The Greatest Detriment to Building Wealth

Here are some interesting thoughts from Stop Acting Rich: ...And Start Living Like A Real Millionaire on why your home has so much of an impact on your wealth:

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.

Ok, there's more to come on this topic, but let's stop here for a moment. He says that buying a big home that you really can't afford (that's what he's talking about mostly -- reaching for something well beyond your means that sucks the life out of your finances) is "the greatest detriment to building wealth." Wow. Greater than over-spending in other areas? We'll see in a minute, but he'll say that your home influences what else you spend money on, so if you're over-spending in other areas, much of it is due to where you live. That's why he says it "often takes the greatest toll on our financial wealth" as well as from it "all other perils flow." Food for thought, huh?

Here's some more detail:

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.

Think about all the things we see in our neighborhoods that influence our purchases: new/nice cars, lawn service, remodeling/house upgrades, bikes/toys for kids, swimming pools, yard equipment, and on and on and on. Let's face it, the Joneses that most people are trying to keep up with are the ones next door! And if your neighbor has a huge expensive house with all the latest "stuff", you're very likely to match (or even try to surpass) what he has. And if you stretched in the first place to buy the home, then you're in trouble trying to buy all the other stuff too (think this sort of sounds familiar?)

The author goes on to tell what the truly wealthy do when it comes to home buying:

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.

A few thoughts:

1. Notice how he didn't say something like "most of the self-made millionaires I have studied have one thing in common: they made a ton of money." Nope. Instead, the path to wealth involves buying a home (and living in a neighborhood) that you can easily afford.

2. Both making money and controlling spending are important to wealth generation, but notice which is more important (and much more controllable by the way)?

3. This has been my personal experience as well. Looking back, one of the key reasons we've been able to grow our net worth is because we bought a home we could easily afford and thus our associated expenses have been at the level that we can handle them financially. It's still a very nice neighborhood, but is well below what the bank would have loaned us based on our income. Yet another reason to decide for yourself what you can afford in a home -- don't let a bank or real estate agent tell you what you can/should spend. (That said, I think banks are a lot more careful these days than they were when we bought our home 10 years ago.)

Comments

[Tyler]

The people you chose to surround yourself with is one of the most important life choices you can make!

Anyone think there is any advantage to living in a very wealth neighborhood from a networking perspective? Does having executives as your neighbors offer any benefit? Seems like this data says any benefit is offset by cost.

[Tyler]

“If thou wilt make a man happy, add not unto his riches but take away from his desires.” ~ Epicurus

[James]

FMF,

This is a great posting. Everybody knows that you need to avoid "keeping up with the Joneses" to build wealth. But - sometimes its better if its spelled out. This is a good example of spelling it out for someone.

[Satisfied in the burbs]

I am not sure that I am on-board with this one, although I do agree with the underlying premise of living within your means. There was an old adage that you should buy as much house as could afford, which seems to have been discredited with the latest housing bust. However, I did buy as much house as I could afford (twice now) and I don't regret it. I did buy the bigger home in the "nice" neighborhood with the reasoning that those payments would become more comfortable as my salary increased with raises and promotions, which is exactly what happened.

I guess you could get sucked up into keeping up with the Joneses, but I think that would apply to all neighborhoods, not just the nicer ones. I drive 5 and 11 year old vehicles, and don't care what my neighbors think. I am not sure if this is the case for all nice neighborhoods, but one other advantage is that the property taxes support a great school district. I learned the hard way on not buying in a good school district.

In fact, I think that owning a large home in a nice neighborhood is a great hedge against inflation, because it just a matter of time before that one hits. There are very few hedges against such, so it nice to know that at least a portion of my net worth is protected against inflation!

[WorkingHusband]

Good article about not buying too much house. But at the same time, don't buy too little just to save money. Stay away from high crime areas with low quality housing. Having crime hit your family is not worth it just to meet your financial goals. That said, don't go buying some McMansion just to keep up with the Joneseseses'. Look at the old mortgage ratios that banks used to use. Not more than 28% of your gross salary should go to housing and not more than 36% should go to your total debt. If you buy small, buy small in a good area.

[[email protected]]

I agree with "Satisfied in the burbs" and "WorkingHusband", buy a house that is a good fix.

I've been thinking a lot about buying a bigger house as a hedge against inflation too.

If I had to do it all over again, I think I'd buy a cheaper house, pay it off early (maybe in 5 years), then buy my ideal house and rent out the 1st one. That way I could dabble in real estate (albeit on a small scale...)

Having kids, the school system was very important to me. It was a primary factor we uses when picking the area to live in.

I used a spreadsheet to determine what I can afford and how quickly it would take to paid off my mortgage. For me the spreadsheet kept my eye on the goal, and allowed me to determine how much I saved in interest by paying the house off early, and the number of years shaved off of the 30 year loan that we took out.

I'm sure there is a ballpark percentage that could be derived. Perhaps the number could be based off of discretionary income and the price of the home...

Thanks for bringing this information to light.

[Wojciech Kulicki]

I saw this concept in another post a few weeks ago, and I was very skeptical to buy it. The mantra beat into our heads is always "get the worst house in the best neighborhood you can afford."

But now it's starting to become crystal clear and very persuasive...that you want to do exactly the opposite. It just goes to show you how hard the pre-conditioned response we've been brought up with is to change, even when presented with a logical argument.

[Financial Samurai]

Not sure if agree. I live in a relatively expensive home with prices going at $800-1,200/sqft.

Nobody has influenced me at all just b/c where I live.

[Mark]

@Financial Samurai: How do you know you have not been influenced? Many influences are so subtle you would not be aware of them.

[Laura]

Sometimes where you live can have an enormous effect on your quality of life. My husband and I both wanted a particular type of house and we wanted a farm. Both of us had been saving money to buy land since we were teenagers (before we met). We could have bought a house for a lot less than we have now spent on our farm and building a house; if we had bought a cheaper house, one of us could now quit work. However, the enjoyment we all (my husband, myself, and our children) gain from our farm is immeasurable and immense. I think what matters most is an awareness of your financial situation and the financial consequences of any spending habits. Prioritize your spending -- don't fritter away money on stuff you don't really care about; instead, save money for things you really do care about.

[MC]

I think it is very true that buying a house in an expensive neighborhood will cause you to also buy a lot of other expensive stuff.

I have seen this over and over in friends--particularly with furniture. When they move into the new house, suddenly they need *more* furniture than before (because of that extra living room and basement rec room) and it has to be *nicer* furniture than they had before because Ikea junk looks stupid in the house with the high ceilings, marble counters, hardwood floors, etc. Furniture like that can easily run you $10K/room---really adds up fast even if you "just" purchase basics.

Another thing to remember about the old rules of thumb is that "the payments will get easier with time" doesn't always apply if you are already mid-career: your salary may very likely have plateaued by the time you're 45-50 years old, and you may also have stresses on your salary that you didn't when you were younger (kids in college, elderly parents you have to support), so assuming the payments will always get easier with time can get you into trouble.

My ex and I bought the house I live in now 15 years ago for less than half what the real estate agent and bank said we could "afford". It's a 30 year old well-built home in a safe and stable working-class neighborhood with surprisingly good schools. When we bought it, my ex and I each made about 1/3 what we do now. We got divorced a few years ago and it was easy for me to buy out his interest in the house. I'll have the mortgage paid off in a couple years, and after that it will still be a great deal with the low taxes. I also like that even though it's paid for the bulk of my savings won't be tied up in the house.

It's nice to be able to put on vinyl siding and asphalt shingles when you have to do the inevitable maintenance, because that's what all the neighbors have. It's also nice that nobody cares if I don't mow my lawn obsessively or if my Dad wants to park his camper in my driveway and live in it for a few weeks.

Of course, you have to be OK with some of your neighbors displaying plastic lawn ornaments (dwarves, deer) unironically. But oh well!

[Photohv]

I do believe in this concept. I was fortunate in
that all my moves up were corporate sponsored allowing to me buy
a house in a fairly nice neighborhood. I have always used 25% of the highest salary in
the household as my guide for mortgage payments. The current trend of using both incomes is dangerous
given the current employment situation.

My wife and I are very frugal and I do tend to compete with my neighhbors, but compete to
spend less. Base on my survey of my neighbors and supported by my utility company, we average 50%
less energy usage. We do not use lawn service. I hear the excuse, we dont have the time. We all have the
same 24 hours, it is how we choose to spend that time that makes a difference. I see alot of people spending it on
play time and relaxation. Which is fine, but don't complain when you retire and you don't have enough money. You could
have if you just kept a little more when you were younger.

[Pete]

I tend to disagree a bit... We bought into the nicest, richest neighborhood in town. We bought by far the least expensive house, got a great deal on it, and had to do quite a bit of work to bring it up to date. However, we have an extremely nice, well-kept, friendly, safe neighborhood now. This neighborhood is full of people who do have a lot of money, but have made it here because they have made smart financial moves and there really is no "keeping up with the Joneses". We see nice, older cars, the same cars year after year... If I drive into some of the cookie cutter cheaper neighborhoods, I see far more "keeping up with the jones" in the form of new cars every couple years, boats, lawn equipment, toys, etc... My experience has been that you find a lot more of that in the middle-range neighborhoods than in the upper ones. The level of financial maturity is different.

[FMF]

Pete --

You said:

"this neighborhood is full of people who do have a lot of money."

How do you know that? Personal conversations with the people/some access to their financials?

I'm asking because that's just the point the author makes in the book -- that people living in these sorts of neighborhoods often LOOK like they are wealthy, but they aren't really. And he has research to back up his POV.

Of course, there are always exceptions to the rule, as you know...

[Mark]

I am in the process of buying a relatively inexpensive home in a very expensive so-called "old-money" neighborhood, which you might think "is full of people who do have a lot of money.".

I have no idea if the neighbors are really wealthy or just pretending to be. But I do know that three houses on the street are bank-owned, meaning that at least three of the recent residents didn't make as much as they thought they would!

[Crystal]

I live in a classic "starter" home in a very small subdivision of "starter" homes. It was a complete foreclosure neighborhood due to a corrupt builder and appraiser. The houses were built in 2004, but were sold for more than $100,000 more than they were actually worth, so people had abandoned ship in 2005 and the builder ran off. Only two couples stayed to battle it out and the rest of the 25 houses were bought by couples or families looking to purchase their first home. When we bought our home in 2007, there were 4 foreclosures left. Now there aren't any.

Our neighbor on the left is a locksmith and our neighbor on the right is a maid. Everybody seems to be friendly and loves the fact that the streets are dead ends since their children can play pretty safely. A few of our neighbors seem to entertain themselves simply by sitting outside most of the year and drinking beer...it's like a built-in Neighborhood Watch.

My point is that even though we could have afforded a $200,000 house in a more mature middle-class neighborhood, our $114,000 purchased an almost-new home in a very safe neighborhood. We don't have a Homeowner's Association, but peer pressure seems to keep all the houses and yards looking ok. A few houses are even having little competitions between themselves on how awesome their yards can look, which has been the only keeping-up-with-the-Jones's that I've witnessed.

We've only put $2650 into the house other than the mortgage, taxes, and appliances (those were $2300 since the house had nothing...the previous owner took everything including the light bulbs). $2200 was for the wood laminate floor we had installed downstairs since the cheap Berber was tearing up our vacuum cleaner, $300 was for the paint and supplies we used to repaint the bottom floor, and $150 has been put into soil and plants that I've used in the front yard (like my ever-blooming Double Knockout rose bush, the small garden that runs along the walkway, and the Crepe Myrtle in the middle of the yard).

By living in this neighborhood, we understand that marble countertops would be silly and $10,000 of furniture in each room would be a complete waste. We are slowly buying really nice furniture at our own pace simply since we rather only buy each piece once in our lives and keep it forever (like our solid wood Ashley bedroom set). We do not need a BMW in the garage or a swimming pool just to keep our house in line with those around us...I truly enjoy the basic and simple way we can live without stressing over home values and keeping our house up-to-date.

[Pete]

Yes, perhaps I wasn't very clear... What we've found is that these people have nice, big houses, and live in this nice neighborhood. But they aren't buying new furniture all the time, they all drive nicer older cars, keep them for a long time, etc... Just in the conversations with them, you can tell that they are smarter about their money than many people in the mid-size neighborhoods (ie. no car payments, saving for college, put an emphasis on education, large emergency funds, etc...). Just an observation, but as I said you don't see people going out and buying all kinds of new "toys" but you do see a little more pride in ownership/maintenance of their houses. I think the boat example is a good one... I drive through our neighborhood and can think of one person who bought small, used fishing boat and keeps it in their 3rd garage... Go through the smaller/mid-sized neighborhoods and I see shiny brand new speed boats in the driveways, with a nice bid SUV to pull it, etc...

[Bill]

I don't believe in this concept. Just don't keep up with your neighboors and be happy.

[FMF]

Pete --

I see what you mean.

Still, I'm guessing that on average the thoughts in the book avove are more on target than not (based on what I've run into when counseling people on their finances.)

[Crystal]

Bill's post made me think. I agree that you shouldn't have to keep up with the neighbors to be happy, but isn't it a normal, human response to want to?

For example, I really don't care about my yard much, but letting my grass go brown would have been super ugly compared to the lush lawns my neighbors have. I literally felt compelled to add flowers and to remember to water it during the hot summer months. It took hours to clear out patches of grass and to make flower beds, but I didn't want my lawn to be ugly compared to everyone else's. I hate gardening and chores, but I do it anyway just so I won't stick out. Maybe it's only a problem I have, but I don't think so...the reason peer pressure exists is because it works. Otherwise, I wouldn't even have a lawn anymore...

[Jenny]

What a great quote the Epicurus one is. Is it from the Bible? I am not a Christian, so not familiar with the Bible. I resisted buying a macmansion when all my friends were hopping from one upgrade to an even higher one. I stuck to my no frills 1000 sq foot house. I am used to a very modest lifestyle, and in the downturn my payments for utilities, insurance etc. are still reasonable for my income. It really helps that I am used to a modest lifestyle; it must hurt to have to adjust downward for some.

[FMF]

Jenny --

No, it's not from the Bible.

More on Epicurus is here:

http://en.wikipedia.org/wiki/Epicurus

[David]

FMF,

Sorry I'm late to the party on this post. But one question, could you please clarify? Is Thomas Stanley warning against buying a home you can't afford? I'm not seeing that, at least not in the passages you quoted. I think what he's saying is that if you buy a home in a pricey neighborhood, you'll tend to overspend to keep up with all the "toys" that your neighbors are spending. ("If you live in a pricey home and neighborhood, you will act and buy like your neighbors.") This is regardless of whether the initial purchase of the home was a stretch or not. I'm not seeing him address the topic of buying a home you can't afford.

Thanks in advance for the clarification.

[FMF]

David --

Yes, you're correct -- he's saying to buy below your income standard. Now if your income is $1 million, you could live in a neighborhood where all the other people "only" make $500k and you'd likely be able to grow your net worth.

[M.E.]

The greatest detriment to building wealth? Utterly simple to answer: it's taxes. Despite taxes, I did become a petit-millionaire ($3M at present), but I certainly wasn't helped along that road by the $1.5M in income taxes (and still counting) that I've paid--not to mention Social Security, Medicare, capital gains, sales taxes, excise taxes, taxes-on-taxes. Quote me: "All tax is theft."

[Dr. Artfredo C. Abella-Philippines/U.S.A]

The greatest detriment to wealth is fear and not doing acts to become wealthy. People are so prone to acts leading to poverty, one of which is extravagant spending while we hesitate to act in terms of investment, savings and maintaining a frugal life.