How to Tell if You're Rich

This article published with permission from InvestmentU.com.

One of the biggest points of contention in the last election was whether the rich pay their fair share of taxes. Polls show the majority of voters don’t believe they do.

Of course, this begs the questions: Who is “rich” and what is “fair"?

Answers are largely a matter of opinion. But here is a fact: IRS figures show that the top 10% of income earners make 43% of all the income and pay 70% of all the taxes. Is that fair? If not, how much should they pay: 75% … 90% … all of it? And how about the now widely recognized fact

thanks to Mitt Romney’s secret videographer

that 47% of Americans don’t pay any income taxes. Is that fair? Opinions will vary.

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According to the IRS, the top 2% of income earners

the ones who just had their marginal tax rate raised 13% to 39.6%

already pay approximately half of all income taxes. President Barack Obama says it’s about time these folks “chipped in.” What a kidder.

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And who is “rich"? For today’s discussion, I’ll leave aside the truism that you are rich if you enjoy good health, a loving family, close friends and varied interests. Politicians (and most voters, apparently) seem to believe that a person’s wealth can be determined by his or her income. I would argue that you determine real wealth by looking at a balance sheet not an income statement. But why not look at both?

According to the Tax Policy Center, if your annual household income is $107,628, you are in the top 20% of income earners. If your income exceeds $148,687, you are in the top 10%. You are in the top 5% if it is $208,810. And if your household income is $521,411, congratulations. You are in the top 1% … and perhaps demonized by those who view hard work and risk-taking as a matter of good genes and good fortune.

However, net worth is a far better measure of wealth, in my view. According to the Federal Reserve Survey of Consumer Finances, a net worth of $415,700 puts you in the top 20% of American households. You are in the top 10% if your net worth is $952,200. (This jives with the findings of Dr. Thomas J. Stanley

author of The Millionaire Next Door

that one in eight American households has a net worth of $1 million or more.) If your nest egg totals $1,863,800, you are in the top 5%. And

trumpets please — if you have a household net worth of $6,816,200, you are again in the top 1% … and possibly frowned upon by redistributionists who resent folks who live beneath their means, save regularly and handle their financial affairs prudently.

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How do you get rich if you aren’t currently? The basic formula is pretty simple: Maximize your income (by upgrading your education or job skills). Minimize your outgo (by living beneath your means). Religiously save the difference. (Easier said than done.) And follow proven investment principles. (Which we write about here every week.)

Most millionaires

folks with liquid assets of one million dollars or more — are not big spenders. Quite the opposite, in fact.

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According to extensive surveys by Stanley, the most productive accumulators of wealth spend far less than they can afford on homes, cars, clothing, vacations, food, beverages and entertainment.

On the other hand, the wanna-be’s (people with higher-than-average incomes but not much net worth), are merely “aspirational.” They buy expensive clothes, top-shelf wines and liquors, luxury cars, powerboats, all kinds of bling and, often, more house than they can comfortably afford. Their problem, in essence, is that they’re trying to look rich. This prevents them from ever becoming rich.

It surprises many, but the vast majority of millionaires in the United States:

• Live in a house that costs less than $400,000.

• Are more likely to wear a Timex than a Rolex.

• Generally pay $15 or less for a bottle of wine.

• Have never paid more than $400 for a suit.

• Are more likely to drive a Nissan than a BMW.

• Spend very little on prestige brands and luxury items.

Yes, they’re frugal. But they’re also happy, not to mention financially free. They are not dependent on their families, their employers or the federal government. What a feeling.

Some can’t abide by this important lesson but the bottom line is clear: If you want to be rich, you have to stop acting rich… and start living like a real millionaire.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.