What is Wealth?
What is the definition of wealth? What does it mean to be wealthy? This is somewhat subjective as different people may define wealth or wealthy in different ways. What isn’t subjective, however, is the fact that having a large sum of money (i.e. cash or currency) is not the same as being wealthy. Money is not synonymous with wealth, although it does go a long way in setting one on the road to becoming wealthy or accumulating wealth if used strategically. Similarly; having a high income is not necessarily synonymous with being wealthy, but it certainly does put you in a more advantageous position to accumulate wealth if managed properly.
A good example of the difference between income and wealth is one that was shared with me by a finance professor who was also a financial planner. He described two hypothetical “clients”. One was an individual in his 30’s who made a tidy 6-figure income, rented a posh townhouse in an exclusive part of town, leased a fancy new sports car every 2 years, ate at the finest restaurants, and spent thousands per month on bar bills. He had no savings or investments to speak of, and he carried thousands in credit card debt on which he made the minimum monthly payment.
The second client was a married couple in their late 50’s who were approaching retirement from their middle-class jobs where they never made as much combined in any given year as the first client made. They had 2 modest houses – one in which they lived and the other a rental property – that were paid off. They drove the same, well-maintained cars for an average of 8 years. They each had an employer sponsored 401K as well as an IRA which contained a diverse mix of stocks, mutual funds, and fixed income instruments totaling approximately $1million. They also had an emergency cash fund with 6 months of living expenses and no credit card debt.
Now these are obviously anecdotal examples, but they exemplify the stark difference between wealth and income. On the surface, it would seem that the first client – with all of the accoutrements of what most people associate with material wealth – would be the one that most would consider ‘wealthy’. In reality, however, it is the married couple who have actually accumulated more wealth despite never having made the six-figure income in any given year as the first client does. The couple made much wiser decisions with their money in order to create a log-term, sustainable financial safety net that will allow them to eventually retire without having to depend on the paychecks they receive from their day jobs. They utilized the income that they earned from their regular employment to establish something of lasting value for themselves and their families. The income itself did not represent true wealth. The income was simply a tool with which they were able to attain the wealth to sustain them beyond their working years.
In stark contrast; the first client is entirely dependent upon the income generated by his current occupation. If that goes away, he has nothing else to sustain him until he finds another job. The townhouse (which is rented) and the car (which is leased) are not assets for him. They are liabilities. He has no equity or stake of ownership in either of them. He has no savings, no investments, and high credit card debt. Despite outward appearances of “living the good life” he is, in fact, living on the razor’s edge of potential financial ruin. He is living paycheck to paycheck. Those paychecks may be relatively large, but his expenditures far exceed his income. Instead of using his high income as a medium through which to accumulate wealth, he chooses to finance a lifestyle that is actually beyond his means. The cliché: It’s not what you make, it’s what you save (invest) has more than a kernel of truth to it. There is no guarantee that the income you generate now is what you will continue to generate over your working lifetime. It could be higher, or lower. In some cases, it could be much lower. As I write this, there are several thousand people among the unemployed who were making well into six-figures before our economy hit the skids in 2008. Many of those people are still either unemployed or working in jobs that pay considerably less than what they were making in their previous occupations. Those who failed to prepare for this possibility are struggling mightily.
Live below your means
One of the keys to attaining and accumulating wealth is to live below your means. This is exactly what the couple in this example did throughout their working lives. They lived within their means, which means they were able to meet all of their regular financial obligations such as paying the mortgage, utilities, insurance, etc. in addition to being able to put aside money to invest for their retirement. Their investments included real estate, stocks, mutual funds, and bonds. They also kept an emergency fund of cash on hand. Having this liquidity enabled them to meet their regular, short term obligations in the event that they found themselves unemployed, or out of work temporarily due to a temporary disability such as illness or injury. Having the cash readily available to supplement whatever unemployment insurance or disability insurance benefits they would receive allowed them some financial ‘breathing room’ in the event any of these situations came to pass.
The definition of wealth may be a subjective notion on some level, but we shouldn't make the mistake of assuming that a high income (also subjective) and a lot of expensive "toys" are synonymous with being wealthy.
Just for some added perspective: "The healthy man is a wealthy man, but doesn't realize it" – Italian Proverb
More by this Author
When analyzing investment returns it is important to differentiate between the simple arithmetic return and the geometric return (a.k.a the Compound Average Growth Rate or CAGR). The geometric return is the more...
The terms Money and Wealth tend to be used interchangeably, but they are not synonymous terms. Money is merely a tool used to help create true wealth.
No comments yet.