On this episode of The Long View, Nick Maggiulli, author, blogger, and chief operating officer and data scientist at Ritholtz Wealth Management, discusses why net worth is key when it comes to financial planning, why money can’t buy happiness, and lessons from his new book called The Wealth Ladder: Proven Strategies for Every Step of Your Financial Life.
Here are a few excerpts from Maggiulli’s conversation with Morningstar’s Christine Benz and Amy Arnott.
How One Rule Can Simplify Your Spending Decisions
Christine Benz: You share what you call as the 0.01% rule. Can you talk about what that is and how it can aid with decision-making about doing spending, and what expenditures to stress out about and which to not stress out about?
Nick Maggiulli: Yeah, so the 0.01% rule basically says that you can spend 0.01% of your wealth or just another way of looking at it’s one-10,000th. So you could call this the one-10,000th rule as well. You can spend one-10,000th of your wealth on a daily basis without having to worry about anything. And so I’ll explain where that comes from. So let’s say your net worth is $10,000. You’re basically right on the cusp between level one and level two. That means you can spend an extra $1 per day without any worry about jeopardizing your future wealth. And where that $1 that 0.01% comes from is, on an annualized basis, if you’ve got a return of 0.01% a day, that’s like a little bit under 4% a year. It’s like 3.7% a year. It’s very conservative return. So every day your wealth is generating that much money.
So if you have $10,000 in wealth every day in theory, you’re generating an extra $1 a day without doing anything. So in theory, you could spend that $1 and not jeopardize your future wealth. So if you have $100,000 in wealth, you could spend $10 a day. If you have $1 million in wealth, you can spend $100 a day, et cetera. Now, obviously this isn’t your total spending. If you live in the United States, you’re not going to survive on $1 a day. This is the marginal spend. Everyone’s making a spending decision, you’re making it on the margin.
Like when you go to buy a car, you’re not saying, oh, should I get a Toyota Camry or a Maserati? You’re debating between the Camry and the slightly nicer Camry. That’s what I’m saying. You’re always doing it on the margin. Like when you sit down in a restaurant and you’re like, do I want to get the burger for $20 or the salmon for $30? That marginal difference is $10. And so my argument is that once you have like $100,000 in wealth, that extra $10, you can spend that every time you go to a restaurant without worrying about it. And so the 0.1% rule works in that way by just it allows you to have some lifestyle creep because you’ve shown financial disciplines. Like, hey, look, I’ve reached this level of wealth so I can now spend more in certain categories. But until I reach that level of wealth, I’m not going to do that.
And so like in my example—I still to this day, I don’t have basically any travel freedom. When I go to a restaurant, I’ll buy whatever I want. I don’t care. But I am still getting the coach seat. Maybe I will upgrade my seat to a slightly nicer seat, not a first-class seat, but I’ll go like get something with more legroom. That’s where I’m at in my wealth journey. Like one day if I do well, if things go well for me, I will maybe always get a first-class seat, but that’s not in the cards for me right now. And so I’m spending according to my wealth level, and I’m very strict about that. It’s because that the extra whatever $100 or whatever it is, is not enough to upgrade to first class every time. So I can’t spend that money. That’s how I work through it.
Why Housing Is More of a Consumptions Good Than an Investment
Amy Arnott: You also write that housing is really a consumption good and not an investment. Why is that? And are there any levels where housing is more important in building wealth and getting to the next level?
Nick Maggiulli: I think housing is important for most Americans because it is the primary way in which they build wealth, even though it is a consumption good. But when you pass on and you pass that property on to the next generation, that’s when it becomes a nonconsumption good at that moment of time. So if you assume, oh, I have children, they have their own house already. When you pass and you pass on your property, that’s the moment when it’s no longer a consumption good. Now it’s an asset for your family. So it really depends on when. It’s like when you’re thinking about it throughout your lifecycle. Like, yeah, for you, it’s a consumption good, but for your offspring and so on, it won’t be a consumption good. So I think primary residence is, once again, the homeownership rate is still like 66% or something like that in the US. Most households have a home. I don’t expect that to change in any drastic way. It’s going to be anywhere between 60% and 70%, probably throughout the rest of my life.
And it is a way to build wealth because you own this thing, the property prices don’t change too much. I know in recent years they’ve gone up a ton, but I don’t expect them to move a lot for a host of reasons. There’s, what do we call it, a Nimbyism or whatever, people preventing other houses from being made, and so on. I don’t expect major changes in-house prices going into the future. Does that mean that they’re going to keep growing at the same rate? No. And so we could get into a discussion about the future real estate prices, but generally it’s been a pretty stable asset class. And I think there’s a lot of entrenched political and cultural reasons why it will remain a relatively stable asset class. Now, does that mean it’s going to beat the stock market or whatnot? I have no clue. That’s why I say you got to diversify.
How People With High Income and Low Net Worth Can Fall Into an Overspending Trap
Benz: So you write in the book that people can get into overspending trouble if they have high incomes but not necessarily high net worths. But you point out that income can be fickle. So you believe that people should use their net worth to guide how much they can reasonably spend. Can you talk about that?
Maggiulli: So they’ve done studies on negative income shocks among US households and something like 10% of households are going to see a 50% or greater decline in income over the next two years. So like one in 10 households are just going to have a massive hit to their income in the next two years. And what does that mean? Usually most households are two income-earners. All that just means is one earner is going to lose their job in the next two years. It’s not unreasonable that one person might lose their job in two years, right? So one in 10, that is. So because of that, that’s why I think income is fickle. And more importantly, among higher earners, negative income shocks tend to be persistent. So in other words, if you have a very high-paying job and you lose it, I wouldn’t expect to get back that old income you had, that higher income anytime soon. And trust me, I have friends where this has happened, like, oh, I lost my high-power job doing this. And I got another job, but I took a 40% pay cut or I took this.
It’s like almost starting, unless you can get a job right away back in the exact same role you were doing, it can be tough for people. So that’s why I think you have to spend based on wealth, not income, because as volatile as wealth can be, it is far less fickle than income. Wealth has a little bit more staying power. Of course, there’s things like the Great Depression where wealth dropped off a cliff quickly, but that’s usually not the case. And so your wealth will be a lot more stable than your income will be over the long haul.