Too many people don’t understand the difference between wealth vs income. To put it simply, wealth is the difference between assets and liabilities while income is money earned over a specific period of time. Too many people think that the definition of being rich is having a high income. That’s completely inaccurate.
It’s basic financial statement analysis. We have the income statement, balance sheet, and cash flow statement. This doesn’t just apply to businesses, it applies to individuals as well. Wealth is your net worth. It’s what’s leftover after you subtract your liabilities from your assets. That’s the most important number on an individual scale.
Income is how much money you bring home every day, month, or year. While it’s an important number, someone can have low income but high wealth and vice versa. I personally bring home approximately $130,000 in income per year. However, my wealth is at a much higher number than that.
Wealth is a number at a specific period of time. Income is a number that happens over a specific period of time. Too many people don’t understand what it takes to be truly rich. Many people see high powered Wall Street executives and think that they made it.
That they are so rich that they have more money than what they know what to do with.
What others don’t understand is that they may be one paycheck away from declaring bankruptcy. From losing their house, car, and even their vacation homes. From working in the corporate world, one theme I found was that people do not understand basic personal finance habits to get them to the rich category.
No matter how high their income is. It was mind boggling to find that about people.
Wealth vs Income: What is Wealth?
Wealth is the leftover amount after liabilities are subtracted from your assets. Liabilities include mortgage debt, credit card debt, any payable amounts, car debt, and the like. Assets include cash, stocks, bonds, investments, cryptocurrencies, and more. Some people have more liabilities than assets and some people have vice versa.
My net worth of approximately $430,000 is the leftover number from subtracting all of my liabilities from my assets that I own. My liabilities are substantial and includes a $30,000 personal unsecured loan that I took because the interest rate was so low. The lender was willing to lend to me at 4%. That was ludicrous to me.
With inflation at 7% at the time with a 4% interest rate, I was actually making more money by having debt rather than not having debt. Moving on though, it’s important to track what your net worth, i.e. wealth is, so that you can figure out how to optimize it. I religiously follow and track my net worth to see areas of improvement.
I currently have very minimal credit card debt (under $500) that gets paid off every month on time anyway. It’s not a big deal to my finances as compared to the rest of Americans. My assets consist of my 401k, HSAs, cash, and car balances. My car has been depreciated down very nicely over the years.
I aggressively depreciated it down to a $4,000 balance from $10,000 because I wanted my net worth to be less dependent on it over time. I do this even though my car is worth about $13,000 in the ludicrous used car market that I’ve been seeing these days. Your net worth depending on a depreciating asset is not a good thing to do.
Wealth vs Income: What is Income?
Income is the money that you earn over a specific period of time, usually over a year. For the majority of people, their 9-5 income will consist the majority of their income. However, that’s not the only source of income to include. It includes income from stock appreciation, dividends, cryptocurrencies, and more.
In 2021, I brought home approximately $200,000 in income from the 9-5 and from asset appreciation such as from stocks and dividends. In 2022, I’m looking forward to a total compensation of $300,000. It’s an aggressive goal that I’ve never hit before in my life. However, I would still like to try and strive for it.
The bread and butter portion of my income is my 9-5 and stock appreciation. Dividends are not a very large portion of my income though it has been increasing every year. I generate approximately $4,000/yr in dividends from the assets that I invest in that I keep reinvesting. I hope to grow that even further going forward.
Income doesn’t just have to be from a paycheck. It can take many various forms. Income is just money that you generate from any form possible. An important part of income is that you should try to expand the number of income sources as much as possible. You may already have a good number of income sources already.
In the wealth vs income debate, income is what helps the wealth part grow higher and higher. If you have a low income, it’s not the end of the world. However, it is very helpful in accelerating and turbocharging your path forward and upward. These days, there are so many ways that you can generate income that it is wonderful.
All you have to do is find those income sources.
Does Income Matter to Build Wealth?
Yes, income matters in building wealth. There is a positive correlation between income and wealth. However, the relationship isn’t strong, as shown by this study. This is fantastic news! It means that while a high income helps in building wealth, it’s not a necessity to build wealth.
There’s no need to make half a million dollars per year to build wealth. Otherwise, the vast majority of people wouldn’t be able to get there, myself included. I personally don’t think that I will ever make half a million dollars in income from my day job, alone. Never say never but the chances are very slim.
Although there’s no need for a high income, there is a need to save as much money as you possibly can and invest for the long run. It’s what puts the fuel to the fire that will blow you up to monumental success. There are many people who say rich people are rich because they just had a high income.
That couldn’t be further from the truth. You should use this information as motivation in order to make the right choices to build wealth. There’s no need to work 24/7/365 in order to generate that additional dollar worth of income. The job that you have is just fine in order to grow your wealth.
That means you have a considerable amount of time to enjoy your life and move forward in the world. One third of your life is spent sleeping, one third working, and the last one third on anything that you heart desires. Life isn’t all about wealth vs income, it’s about enjoying the process along the way as well.
Wealth vs Income, What is More Important?
In the earlier stages of the wealth vs income journey, income is much more important. A 100% return on $1,000 is only $1,000. That pays for maybe one month’s rent. Therefore, the income side has to pick up the slack for the wealth side of the equation. When I started out my journey, I would be ecstatic for a 1% return in the markets.
A 1% return on $10,000 is only $100. That’s not an impactful amount of money by any means of measurement. However, I kept going and never stopped. Whatever amount of money I could save from my income, I saved money. No exceptions. There was no way that I wanted to work a 9-5 for the rest of my life.
Therefore in the beginning stages of my financial independence journey, I focused on increasing my income as much as I could. I purchased as much of the S&P 500 as I could and focused on increasing income. In just two years graduating from college, I increased my income to $100,000+.
These days, I am almost at the six year mark of the journey. As a result, wealth is much more important to me now. A 1% positive return can be my entire two week paycheck. Whereas before, it wouldn’t even cover 1% of it. It’ll only be a matter of time before my wealth generates more money than my salary.
Once that happens, then I am officially financially independent. What’s even more motivating is that it’s an achievable goal in the next five years. In the beginning stages of your journey, focus on growing the income in the wealth vs income debate. Then your wealth should be the one in control thereafter.
Don’t Confuse Income Inequality With Wealth Inequality
There are way too many articles that don’t understand the difference between the two. The wealth inequality is much more severe than the income inequality. Why is that? There’s only so much stuff we can buy with our income. Our income potential is unlimited but our buying potential is limited.
There’s only so much money you can buy on stuff. Where does the rest of the money go to, then? It goes to wealth generating assets. When they say the rich get richer and the poor get poorer, the articles are talking about wealth inequality. The poor has to spend the majority of their income on necessities before moving on to assets.
Income inequality isn’t necessarily a doomed scenario because a high income earner can mismanage their money. You see stories of people making $200,000+ spending $400,000 every year and has to declare bankruptcy after years of the same lifestyle. Comparatively, someone making $50,000 can build wealth slowly but surely.
However, wealth inequality is a doomsday scenario with little chances of changing the scenario. No matter how hard you try, there’s less than 1% chance that you’ll have the same amount of wealth as Elon Musk. Not just you, but me, and for 99.99% of people. The media talks about how bad the extreme wealth inequality is.
However, no matter how mainstream these problems are, this will never get reversed. The extreme wealth inequality has been true since wealth was invented. We will never be able to change it no matter how hard we try in terms of policy changes and the like.
However, it is important to understand the differences to make informed decisions going forward.
Increase Both Wealth and Income, if Possible
The best personal finance strategy is to not separate between wealth vs income. But rather to increase both at the exact same time. Now, sometimes this isn’t even a possibility. We don’t have unlimited amounts of hours in a day to raise our income with. Therefore, at the very least, pick one to increase and stick with it.
However, you want to win on both fronts. You can win the war on both fronts by increasing your income as much as you can and saving money as much as you can. The first couple of years will be downright PAINFUL. Absolutely painful. It’s physically painful when money restricts your decisions and movements.
I’m not proud of this but I will admit that paychecks physically hurt me because I knew most of it was going towards investments. Although I am glad that it’s brought me up at the position that I’m at right now, it still pained me to go through with the process. These days, I am spending away my heart’s desires.
I spend little $10 purchases without being bothered by it whereas before, I would downright choose not to spend the money. With the coronavirus pandemic, it has built up so much pent up demand within me that I want to unleash after it is over. However, I couldn’t get to this spot without first putting in my dues.
Therefore, try to increase both at the same time in the wealth vs income debate. It’s going to take some sacrifices to get there. There’s no doubt about that. There are no rich people who haven’t gotten there organically without making some sacrifices. Your future self five years from now certainly will thank you for it.