The Difference Between Money and Wealth
The Difference Between Money and Wealth
Money and wealth are not synonymous. In fact, they are almost (but not quite) opposites. Money is nothing more than a tool that can be used to obtain assets in order to build wealth. Money, in and of itself, is not wealth nor is it even truly an asset. Money (particularly fiat currencies like the U.S. Dollar) actually loses value as time goes on due to inflation and the fact that our money is no longer backed by anything tangible such as gold or silver. This loss of value is exacerbated by the fact that the federal government can simply print dollars out of thin air, increasing the money supply and diluting the value of the dollars already in circulation. This also increases our debt load as a nation. Fiat currencies such as the U.S. Dollar are backed by nothing more than a promise from the federal government. The only advantage the U.S. Dollar has over other currencies is the fact that the U.S. dollar is currently the world's reserve currency, so the US dollar is in demand both domestically and by other nations globally due to its reserve status.
We have enjoyed great benefit to our overall standard of living by virtue of the fact that the US dollar is the world's reserve currency. However; by looking at the chart below, we can see that world reserve currency status has historically had a limited shelf life. The US dollar has been the world's reserve currency largely since the 1920s but more officially since the end of World War II
One of the biggest mistakes we make is to assume that money is the same as wealth. This isn’t to say that cash shouldn’t be a part of every portfolio, or that you shouldn’t keep some cash on hand to meet short-term financial obligations or to finance your emergency fund. You should absolutely keep some cash on-hand in an emergency fund equivalent to at least 6 months of living expenses to serve as a buffer against unexpected adverse events such as the loss of income or an unplanned expense.
Money is a medium of exchange that allows us to obtain the things we want or need. It also provides us with liquidity. Obviously, assets such as stocks and real-estate are not as liquid as cash, so we wouldn’t be able to quickly convert these investments into cash to fund immediate needs and obligations such as food, mortgage payments, utility bills and the like. You should always have access to enough cash to meet these near-term, recurring obligations, but keeping all of your assets tied up in cash is not a very sound long-term financial strategy given the depreciating nature of the value of the dollar due to inflation.
The notion that cash is not the same as wealth or that money is not wealth may seem counter-intuitive to many people who equate having a lot of paper money with being wealthy. This is an easy mistake to make if one doesn’t understand the relationship between paper money and wealth. The difference is even more pronounced with a fiat currency such as the U.S. Dollar since the actual value of the dollar is not linked to anything of tangible worth. The federal government’s ‘promise’ is not something of measurable or standardized value. There is essentially no chance that your cash will increase in value with time. This is why wealthy individuals like Warren Buffett and Bill Gates don’t have all of their wealth tied up in cash. You would be hard-pressed to find anyone among the wealthiest people in the world who keeps all or even a significant portion of their wealth in cash because cash itself is not a true wealth-building asset.
For example: $1 million dollars in 1950 had a tremendous amount of buying power. It still has a lot of buying power today, but nowhere near what it was in 1950. If someone with $1million dollars had chosen to keep the entire sum in cash for the last 60+ years instead of investing that cash in some wealth building asset like stocks, real estate, or even in an interest bearing account, the relative buying power of that $1 million dollars would have been greatly eroded over that time period by inflation. In essence, the money would have actually lost value over time.
Relative value of Currencies
Just for clarity: currencies, when measured against other currencies do fluctuate in value, and the currency you hold, could theoretically rise in value when measured against another currency. This is the basic premise of Foreign Exchange, Forex or FX trading. So, for individuals who trade Forex, there may be an advantage to holding US Dollars, or Euros, or Japanese Yen in the context of holding one currency against another currency. For example: If you bought the US Dollar and sold the Japanese Yen when the USD/JPY exchange rate was 93 (1 USD, per 93 JPY) and then sold the US Dollar, simultaneously buying back the Japanese Yen when the exchange rate moved to 102 (1 USD per 102 JPY), you were able to receive more Japanese Yen (102) per each US Dollar than when you initiated the transaction (buying USD selling JPY at 93). The US Dollars you held increased in value from 93 Japanese Yen per US Dollar to 102 Japanese Yen per US Dollar. Of course, there are conversion fees and other costs to factor in, but I kept is simple for the purposes of this example. The average person is likely not sitting in front of a bank of monitors all day trading Forex as part of their personal wealth building plan (although some are doing just that), so I wanted to draw a clear distinction when I say that cash / paper money does not increase in real value over time so it is not truly an asset.
The key take-away here is to look at money as another tool in your financial arsenal. When used strategically, it is merely a component to assist in building true, sustainable wealth.