Lewis Schiff, author of the Middle Class Millionaire, a book I reviewed last week graciously answered questions from readers of the review.  So today I am posting the questions asked and answered.

How is the credit crunch affecting MCM and the middle class?

All the recent financial market difficulties have created strains at every level of wealth in America and globally. I work with very wealth clients (net worths in excess of $25 million) and they, too, are revising plans.

However, our research is very, very clear–even the research we’ve done in 2008 confirms this: the split between the struggling middle-class and the thriving middle-class (we call them “Middle-Class Millionaires”) continues. The very habits that allowed the MCMs to pull ahead during the “good” years are also helping them during the bad years. They report a greater tolerance to economic hardship in terms of their working habits and their financial strength.

With regards to their working habits, the four qualities we defined as “Millionaire’s Intelligence” are becoming more important these days. We see the competitive and driven nature of Middle-Class Millionaires emerging clearly in the form of mergers and acquisition (small business activity is way up) and aggressive investment for new opportunities. By contrast, most of the middle-class will tell you they are just keeping their head down and waiting for all of this to blow over.

When it comes to their financial strength, they have more ways to finance their lifestyle beyond just home equity so, even as they experience the same credit crunch we are all facing, they have managed to provide themselves with more options than others. For example, they may have stock market margin accounts, life insurance policies and business lines of credit to borrow against that others might not.

One of the press’ favorite stories these days is to report how bad wealthy people have it. It’s just not true. I get calls all the time from reporters asking me if I know of any MCMs getting kicked out of their mansions. First of all, they don’t live in mansions. We document pretty extensively in the book, The Middle-Class Millionaire, where they live and how they live. Second, sure, there are some MCMs who’ve gotten themselves into a financial hole they can’t dig out of. But they are not, by any stretch of the imagination, caught up in the subprime mortgage mess, except, perhaps, as investors in residential real estate.

As for the middle-class, well, their role in the current credit crunch is less clear. People who would describe themselves as middle-class, and fall generally into the income category of the middle-class, have definitely gotten caught up in the credit crunch and the mortgage debacles of 2007-08.  We are at a critical juncture in the history of the middle-class. The real incomes of the middle-class are shrinking relative to the top 10% of American households. Our demographic picture used to look like a bubble with a big lump in the middle (the middle-class) and a small population of low income and wealthy people at either end. These days its beginning to look like a barbell as the lower income folks grow along with the higher income folks, all at the expense of the middle-class.

One of the messages we tried to address in the book, The Middle-Class Millionaire, through our original research, is what it really takes to be in the top 10% these days. It’s not easy–it takes hard work, perseverance and commitment to success. People get upset when I say this, but not everyone was cut out to create wealth. The sooner individuals realize that they shouldn’t try to keep up with the Joneses–when the Jones family is ready to outwork and outspend you, the better.

Not very long. One of the things that makes the MCMs different from “Baby Boomers” is that they are reaching levels of significant wealth much sooner these days. You start to see MCMs emerge in their early 30s. Part of that has been helped by the growing economy but a good deal of it is just the result of their driven nature. When you view these individuals as a group, it becomes clear that the habits one needs to succeed can reveal themselves very early on in one’s development.

I’ll sound a bit like Yoda when I say this but: in a sense no failure is acceptable to MCMs and at the same time, all failure is acceptable.

What I mean is: when MCMs fail, they feel just as bad as when the rest of us fail. However, they have a very different response after the failure than most middle-class people. When MCMs fail, they tend to interpret it as having learned yet another way **not** to do things.  So they try again, this time with more knowledge and experience than when they tried before. Middle-class people–according to our original research–suggests that when they fail, they don’t try again. They interpret failure as a sign that they were foolish to have tried to change their situation. MCMs interpret failure as a learning process and use it to refine their ways.

For sure. We have a story about one MCM who failed so often that he was living in an unfurnished apartment with just a sleeping bag. His banker encouraged him to give up and even offered to put in a good word for him at the bank where he could get a regular 9 to 5 job. Today, that individual runs an extremely successful business and is a millionaire many times over.

One of the individuals we surveyed had experienced 6 significant failures before becoming extraordinarily successful. To become successful in this country requires you to court failure, to flirt with it and, often, to screw things up.

In so many ways, the advice we’ve gotten our whole lives, to avoid failure, to chart a steady path from higher education to entry level job and up through promotions, are contrary to the ways people create significant wealth in this country.

Income is a misleading way of looking at “becoming a millionaire.” One of the things you have to do to succeed is to learn how money works. The kinds of people we wrote about in The Middle-Class Millionaire are either business owners or successful executives. They use money in a lot of ways that go far beyond just receiving paychecks and investing money left over at the end of the month. They make use of incentivized compensation, like stock options or company ownership. They take risks by investing in businesses and real estate. They convince other people to invest alongside them so they can spread their risk around and gain access to valuable experience and the contacts of other investors.

When it comes to income and spending, they are very flexible about that as well. A successful MCM may make $100,000 a year income but may also receive company benefits equal to that or greater. They may have businesses that allow them to use tax deductions in ways that a typical employee don’t.

I did write another book about how to save your way to being a millionaire. It was called The Armchair Millionaire. But make no mistake about it, the Middle-Class Millionaire is using tools that are far more ambitious than the savings program I outlined in The Armchair Millionaire. And there’s a clear distinction between the two messages

The Armchair Millionaire describes a way to make your money grow faster than inflation, fees and taxes deteriorate its value. I view The Armchair Millionaire program as a way to keep your bank account fully gassed up so you can go the long distance.

The Middle-Class Millionaire describes those who are pulling ahead of everyone else. They are learning how to leverage their abilities to create significant wealth. They’re taking a stock car and turning it into a hot rod.  Sorry for the car metaphors, it’s a bad habit.

MCMs are very diversified. Most have a combination of assets. Their homes and other real estate, their business interests, their investments and their collections. With regards to their investments–and if you’re talking about stock market investments (as opposed to private equity investments which are generally long term investments) they should follow the same rules as all investors. As the investing horizon becomes less than 5 years away, they should move the money from volatile investments, like equities, and into fixed income investments, like bonds. By the time they are in retirement, they should have moved at least 80% of their investments into equities.

That being said, MCMs are not the type to retire. They are not looking to get to 65 and then punch out. For the most part, MCMs actually like working and want to keep working for as long as they can. They may slow down or become consultants but they are not looking to spend their 70s and 80s sitting on a rocking chair.

There are two answers to that question and they are interrelated. First, America’s middle-class has become consumed by keeping up with the Joneses. The problem, as I mentioned earlier, is that there’s always a family or families within every community (these are the Joneses) who are willing to outspend and often outwork everyone else. So, most regular middle-class families will never manage to keep up.

Secondly, the MCMs are a large population in their own right and they have allowed many businesses to create financing models that ultimately found their way down to every corner of the middle-class and beyond.

For example, leasing a car used to be the province of the well-off. But, as the financial systems learned how to lease cars effectively, they rolled these leasing programs all the way down to the regular middle-class. Too many middle-class people, in an attempt to keep up with the Joneses, leased cars they shouldn’t have. Even the leasing companies know this and they’ve really stopped many leasing programs for regular folks. So the easy consumer credit systems, when combined with people’s willingness to over extend, created a consumer debt problem in America.

It will take more than just legislation, more than just innovation, to solve America’s addiction to debt. Americans must re-think the consumer culture and how they behave within it. This is true of both Middle-Class Millionaires and the middle-class. Just because the MCMs can afford all these toys more easily than the middle-class doesn’t mean they should buy them.

This goes with my earlier point–that not everyone was cut out to create wealth. Many people–in my opinion–should consider leading more modest lives that coincides with their more modest incomes and wealth.

Two great questions. Leaving an inheritance for their children is very important to MCMs as it is to the middle-class. However, they have two other concerns that compete with this one. First, they want their kids to have a good work ethic–which MCMs tend to have themselves. Thus, they fear leaving too much money to their kids will destroy their will to work for their own fortunes. Second, they want their kids to have great experiences while the parents are alive. Increasingly, you see that MCMs and their kids are going on outrageous vacations together where they learn and do unique things. Unique experiences are the ultimate luxury and MCMs enjoy the notion of passing on great experiences as well as money. They struggle to balance all of that and at the same time, making sure they don’t outlive their wealth. Many MCMs I know plan on living active lives past 100 years old! So they need to make sure the money’s there to support that.

This wraps up our question and answer section with Lewis Schiff. I hope you enjoyed this bonus questions as much as I did.