorities.

Multiple Streams of Income: Every one of them had multiple sources of income. Most had some type of small business income, rental income, interest income and other sources. The average wealthy person has a minimum of 3 sources of income. Each of them believed this gave them better security because the chances all of the income sources would end at once was zero. Someone that has a single job and earns all their income through W-2 income not only pays the highest amount in taxes, but can also have their entire income end instantly with a job loss. Having multiple streams of income minimizes that possibility.

A Better Way – Wealth Building

The wealth-building entrepreneurs and investors I profiled above have a profound understanding of financial literacy. Sadly, this is a topic not addressed in our school systems at all today. It is not even really taught in college business programs but is probably the single most critical element of wealth building and a prosperous future.

Wealth builders don’t concern themselves with outward appearances and don’t live beyond their means. None of them would ever consider living like the faux rich. They don’t derive a shred of their self-worth from the opinions of other people. They don’t believe they need to impress people with their success by driving luxury cars and living in giant homes with sky high property taxes.

Most of them would consider the idea of working for W2 income for 30-40 years and investing only in a company-sponsored 401(k) plan with vanilla, high fee, and poor performing mutual funds to be a guaranteed way to live in poverty at retirement. Spending like the the faux rich along the way to this dismal future is like stupid on steroids.

Instead, they are entrepreneurs and investors that focus more on saving and investing. They are creative, independent, focused, and follow their own compass. They live modestly but have far more wealth than most Americans today. They may not look “rich,” but they got it where it counts.

They are financially literate and willing to spend their own time and money to learn new and creative ways to invest, build businesses, enjoy freedom, and seek financial independence on their own terms.  Using entrepreneurship, alternative investing, creative financing, tax savings, and living a modest lifestyle is a better way. Each of them is a Money Outlaw!