Nick Maggiulli: Climbing The Wealth Ladder | Rational Reminder 376

Thanks for having me back on, guys. Appreciate it.

That's great. Appreciate it.

The wealth ladder is a new framework for thinking about building wealth that basically argues that your financial strategy should change over time. And when I say over time, I really mean as you build wealth. So kind of as your financial situation evolves, the thinking around the decisions you make in terms of your spending, your income, your investments should change as well. And so how it does this, it breaks wealth into six distinct levels. And this is all in US dollars. I know you guys are Canadian so I think we can probably just use the same translation for Canadian dollars and it's probably close enough even though the exchange rate's a little different. I think there's slightly less wealth in Canada than the US. So it probably actually maps decently well. So in the US, these six levels are: level one is less than $10,000 in net worth. And by the way, this is net worth. So it's, you know, all your assets minus all your liabilities. So less than $10,000 is level one. Level two is $10,000 to $100,000.

That's level two. Level three is $100,000 to a million. Level four is $1 million to $10 million. Level five is 10 million to 100 million. And level six is 100 million plus. And the thinking behind this, obviously it's a log scale so everything multiplied by 10. If you just memorize level three is, you know, $100,000 to a million dollars and then you can just go up by multiplying by 10 or go down by dividing by 10 and that actually divides the United States pretty nicely in terms of the distribution. About 20% of households are in level one, so that's, you know, less than $10,000. 20% are in level two, which is 10,000 to 100,000. 40% are in level three, which is kind of like the, you know, middle class in the United States, I would say, which is 100,000 to a million. And then you have 18% of households in the United States that are in level four. That's 1 to 10 million. And then the top 2% is level five and six. And level six in particular has like, there's like 11,000 households in there. It's a very, very elite small group that are in that 100 million plus range. And there's only about 30,000 of those people in the world. So the US has about a third of all the centillionaires.

But from that you can just start to see like, wait, so my income decisions might change across the ladder, my spending decisions might change, my investment decisions or how they're allocated might change, and we can get into all of that.

I think the idea of a wealth ladder has been talked about for a very long time. Like, people just say it like, 'Oh, you're climbing the wealth ladder.' It's just like a common concept that's been thrown around. I've at least seen it in the literature in terms of like just how people talk about this thing. And I said, 'Okay, why don't I actually define this? Why don't I try and make it into a real thing? I'll come up with levels. Like I'll come up with different strategies that have to fit within each level, etc.' And so that's kind of where I came up with it. I just realized that like financial advice should change over time. Like yes, there's a lot of great strategies. You can be like, 'Hey, just, you know, buy a globally diversified index fund, save money.' Like that's going to be a great strategy for most people and that's going to work for like, you know, probably 60 to 70% of people. But for some people that are deeply in debt or something, they need a different strategy. And for those that are trying to really build like extreme wealth, it's not just the, you know, the S&P 500 is not going to get you there by itself unless you have like a super long time horizon or a really high income, right? And so I think realizing that there's other strategies out there and just thinking about this more holistically is what kind of got me to this point.

So the 0.01% rule basically states that you take your net worth and you multiply by 0.01% or divide by 10,000 and that is roughly how much your wealth should generate like on a daily basis. That's my assumption here. And if you actually do that, you know, 0.01% per day, which is about one basis point a day, that ends up being 3.7% a year, which is like a more conservative 4% rule. It's like a 4% rule in disguise. And the idea here, the goal isn't to say, hey, you should spend 0.01% of your net worth every day. It's like when you're making that marginal spending decision, if that marginal spending decision is less than 0.01% of your net worth, then don't worry about it. It's almost like a triviality rule, right? So, let's say you have a net worth of, you know, a million dollars, right? That means that all else equal, your net worth should be going up by about $100 a day conservatively, right? So, if you're at a nice restaurant and you're like, 'Oh, do I want to get this salmon or the burger and the difference in price is 10 bucks or 20 bucks, like who cares? It's less than that $100 amount. Just buy the thing and don't worry about it again.' Right? Buy the thing you want, right? If you want the salmon, assuming, right? So the whole purpose of this rule was like I'm trying to allow for lifestyle creep because I think right now there's like the personal finance community, the only real argument I hear is like, oh no, you can't let your lifestyle creep. You have to keep your spending the same no matter how much you make. And like...

I think it's a little strong. I want to allow some lifestyle creep but only after you've like built wealth. So it's like, hey, I've done the hard work. I've saved this money. I've invested it. I've built this financial base. And as that base gets bigger, you get to spend a little bit more over time, right? And so that's the assumption behind it. And I think it's very conservative. Of course, I'm not recommending someone spends, you know, 0.01% of their wealth every day. But if you're doing this on occasion, it's not going to be a big deal. And so that's how I tried to solve the problem of allowing some lifestyle creep, but only after you've demonstrated the financial discipline to get there.

Yeah. I mean, I think if you think about the big spending decisions most people make, it's going to be like in a handful of categories. It's like your house, your car, how often you're traveling, where you travel to, right? So, you start thinking about these categories. And I mapped all these categories onto the different levels on the wealth ladder. So, for example, in level two, which once again is $10,000 to $100,000 in wealth. Once you're in level two and by the end of level two, you have what I call grocery freedom. So when you're at a grocery store, you're like, 'Okay, the difference between, you know, buying one item versus the maybe more premium version of that item is going to be anywhere from like let's say $1 to $10, right?' And that's where level two is, right? If you take, you know, $10,000 times 0.01% is $1. $100,000 times 0.01% is about $10. So that marginal choice, like can I afford to get this nicer version of this thing at the grocery store? Like yes you can once you're at the end of level two, right? And then when you're in level three I call that restaurant freedom because now once you're at a restaurant you can kind of buy what you want by the end of that level, right? Level four is what I call travel freedom. That's where you can start to, okay, maybe I'll buy a slightly nicer seat on the airplane. I'll stay at a nicer hotel and then it goes from there. I think level five is where I say house freedom where you can basically get a house almost anywhere you want. Now, not any house, but like by the time you have 10 million bucks, you can basically live in any neighborhood. And so, you can kind of just go from there, right? As you start seeing your wealth just increase through these levels, like the spending categories change and thinking about kind of the level of freedom you have. And of course, this is never like, this is not a perfect metric. I'm just trying to come up with like rough ideas of thinking about this. Like, if you were in level four, like you just start getting travel freedom. It's not like, okay, I have $1 million now, I can go crazy. Like it's like no, you probably still fly coach. You probably still are staying in a cheaper hotel. Maybe once in a while you can like upgrade something slightly, but as you get deeper into level four, you know, let's say you're like halfway through, you're like 5 million bucks. Yeah, you can probably stay at a nicer hotel. You can get a nicer seat on the airplane, right? And I think that's the thinking behind it is because you've shown the financial discipline. So the reward is more spending, right? Versus what most people do is they say, 'Oh, your income's gone up a lot. Now you can spend more.' And I don't like that because income's fickle. It comes and goes. Like imagine an athlete, like an athlete has like a five-year, you know, they have a five-year career. Yeah, they have an insane income. They could spend a ton of money, but like once that dries up, they have no wealth at the end, like what happens, right? And I think, you know, there's always that cautionary tale of athletes that go broke and things like that. I think it's because they spent based on their income, not their wealth.

Yeah. And once again, the whole point of this stuff, it's not that this thing is perfect. It's like I've had so many people have problems with spending money and they're like, 'Oh, I got to do this. I got to do that.' I'm like, try and come up with, I tried to come up with a framework that could help them stop worrying about this. I had someone who's like worth, you know, I think it was worth like $4 or $5 million. She's like, 'I don't worry about the grocery store prices anymore since talking.' I'm like, 'You didn't have to worry about the grocery store prices probably decades ago, but like the fact that now you're actually changing your behavior is good.' And it's like, you know, don't sweat the small stuff. Focus on the things like, yeah, if you're in like, you know, level four, like, okay, do I want to get a first class seat or do I want to just maybe get like an emergency exit row seat, right? If you're like middle level four, that's a fairer question than one you should think about. Not, oh, do I get the premium, do I get the cage-free eggs versus the standard eggs? That's not even like, just get what you want. If you want the cage-free eggs, get them, you know.

So similarly, the 1% rule, you know, 0.01% rule is for spending. The 1% rule is for making income decisions, right? So if you do 0.01% times your net worth, that's usually a very small number. It's how much you're spending. For income decisions, I think this is very helpful. Especially if you're like a freelancer or someone who has kind of like, you're always evaluating income opportunities. If you have a nine-to-five job and that's your only income, this is not as helpful if I'm being honest. But the idea is take your net worth, multiply by 1%. And if this income opportunity, the side hustle, whatever, is not going to kind of create at least 1% increase in your net worth, then you shouldn't do it or you should just reconsider it maybe, right? And so I think there's people like, 'Oh, I'll take on this client.' And after all the work you do and everything, you're like, 'Wait, this client is actually not even going to move my net worth by 1%. Why did I do all this?' And so it's not a perfect rule either, but it's made as a way as a secondary check on the thinking you already have about something. So you may feel a certain way about a certain decision. Do I want to, you know, take on this side job? Do I want to do the side hustle? Do I want to take on this client, etc. And you're like, I'm not sure. Well, is there a mathematical framework I can use? Yeah, like do 1% of your net worth. Is that person or is that opportunity going to at least increase that by 1%? Of course, you know, time matters too. If someone said, 'Hey, you can, you know, clap your hands. I'll give you $100.' Like, everyone would do it because it just takes basically no time. But like in the grander scheme of things, think about how this framework can help you with income decisions.

I think as you move up the ladder and like you're in theory like you're investing more, you have more assets, those assets are throwing off more income. You have to really think a bit more about the types of income opportunities you take on, the types of, is this job worth my time? This is even in your own career. Like imagine you get to a point, you're in this, usually happens for people I think in level four because you get to a point where your investment portfolio could be earning more than you and even by a considerable amount where like what you do on the investment front is far more important than what happens in terms of, you know, your job or something like that. And so I think thinking about that is very important because now like the opportunity cost of your time is going up. Now I'm not saying you don't want to overdo this, right? I think Tim Ferriss recently talked about this where he's like you can put a value on your time that's super high and you're like, oh, my time's worth $1,000 an hour and if you think, if you view everything in your life that way then you're going to, any sort of second of something that's not optimized you're going to like freak out or you're going to just, it's a bad way to go through life. So I'm not saying to do that. I'm just saying when you're thinking about things like, oh, you know, should I take on this job? Do I need to keep working? Like what's the point? Like all those types of questions should be related to the opportunity cost of your time. Not like, oh, should I go to my child's birthday party? Oh, I'd rather just, you know, go work and I can make, you know, $1,000 or something. Like, I don't want you to start making those trade-offs, but I think the trade-offs that do matter are like income decision versus another income decision. That's where you want to really think about those things.

I consider it the strongest relationship in personal finance. And I know you guys have had people on the show that talk about expense management. And I do think it's important. I don't want to say like expenses are nothing, but if you just look at the data, like it's very rare to have high income and low wealth or low income and high wealth. And it's like the data is overwhelming. Like I tweeted something today. 95% of US households with an income over $200,000 have a net worth over $200,000. So anytime someone's like, 'Oh, you know, income doesn't matter. I know someone that has a high income and they spend it all, they're in the 5%.' And don't get me wrong, I'm not saying they don't exist. I'm not saying that person's lying. I'm not saying that. I'm just saying that's the 5%. I would rather focus on the 95% and the thing that's probably actually going to help you, which is your income. So, I talk about this concept and I still get so much pushback on it. Like people are still like, 'Oh, no. It's because you're buying too many lattes, it's this and that.' And I'm just like, 'Where is the data that supports this?' I'll be the first person to shut up and say, 'You know what? I was wrong.' I have not seen the data to support it and no one can show me. And every data set I've looked at shows a very, very high correlation between income and wealth. Now, someone's going to push back and say, 'Well, Nick, if you have a lot of wealth and it's invested, it's going to be creating a lot of income.' Of course, this is like a flywheel, right? You have higher income, you save it, you invest it, it creates, that's now wealth. That wealth throws off income, right? It creates a flywheel where more income creates more wealth, which creates more income, etc. So, if that's your counterargument, then I'm like, that's my point. Like, this is exactly true. Like, the wealth is creating the income and vice versa, right? And so, that's all I'm trying to say. I'm not saying expense management doesn't matter at all, but if you have to think about what am I going to do over the next five years, I think your spending is not the place to spend all that time and it's more of your income.

So, it depends over the time period. So, I have this data here. Give me one second. So, over a, I think it's over a, I looked at 10-year and 20-year periods. And so, and this data is different. So most of the data I talk about is from the Survey of Consumer Finances which looks at like household snapshots, like just different households over time. There's another study called the Panel Study of Income Dynamics which follows the same set of households over time and I use that data to see, okay, if I follow a household, if I see a household today and I look at them in the next snapshot, like 10 years later, or that's probably two snapshots later, where are they? Are they in the same wealth level? Are they up, down, etc.? And so over a 10-year period, about 20% of households will increase by at least one wealth level and 3% will have increased by two wealth levels. And over a 20-year period, about 33% of households will have increased by one wealth level and about 5% will have increased by two levels. And so you're seeing there is upward mobility even in the United States despite what people say. And there's not a, I mean it's good mobility, but you're seeing even this is not just mobility like, oh, I gained wealth. This is I gained enough wealth to get into a new level. And so for some of those people that's going to be a marginal increase, for others it could be a 10x or more jump. For those that went up two levels, their wealth went up at least 10x over a period of, you know, a decade or two.

So, regardless of time period, the downward mobility is about the same. So, there's about a 10% chance of falling down a level within 10 years or 20 years. So, that's actually kind of good. It shows that there's not like necessarily like over a longer period of time there's more downward mobility. It's about the same. And then going down two levels, it's going to be about 2% of households. And so once again, going down a wealth level is not necessarily always the result of like something really bad happening. I think it could be, there's some people that had, you know, retirement, you're in retirement, you pull down your money, could happen. You fall down a wealth level. That's not necessarily a bad thing. You expected that to happen, right? There's also cases of, you know, divorce. Two individuals are in a household, they divorce, they have to split their assets. Now you have two individuals possibly at a lower wealth level, right? You take anything, multiply by 0.5, you could see how you could fall down a level. In addition, there's like investment things that can happen. If you have a lot of your money, let's say you have a business and almost all of your net worth's in that business and something bad happens to it. We go through a COVID-like scenario, you own a bunch of restaurants, you could see how you'd fall down a level or two. So those are examples of how that happens. It is rare though, which is the good part. And so once again, only about 12% of households will experience a downward shift in level over a 10 or 20-year period. What that tells you though is most people actually stay in the same wealth level over a 10-year or a 20-year period. Most of them will be in the same wealth level. That doesn't mean they didn't build wealth, but they didn't build enough wealth to jump out of their level, right? So even in like, I think this is very common in like level three and level four because once you're in these levels, like especially level four, it's the hardest one to get out of. I think it's something like 64% of households that are in level four today, or at least this is based on the historical data, 64% of those households will still be in level four a decade from now or two decades from now. So, one way or the other, like it's very difficult to break out of these levels once you get there because the strategies that get you in there may not be the same as the strategies that get you out. And we can go into that later.

It's actually, so once again, there's limited data on this because the Panel Study of Income Dynamics doesn't have too many households in this level, but it's technically based on the data I have, level five. So those with $10 million to $100 million are most likely to be in level four, $1 to $10 million, of all the levels. So of all of them, anyone that's most likely to fall down, it's technically level five. Why do I think that is? Divorce, as I just mentioned. I just talked about the concentrated holdings. Like if you have a business, all my money is in this one business and it's worth 20 million bucks. Right now you're in level five. Something happens to that business, you could see most of your fortune wiped away. So that's what we see in the data. Once again, there's not enough households in this data to really be like 100% definitive, but based on what I've seen, that's what the data looks like.

So in general there's like this trend from like let's say levels one and two to like levels three to four to levels five to six where the main assets that people own in levels one to two is mostly like their car and then it starts to become their home by like levels two to three and then as you go into like levels four and five it starts to become their retirement accounts, stocks, things like that. And then, you know, five and six is where you're starting to see private business ownership. So like equity in your own company or you have equity in a startup that kind of got very, you know, got very big and either sold for a lot of money or it's just worth a lot of money. So that's what we tend to see in the data and in general this trend is like from less income-producing assets to more income-producing assets over time. Right? So of those in levels, you know, one to three, you know, less than 25% of their assets are in income-producing assets. So, and by the way, your home is not considered an income-producing asset. Your primary residence is not considered one in this instance. Compare that to levels four to six and over half of their assets are in income-producing assets. So, that includes your retirement accounts, real estate, stocks outside like a brokerage account and private businesses. And so when you just look at that over time, and this was in chapter three of The Wealth Ladder, I'm walking through every single asset class and just showing you, okay, here's all the levels and here's the distribution of the percentage of their assets in each level allocated to that particular asset class. And it's interesting because obviously like for those lower on the wealth ladder, like they just don't have money to go and buy stocks. They don't have money to do all this stuff. And so it's very obvious, but as they do start to get money, you start to see, okay, they buy a home and then after they buy a home, then they have a retirement account and then they start to own stocks and then maybe they even have a business, right? And so it's kind of that progression up the wealth ladder and it makes it very useful for those that are kind of looking at these types of things.

Yeah, it's more income-producing assets all the way up. And like I wrote about this in the first book, Just Keep Buying. I said, you know, the continual purchase of a diverse set of income-producing assets. I wrote that back in 2022, did not have this data yet. And looking at this data now I'm even more convinced of that because there's one of the charts in the end of chapter three where I take all this together and I say, okay, look at just the percentage of income-producing assets for each wealth level and it just increases in every single one. Level two has more than level one. Level three has more than level two, etc. all the way up the wealth ladder.

And so that's kind of my main takeaway. It's like the people that have the most wealth also tend to have most of their money in a, not even just most, they have more money obviously, but like a higher percentage of their assets are in these types of, you know, asset classes that are income-producing than those lower on the ladder.