Income vs Wealth
Posted on May 26, 2006
What’s the difference between “income” and “wealth”? I recently spent a couple of hours milling around an airport terminal with nothing to do, so I decided to ask that question of several people who were also killing time waiting on flights. Their answers surprised me. Although they stated it a little differently, most of their comments centered on the idea that the more income one had the wealthier they were.
I found this interesting, because I’ve always thought of wealth and income very differently. When I got back to my office I decided to do a little research. I found the Survey of Consumer Finances sponsored by the Federal Reserve Board and it revealed some very interesting facts. The survey showed that the wealthiest 1 percent of households own over 33 percent of the nation’s wealth and the bottom 40 percent own less than 1 percent of it. The survey painted a very different picture regarding income. It showed the bottom 60 percent of households controlling only slightly more than 4 percent of the nation’s wealth, but they had nearly 27 percent of all income.
Granted, some income is earned and some is unearned or passive, but typically working people think of their salary as their income. Most who want to improve their standard of living, strive to improve their skills so they can earn more. They seldom devote time and energy to learning how to build wealth. The problem with this thinking is that earned income is derived from trading time for money. Sure, some people are able to get more for their time than others. A doctor gets much more per hour than an auto mechanic, but both are still trading time for money.
Standard of living is increased by what one spends, but wealth is created by what one invests. That’s why without investments, there are people living a high standard of living who may be only a couple of paychecks away from financial disaster.
Let’s look at it another way. The difference between income and wealth has more to do with how you manage your earnings than with how much you earn. Many high income earners spend everything they make and often more than they make living the highest standard of living possible. They don’t think about the future and as a result, they never build wealth and often struggle in retirement. On the other hand, there a few people who live a standard of living that allows them to save and invest and they often build great wealth and have wonderful retirements. This is evidenced by the wide disparity between the distribution of wealth and income as shown in the survey I mentioned earlier.
It’s a cold hard fact that getting from birth to death has a cost. What you spend today pays for today. What you invest today pays for days in the future. Here’s a tip! If you adjust your standard of living today to enable you to invest you will be able to live better in the future and avoid the economic shock that many people experience when they retire. With growing doubts about Social Security and companies freezing or suspending retirement plans, younger workers are being forced to make plans to better care for themselves in retirement.
I believe that in the long term, real estate investing is the best way to provide for retirement, but if you’re not comfortable with real estate, at least start investing in something. A week’s pay invested at age 20 and left alone to grow and compound could pay for several months in retirement. The reason I like real estate is because it’s secure, it has shown remarkable growth over the years, but most importantly it’s harder to get your hands on money invested in real estate when you’re hit with those urges to make impulsive purchases.
The most important thing to remember about this tip is that the sooner you get started investing and the more you are able to invest, the better life you will have in the future. Without investments, you can’t sustain a standard of living any higher than your earnings will support. When age or illness reduces your ability to earn, your standard of living will have to decline. Not a very pleasant thought, is it?
Some people have the attitude that there’s no guarantee of tomorrow so they’re going to enjoy all they can today. The problem with this thinking is that they become like a farmer who eats his seed corn. They become dependent on others for survival and they’re usually the first ones to complain when life gets tough. We’re supposed to be the smartest creatures on earth, but even squirrels stash away nuts for the winter. Savings and investments are our nuts and the more of them we stash away the better life we’ll have.
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