In personal finance Income and Wealth are two very different things that are weakly correlated with each other. Having a high income does not mean that you are wealthy, and having a low income doesn’t mean you are penniless.
In personal finance, wealth is your net worth. That is the value of all our assets minus your liabilities. Assets being things you own, such as your house and shares in index funds. Your liabilities are things such as personal loans and mortgages.
Now is being wealthy the same as being rich? You might think they are the same but there is a tiny difference between the two. The rich have lots of money, and the wealthy don’t worry about money.
While the rich might have lots of money, they tend to also have lots of expenses that keep them up at night or they might have a high-income job, but they have to get up every day to go to work. And they have to worry about the possibility of losing their job or getting injured and not being able to work for the long term.
Wealth Represents What You Own
The wealthy people, on the other hand, don’t have these worries. Why? What’s the difference?
First, let’s look at the definition of wealth. It can be defined in a number of ways but I like this one. Think of Wealth as the number of days that you can survive without having to physically go to work and still maintain your standard of living.
If your monthly cost of living is let’s say, $5,000 and you have $20,000 in savings, your wealth is about four months. Using this measure your wealth is actually measured in time, not dollars.
Now, if you build up your wealth over time eventually, your wealth will be measured in years, then decades, and then lifetimes. Think of the truly wealthy family’s. The Rothschilds and the Siemens family. They both made
Income is What You Earn
Income is what you earn. It’s the flow of money into your life from a salary or wages. Having a high income does not mean you will become wealthy. High-income earners usually have high standards of living which makes them spend more. While there are many who get by on less income. It all depends on how people manage their money and spending.
People on modest incomes can often get buy perfectly fine and even get ahead by putting money away for retirement. They are building wealth. Meanwhile, people earning high incomes can easily go broke and can struggle to get by financially
Just think about the athletes, actors, and musicians who earned millions in the past can often become bankruptcy. Take a look at some of the recent article headlines in the media recently.
I know the cost of living is increasing, and the price of housing has gone through the roof, but I still believe that you can get ahead on an income of $100,000 and build wealth. You just need to live within your means.
I know that $100,000 might seem like a high average income, especially if you are earning less than this. The average household income for 2019 over the entire country was $105,719.
Let’s look at an example;
John is
John got married and had a family. His family lives a normal life in an average house. He and his wife managed to pay off the mortgage a few years ago. Their children all attended public schools, and when they grew up, they all got used cars and paid cash. They may not live an extravagant life, but the family is more than comfortable – and they are now debt free.
John has been investing 20% of his income over his entire work life and now after 30 years, has built up an investment portfolio worth around $1.5 million.
With an annual budget of $45,000, John’s family could easily sustain their current lifestyle for more than 30 years using the 4% rule, without John or his wife ever needing to work again.
Now if you don’t believe this example, I will show you some calculations from statistical data in an upcoming post- so subscribe to get notified when that post comes out.
The Myth of the High Salary
A high salary can help an individual or family appear wealthy, but it takes commitment and sacrifice – regardless of what income they earn– to gain real wealth. In truth creating wealth doesn’t require a large income; it just requires a conservative, long-term approach.
Although, a higher income does make it easier.
Some people think that a pay rise is the only way that they can fix all their financial problems. Bad news– it won’t fix anything. As long as you don’t have your spending under control, a pay rise will just inflate your lifestyle.
Now, I am all for you asking for a raise. But that is not an excuse for doing nothing else. Throwing your hands up and claiming there is nothing more you can do to improve your financial situation because you didn’t get a pay rise is not helpful for anyone.
See, there is a major difference between income and wealth. And everyone can start improving their wealth right now!
Earning More vs Being Wealthy
When you are in financial trouble, earning more is not always the solution. That is because it is easy to spend money than it is to earn. You might earn more, but chances are you will just end up spending it.
Getting a pay rise generally leads to more spending. This is what people in the financial world call lifestyle creep. You need to first create good financial habits and make some financial goals.
Once these goals and habits are in place, you will find that a pay increase will generate more wealth for you, and not just allow you to spend more. Earning more doesn’t necessarily mean you can afford more.
Understand Compound Interest
Compound interest is the key to growing wealth. But studies have always shown that not many people actually understand it. Sure, people might understand the
Compound interest is not well understood because it works on a longer time scale than most of what we interact within the world. Social media works on days. Your life generally revolves around a working week. Compound interest works on years and decades.
Compound interest is the interest that you as an investor earn on the original investment. Plus, all the interest earned on that interest that has accumulated over time.
Interest on Interest
Let’s look at where it gets its name. It’s called compound interest because it’s the
Simple interest: $10,000 + $500 +$500 +$500
You would earn $500 for each year invested, totalling to $11,500 at the end of
- Year 1: $10,000 + $500
- Year 2: $10,500 + $525
- Year 3: $11,025 + $551.25
In
Now, debt also uses compound interest, except now the interest is working against you. That is why you need to get rid of any bad debt asap.
Summary
To summaries,
- Wealth is your net worth. The total value of all your assets minus your debts.
- Income is the amount of money you earn through work or investments
- Wealth takes a long time to acquire while income is earned immediately
- Income generates wealth, once you have wealth you can enjoy the fruits of your labour
- Wealth includes cash, properties, cars, and investments
- You can only become wealthy by saving some of your income. If you don’t save money, you will never be wealthy and end up relying on your income.
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This is a nice summary. Thanks, Rohan