The Wealth Ladder

Chapter 1

Spending up
the Wealth Ladder

When Cleopatra was the queen of Egypt, she was the richest woman in the world. To entertain her guests, she often threw lavish parties. Following a series of such feasts, Mark Antony, the Roman general, remarked that she hosted the most extravagant banquets in the world. Wanting to impress Antony even further, Cleopatra claimed that she could spend 10 million sesterces (about $20 million today) on a single meal. Thinking that such a feat was impossible, Antony made a bet with the boastful Cleopatra. The Egyptian queen accepted and claimed that she would prove him wrong the next day.

To keep her promise, the following day Cleopatra had her servants set up a banquet similar to the ones she and Antony had enjoyed in the previous days. But this time Cleopatra wore one of her most prized possessions-a pair of pearl earrings. These weren't just any pearl earrings though. They were considered the largest pearls the ancient world had ever seen.

When Antony arrived at the banquet, he joked that there was no way that it had cost 10 million sesterces. Cleopatra replied that he was correct, and that she would consume the 10 million sesterces herself. To fulfill her promise, Cleopatra had her servants bring out a glass of vinegar strong enough to dissolve pearls. With Antony watching, she removed one of the prized pearls from her earrings, dropped it in the glass, and watched it dissolve before drinking it. As Cleopatra began to remove the pearl from her other earring, Antony conceded that he had lost the bet.

The story of Cleopatra and her pearl earrings highlights the lengths people will go to to flaunt their wealth. But it also illustrates how spending money is relative. There are people like Cleopatra, who can consume vast resources without impacting their wealth. Then there are others who must track every dollar they spend in order to stay afloat. It reminds me of the time Jay-Z said, "What's fifty grand to a mother****er like me? Can you please remind me?" When Jay wrote those lyrics in 2011, he had an estimated net worth of $450 million. This means that, at the time, "fifty grand" represented about 0.01 percent (or 1/10,000) of Jay-Z's fortune.

This data point might seem random, but 0.01 percent of your net worth is actually a great proxy for what constitutes a trivial amount of money for you. For example, if you have a net worth of $10,000, paying $1 more (or 0.01 percent more) for something shouldn't have any long-term impact on your finances. Similarly, if you have a net worth of $100,000, you should be able to pay $10 more for an item without skipping a beat. I call this the 0.01% Rule ("the Point Zero One Percent Rule").

Using the 0.01% Rule as a guide, we can demonstrate how the Wealth Ladder relates to spending money. To do this, I've listed the six levels of the Wealth Ladder below and how they relate to different spending categories:

Level 1. Paycheck-to-paycheck (<$10k): You are conscious of every dollar you spend. This includes people with crippling debt.

Level 2. Grocery freedom ($10k-$100k): You can buy what you want at the grocery store without worrying about your finances.

Level 3. Restaurant freedom ($100k-$1M): You can eat what you want at restaurants.

Level 4. Travel freedom ($1M-$10M): You travel when and where you want.

Level 5. House freedom ($10M-$100M): You can afford your dream home with little impact on your overall finances.

Level 6. Impact freedom ($100M+): You can use money to have a profound impact on the lives of others (e.g., buy businesses, engage in large-scale philanthropy, etc.).

What's interesting about the intersection of the Wealth Ladder with spending is that you quickly realize that certain sums of money won't improve your life in any noticeable way. For example, for the typical person in Level 3 ($100k-$1M), an extra $10,000 won't move them to Level 4. This isn't enough to free someone from considering the cost of lodging and transportation (i.e., travel freedom) for the rest of their life. However, that same $10,000 given to someone in Level 1 will likely get them to Level 2, unless they are deeply in debt. The same amount of money given to people on different levels of the Wealth Ladder will have a drastically different impact on their lives.

The reason why the Wealth Ladder integrates so well with each spending category listed above is because of the 0.01% Rule. In each level, a single spending decision represents about 0.01 percent of the net worth level shown. For example, let's say you are at the grocery store deciding whether to purchase a dozen eggs for $3.99 or a dozen cage-free eggs for $4.99. If your net worth is $100, this single choice (paying $1 extra for cage-free eggs) would have a large impact on your finances, as it represents 1 percent of your total wealth. However, if you were worth over $10,000, the decision to spend $1 more on cage-free eggs would be relatively unimportant to your finances. In other words, if you're worth $10,000, an extra dollar on eggs won't change your life, but if you're worth $100, it might.

In this case, by having more than $10,000 you would have reached the initial stages of Level 2 ("Grocery freedom"). You can start to buy whatever you want at the grocery store. As you gain more wealth, you gain more grocery freedom. By the time you have $100,000 in wealth (the beginning of Level 3), you should have complete freedom to buy what you want at the grocery store.

We can continue extending this idea up the Wealth Ladder to ever more expensive spending categories. For example, imagine you are in a restaurant, where you are deciding between a burger for $20 and salmon for $30. If your net worth exceeds $100,000, then that $10 difference in price is trivial (i.e., it's less than 0.01 percent of your net worth). This means you have reached Level 3 ("Restaurant freedom"). If you continue to scale the logic of the 0.01% Rule upward, you will see that the impact of a single spending decision within each Wealth Level is as follows:

Level 1 (<$10k). Paycheck-to-paycheck: $0.01-$0.99 per decision

Level 2 ($10k-$100k). Grocery freedom: $1-$9 per decision

Level 3 ($100k-$1M). Restaurant freedom: $10-$99 per decision

Level 4 ($1M-$10M). Travel freedom: $100-$999 per decision

Level 5 ($10M-$100M). House freedom: $1,000-$9,999 per decision

Level 6 ($100M+). Impact freedom: $10,000+ per decision

You can see this in the chart on the following page, which illustrates by wealth level how much additional spending someone could have without impacting their finances.

From this perspective, you realize that many people in the same wealth level have similar consumption patterns. Even people in adjacent wealth levels consume in roughly similar ways. For example, people in Level 4 have a lifestyle very much like those in Level 3. Yes, those in Level 4 may have a nicer car or a bigger house, but they don't have a chauffeur. They may buy slightly fancier food or upgrade to business class more often, but they don't fly private. Despite their 10x difference in wealth, people in Level 4 live in a way that is familiar to people in Level 3. This is why Level 4 is considered upper middle class and Level 3 is considered middle class. Both have similar lifestyles, but one is just slightly fancier.

Of course, exceptions to this general pattern exist. Not everyone consumes based on their wealth level. You will find those in Level 6 who still fly economy class and hunt for bargains. And you will find those in Level 1 who regularly splurge on dining and travel even when they probably shouldn't.

The primary reason is that many people spend based on their income, not their wealth. This can make sense at first glance. After all, if you have more money coming in, you can have more money going out. But spending based on your income won't necessarily help you climb the Wealth Ladder. For example, if you earn $1 million a year, you can afford to buy cage-free eggs, order fine bottles of wine, and travel first class quite often. However, if you have zero dollars to your name (Level 1), then you shouldn't be doing any of those things. Until you have demonstrated that you can save money, you shouldn't be living such an extravagant lifestyle. On the other hand, if you made $1 million in a year and were able to save $200,000 of it, you've shown some financial responsibility. As a result, that $200,000 would get you to Level 3 of the Wealth Ladder ("Restaurant freedom"), which would let you splurge a little while dining out.

This is why you should spend based on your wealth, not your income. Excluding inheritances, trust funds, and lottery winnings, having wealth demonstrates financial discipline. It illustrates that you have control over your spending and that you know how to save money. Without such control, you could end up in a bad place financially. For example, if you consume based solely on your income, any disruption to that income could send your finances into a tailspin.

Unfortunately, most people don't realize this until it's too late. The truth is that income can be fickle. One day you're making good money and the next you're looking for a new job. This can happen to anyone, but it's even more common among those with higher incomes. As researchers at the National Bureau of Economic Research (NBER) discovered, "Positive shocks to high-income individuals are quite transitory, whereas negative shocks are very persistent." In other words, sharp drops in income are more likely to be permanent among higher earners. Unfortunately, these large declines are becoming more common over time as well. As one study found:

The share of households experiencing a 50 percent plunge in income over a two-year period climbed from about 7 percent in the early 1970s to more than 12 percent in the early 2000s before retreating to 10 percent in the run-up to the Great Recession.

If your lifestyle is fully financed by your income, experiencing such a steep decline in earnings can be jarring. This explains why some professional athletes end up broke even after making millions of dollars a year while playing. Their problem is that they spent money according to their income, not their wealth. Once that income dries up, their financial problems begin. Though the average annual salary across the four major U.S. sports leagues exceeded $4.5 million in 2020, some of these players will still get into financial trouble because of how they spend money.

This is why the Wealth Ladder suggests that you spend money according to your wealth level. If someone is in Level 2 ("Grocery freedom"), they shouldn't be splurging at fancy restaurants, which is reserved for Level 3. If they are in Level 3 ("Restaurant freedom"), they shouldn't be upgrading to business or first class, and so forth. Of course, they may disagree with me and insist that they need the finer things in life. But this is just an excuse. In truth, the most expensive thing some people own is their ego.

Believe me, I don't like telling people to cut their spending. The data suggests that this isn't the best way to build wealth in the long run anyway. Raising your income is far more important. We will elaborate on this in future chapters.

On the other hand, people shouldn't overdo their spending either. Spending according to your level won't guarantee that you climb the Wealth Ladder, but you are less likely to fall down it. In this way, the Wealth Ladder provides the perfect balance between allowing you to splurge and limiting excess.

The key here is to think about your spending above your necessities. Of course you will need to spend money on food, housing, and a host of other basics. You can't avoid that. But how much more can you spend beyond your needs? That's where the Wealth Ladder comes in. There's a difference between eating for sustenance and buying whatever food you want. There's a difference between flying coach and traveling in style. If we assume that your income pays for your necessities, then your wealth pays for your upgrades.

This works because of the 0.01% Rule. If we assume that your wealth is invested and growing by 0.01 percent per day above inflation, this translates into a growth rate of roughly 3.7 percent per year. This is a relatively conservative annual return, even after adjusting for inflation. Assuming that your wealth will grow by 3.7 percent annually, you could spend about 0.01 percent of your wealth each day and maintain the same net worth. For example, if you had $100,000 invested and it grew by 0.01 percent daily, that would give you ten dollars that you could spend in excess of your income each day. You could spend this money without reducing your long-term wealth. Unfortunately, if you don't have any other income, this won't be much to live on.

This is why spending according to your wealth level generally requires that you have income to live on. For example, if you saved up $20,000 and then suddenly lost your job, you would technically be in Level 2 ("Grocery freedom"). Unfortunately, you won't have all that much freedom when you go to buy groceries. If you can't find another job or income source, that $20,000 would only allow you to spend about $2 per day (or $14 per week) while staying in the same level of wealth. This is the most the 0.01% Rule can offer in this case. Unfortunately, that's nowhere near enough to live on in most developed countries like the United States. As a result, you'd have to either find another income source or spend down your wealth.

This demonstrates that while the Wealth Ladder can act as a guide to how we spend money, we must consider our income as well. Someone with $30,000 in the bank and no job needs to be more cautious about how they spend their money than someone with $10,000 in the bank earning $200,000 a year. The same thing is true for retirees who aren't working anymore. A sixty-five-year-old retiree with a $1 million nest egg can't spend money like an employed thirty-five-year-old with a $1 million investment portfolio. Though they are both at the lower end of Level 4 ("Travel freedom"), the sixty-five-year-old doesn't have that much travel freedom.

But there is an additional layer to this problem that can impact how you spend your money, and it has everything to do with what your wealth is comprised of.