Nick Maggiulli: The Wealth Ladder Has Six Rungs (and Most People Never Climb Past Four)

Yeah, thanks for having me.

Yes, of course, that's still valuable advice. But I think what a lot of people get themselves tripped up on is as their wealth goes up or as their income goes up, they start to spend more. And I think that's okay. I think your spending increasing with your income makes sense. It just needs to increase at a slower rate than your income. So that means you're always saving more, right? So that's one way to think about that. And I can talk about the spending rule that gets you there and the different ideas related to that. But you can spend more as you earn more. It's just a question of how much. The Wealth Ladder actually has a rule for this that will solve that.

Yes, 0.1% rule. Or you can think of it as the 1/10,000th rule. All your assets minus all your liabilities, you divide that by 10,000 and that is the marginal amount of money you can spend on a daily basis without impacting your wealth. So let me just run a quick example. Let's say your net worth's $10,000, right? Let's say your income and your spending is completely the same, right? You spend every dollar you earn, right? If you have $10,000 in wealth, if it's growing at 0.1% per day, that allows you to spend $1 per day, you know, on average, and you would stay at the same level of wealth over time. By the time your wealth hits $100,000, you can spend $10 a day. By the time it hits a million dollars, you can spend $100 per day, etc. And once again, this is in excess of your income. So this is kind of like that marginal decision you make when you're at a grocery store, when you're at a restaurant. Like the difference, the size of that spending decision is determined by your wealth. And so, for example, the levels here, once we get into the levels, I think it'll make more sense. But level two is what I call grocery freedom. And that's a net worth between $10,000 to $100,000. And so the idea is the marginal spend is anywhere from $1 to $10. So when you go to a grocery store and you want to, oh, I want to get this slightly nicer eggs or the slightly nicer cottage cheese or whatever you're buying, you can spend that extra marginal $1 to $10 on that item without worrying about it, right? That's kind of the idea. And that scales as you gain wealth, right? And it changes categories, right? Level three, which is $100,000 to a million dollars in wealth, that's what I call restaurant freedom. So you can spend, you know, $10 to $100 more when you're at a restaurant. That's kind of like the idea. And so I think most people spend on the margin. And so thinking about spending in this way, I think, is very helpful because it allows you to spend a little bit more without necessarily jeopardizing your wealth.

Exactly.

Yes, exactly. And so I think the whole idea of this rule is not to... we can get down to the fine details like this, but the idea is, okay, where can I spend more money and not have to worry about money, right? And so I say level two, grocery store, right? So you have $10,000 to $100,000 in wealth. Don't worry about kind of what you spend at the grocery store. Once you go $100,000 to a million, which is level three, you don't have to worry as much at restaurants. And then once you go level four, which is 1 million to 10 million, I call that travel freedom. So you can start to spend more. You can start to upgrade your seat a bit more. Of course, right at the beginning of 1 million, you may not be able to do that too much, but you can, you know, get a better seat, get a window seat. Oh, I want more leg room. Like you can do stuff like that. You know, stay in a slightly nicer hotel. And as you do that over time, what this allows for as your wealth grows, you get to spend more and it also doesn't jeopardize like your financial future. That's the idea. So in your example where someone's spending 80 grand, they're already saving 20 grand a year. So they can in theory spend that and their wealth would stay flat, all else equal, right? Of course, we don't want that. We want them to grow their wealth. So they're saving 20 grand a year, which is great. And then on top of that, they could spend $100 a day on top of that and they would still see their wealth grow over time, right? So...

You could assume your investments are earning 0.1% per day, which is annualized 3.7% per year.

Yeah, you would be... I mean, this is on average, of course. If the market's down 50% in a year, this is not going to work, right? But on average, if we assume that your wealth grows at 3.7% per year, which is very conservative, I don't think anyone's going to argue with that, then we can assume that you can spend that level and your wealth would just stay at a million dollars indefinitely. That's the assumption. Of course, the real world's much messier than this. I think most people who have a million dollars and probably have a decent income are saving money and that's good. The whole idea is just creating some sort of heuristic, so like when can I spend more money and not worry about this? And I wanted to provide a little bit of lifestyle creep over time without going overboard, because I think the 'oh, never spend anymore, don't have any lifestyle creep' — I don't think it matches the data. I don't think it matches, you know, human nature. People want to reward themselves for doing well. And so this rule, which we've kind of gone through these specific details, is just a simple way for you to say, hey, you know what, I'm in this wealth level, I can splurge a little bit more in restaurants now, or I can go and upgrade my seat on an airplane, right? And so for example, when I was in level three, I never did any sort of travel freedom. I always took the cheapest seat, the cheapest everything. Now that I've slowly kind of gotten into level four, I will upgrade my seat. I will do small stuff like that. So my behavior has changed based on this. I actually use this rule. I came up with it obviously after the fact, but I came up with it while I was building wealth. I didn't know it from 10 years ago or something. But that's kind of the thinking that I actually use and I think it's very valuable in that sense.

I try to, like, everything I do with future estimates is like 4% real returns. This is even more conservative than that. And it's also simple, right? It's like, okay, take my wealth, divide by 10,000. That's the number I can spend like on a daily basis. Of course, what if you don't spend it for a week? Could you pull it for a weekend? Yes, you could. There's all sorts of ways you can play with this rule. I think I just want to keep something simple like, oh, hey, I have a little bit of travel freedom. Oh, I have restaurant freedom, etc.

People like that one as well. That's called the 2X rule. So if you want like a pair of nice high heels as a woman or a nice pair of leather shoes as a man, whatever it is, let's say you spend $300 on these shoes, okay, save double, save 600, take the 300, buy the shoes, take the other 300, and invest in a diversified portfolio or the S&P 500, whatever you want. It doesn't really matter. Invest it or give it to charity. There's a lot of different things you can do with this rule. I like coming up with these rules because every person is going to have different feelings and reactions to them and some will attach to one rule more than another. And so I don't think any one of these rules is completely correct. I think I'm just trying to provide options for people because I do think the spending guilt is very deep in our society and I don't want to name names. I think there's a lot of very popular personal finance people out there who are very anti-spending and a lot of them talk about, you know, lattes and all this other stuff which is kind of crazy. I know you've had people on this podcast, you've discussed these ideas before, but I'm just trying to reverse that. So I'm like, hey, if you don't like this rule, try this rule. If you don't like this, try this. I think there are different ways of looking at it. I personally like the 0.1% rule, even though it's a little more technical because it moves over time, right? And so the 2X rule is great as well, but everyone kind of will see what they like. And so I've talked about both of those.

I'll also give some data as well. I think this is going to be helpful for your listeners because understanding, okay, well, how many people are in this wealth level, etc. So this is US household. So this is if you have a spouse or something, that includes both of your net worths together. Basically 20% of US households are in level one, that's less than $10,000 in total wealth. So once again, include your home equity, include your vehicle, cash in your bank accounts, your retirement accounts. Take all those assets, then take out all your debt. That's student loans, mortgage, credit card. You take that difference, and that's your net worth. That basically determines where you fall on the wealth ladder. So once again, level one, less than $10,000. That's about 20% of households. Level two, that's $10,000 to $100,000. That's also about 20% of households. Level three, that's $100,000 to a million dollars. That's what I would call like the middle class. That's around 40% of households. So I know people say the middle class doesn't exist, but if you actually just look at the wealth data, like they are there and they are the largest cohort. Level four, that's 1 million to 10 million, that's going to be about 18% of households. And then level five, which is 10 million to 100 million, and then level six, which is 100 million or more, those two cohorts represent the top 2% of households, right? So going through it again, 20% in level one, 20% level two, 40% in level three, which is 100,000 to a million. That's the middle class. 18% in level four, it's 1 to 10 million. And lastly, you have 2% in the level five plus, we'll just say, because I mean there's so few households there that there's not a lot of data on them and then it's very hard to track as it is.

Yeah, there's a lot of different ways this can happen. So let's say you're in level one, you're 18. There's a few different paths you have. Most people, or not most people, there's a good portion of the United States, I'd say maybe a third to 40% will end up going to college. They'll get an education that ends up getting them a job that gets them out of level one, right? You get that education that raises your income,

Yes, yes. Eventually, it can give you a negative net worth, but you'd hope eventually the income increase that you wouldn't have had if you hadn't gone to college ends up getting you out of level one eventually, right? That's one path. Second path is you just start working at 18, right? And there's different ways, different jobs you can have. You can start working at a grocery store and work your way up. You work at a Chipotle and become a Chipotle manager. They're making six figures now. So there's a lot of different paths there. The thing I like to focus on in level one is just getting that safety net, right? Because having that emergency savings is so important. And I like to think in every wealth level, something is being amplified in your life. And so in level one, I think the thing that's being amplified is bad luck. And what do I mean by that? Something that is just an annoyance for someone in let's say level three or level four could derail your life completely in level one. And so like let's just take a simple example. Let's say you have a car. You drive to work. You get a flat tire. You don't have money to replace the tire. Okay? So you just can't get to work. Now if you can't get to work, you could lose your job. You lose your job, you get behind, you know, get into credit card debt. You could just see how it spirals out of control from there. That's a very simplified example, but it goes to show how just a simple piece of bad luck is just so much worse for someone in level one than it is for someone in level two, etc. Right.

So the thing I focus on in level one is, okay, you're 18, starting out, whatever you're doing, find a way to just get some sort of safety net. And it doesn't have to even be you. If you have friends or family that can help you and just like provide that initial safety net, that's great. And then find ways so that you can actually do that for yourself. You want to get some sort of just base level of self-sufficiency. And it's okay if you have some debt, that's not the end of the world. But if like once again, if one of these bad luck events happens to you, it's not going to knock you out completely. That's the goal because debt, you can pay that over time. You know, that's not necessarily always an issue. It depends the type of debt as well. But that's what I would focus on in level one, that starting out person.

Yes, exactly.

Yeah. So I think time is going to be consistent throughout the wealth ladder and we can get into that especially at the higher wealth levels. The median age in each wealth level just keeps going up and it goes like for example the median age in level four is 62 and we'll get into that. Getting to $1 million is not 20 and 30 year olds and we can get to that. But so in terms of that time, time is a piece of it. But I think it's getting skills that can create the income that makes it easier to save money. And I think we like to demonize, you know, poor people and say, "Oh, look, they spend all their money on this and that." But if you actually look at the data, they don't have a lot of places where they can cut. They're spending everything just on necessities. They are not splurging all that much. They just don't have income. I haven't seen a data set that shows otherwise. And it's great to be like, "Oh, look, I'm doing well because I made the right decisions and this and that." It's like, "Well, you also had a decent income and maybe your decisions led to that income, which is great, but it's not just like spending decisions that are the problem." And so I don't want to demonize the spending issue. I'm not saying that there aren't people that have spending problems in level one. There definitely are, but I think for the most part, if you look at it, it's an income issue, not a spending issue. So that's the thing I would say is like find ways to get those marketable skills so that you can start saving money to get out of level one. And once again, 10,000, that's your net worth. So you could have a car that's worth a few thousand. You could have a couple thousand dollars in a checking account. You could maybe start a stock portfolio. Whatever it is, there's going to be some combination that's going to help you get there.

Yes, I summarize that as it's very rare to have low income and high wealth or high wealth and low income. This is by wealth level. I'm just going to read the median household income in each wealth level. Right? So level one, which is less than $10,000 in wealth, the median income there is $32,000. Level two, which is 10K to 100K in wealth, the median income is $47,000. Level three, the median income is $83,000. Level four, the median income is $197,000. Level five, that's for people with 10 million to $100 million in wealth, the median household income is $724,000. And in level six, the median household income is $4.3 million. So you see it just launches up. Now, of course, these feed on each other. If you have a hundred million and you're earning, let's say, 4% a year, that's just on that, just your investment portfolio is generating you $4 million a year. So this whole like, okay, level six, 100 million plus, looking at the number 4.3 million, like that shows that the investment income is probably the or business income is a large portion of that. So it's something to keep in mind when you're thinking about these things is these things are a flywheel and they affect each other. And as you get wealth, you're going to start and you're investing that wealth. Obviously, you're going to start having more income and it's just going to feed on itself. So something to keep in mind there. And yeah, once again, I don't want to go through all these numbers here because it's just a little complex thinking about saying this just through a podcast, but I have a table in here which says like, hey, if you're in the lowest income group, like how is wealth broken out across each one of these income groups? And then as you can see, like those with the lowest income tend to have the lowest wealth, right? Even the highest wealth people in the lowest income group have less wealth than the lowest wealth people in the highest income group, which is once again, it's a tongue twister.

Yeah. And the data, it's just so clear. It's the strongest relationship I've seen in personal finance. And I'm just so tired of the spending argument. I wanted to put it to bed forever. I haven't found a better data set on this. And if I do, I will change my tune. But until then, I will stick with what I have.

Yeah, I think that'll help, you know, solidify some of these.

Yeah. So I think the big thing to focus on in level two is education and skills. And that's still true in level one, but I think it's even more true in level two because if you think about the trajectory of your career path, like if you can get the skills that increase your income, like that can set you up to end up saving so much more. And I keep coming back to income. And I know like it's beating a dead horse, so to speak, but it's so true in the data. And if you actually look at the difference between households that let's say stay in level two versus those that make it out of two and go to level three, and we do this like over the course of a decade. I've looked at the same set of households, this is not different households, the same set of people over time. The ones that make it to level three either a had a higher starting income and they also generally spent less relative to their income. They might have spent more money than those that stayed in level two, but as a percentage of their income, they spent less. And so the main thing to take away there is like those that are earning more are making it up higher up the wealth ladder, right? And so I've looked at all this data and that's just like the overwhelming overarching point there. It's the thing to focus on. And why I say education because it doesn't have to necessarily be a college degree. It could be a trade school. It could be coding boot camps. I know now people are like, "Oh, coding is all solved by AI." And I don't believe that as much. I think there's a lot of things that coding can do. I think having those skills is still very valuable. Even if right now, yes, it looks like, oh, we're never going to need software engineers again. I'm a little bit of a programmer. If you've actually tried to code something up just from scratch, these things are pretty dang good. I'm very impressed by them. But they have not completely solved it. And if you think they have, like you haven't actually done it yourself. So I still think these skills are valuable and it's like figuring out what are those skills that are going to be useful in the future and working on those and then finding a way to increase your income. That's the end goal for all of these things because that's what builds wealth and there's just no way around that.

Yes, that's completely true and I think that it's actually overlooked. I think negotiation is one of the best skills you can have because like people will spend hours looking through coupons trying to find deals and this and that. They won't spend that same amount of time on a negotiation which could have a much bigger impact. Right? You getting a multi-thousand raise or even a few dollars per hour if you're paid hourly. Like those little things add up in much bigger ways than trying to find a deal on Facebook Marketplace or something, right? And so I think it's one of those things where a lot of people don't prepare and I think you need to rehearse and go through it and what if they say this? What should I do? Think through that, rehearse it with someone you know and trust and I think you'll actually see that it's quite a good exercise to go through and just thinking about how that would play out.

Yes, it is.

Yeah. So in terms of the wealth ladder, the rule I came up with, unlike the 0.1% rule, I call this the 1% rule. So instead of taking 0.1% of your wealth, you just take whatever your wealth is and take 1% of it. And that amount is the minimum amount you should consider doing something for, right? So let's go through an example. If your net worth is $100,000, you should only look at income opportunities that will eventually kind of get you $1,000 total. Of course, it's divided by the amount of time you put in as well. But I think it's a very simple heuristic. If someone's like, "Hey, would you do this thing for me? It's going to take a few hours and you're going to get paid 50 bucks." It's like, if you're worth 100k, that's probably not worth your time. If you're worth a million, it's probably not worth your time. If you're in level one and your net worth's less than 10,000, you probably should take those opportunities, right? And so it's just a very simple heuristic, but it's just like, hey, like let me think about this opportunity and is this going to add at least 1% to my net worth? If not, then maybe I should pass on it. And I think as your wealth grows over time, you find yourself thinking like, yeah, should I keep doing this? I'm not sure. And I think a lot of people don't necessarily do that and they just keep doing the same thing over and over like, hey, this worked. But at some point, like you're not going to get the same return, right? At some point like the thing that used to add a lot of value to you, I mean literal value like to your net worth, is not going to. So unless that thing is growing over time, it's just something else to consider when you're thinking about that.

I still think hourly rate is very useful. It's the first starting heuristic. But if you're thinking about this, you're like, "Hey, 1% of my net worth at $60,000 is 600 bucks, right?" Does that mean you need to make $600 an hour? No. But if there's a project that someone's willing to hire you for, the question is over the life of this project, is this going to make me $600 at least? Right? And otherwise, you probably shouldn't even spend the time because remember, a lot of projects you have to go talk to the person, set things up. It's not just like, oh, I just spend the time to do the project. There's other hidden costs and hidden time costs that you're not thinking about. So let's say my net worth's a million dollars. If someone's gonna come and bring an income opportunity to me and if it's not worth at least, you know, $10,000, I'm gonna say like, uh, I don't know if I want to do that. Right? Of course, it depends the time, too, right? But I think thinking about those types of things is kind of what matters when we're determining what type of opportunities we pursue or we don't pursue, right? Like I think writing a book is a larger income opportunity than that $10,000 opportunity, right? In the case of like, you know, a million dollar using that as our benchmark, right? So I would be like, "Okay, yeah, I'd be willing to write a book, but maybe I wouldn't be willing to do something else that wouldn't pay that."