Wealth vs Income

I am a bit shy about talking about the issue of wealth, since there is clearly an argument to be said that I am trying to explain to a chicken how to lay an egg. Also, I remember my father telling me: “Never talk about money, politics and religion; you’ll only lose friends.” But over the years, as I have attempted to help people to legally protect their assets, reduce their taxes and obtain great financial privacy, I have asked myself this question: “What is Wealth?”

In my opinion, the most obvious and destructive mistake is made when one confuses income with wealth. Although the two are related they are not synonymous.

Let us start with my definition of wealth: I believe wealth must be defined as assets which (1) generate income, and (2) that are relatively liquid, at least to the extent that they can be transferred to another party in exchange for some fair value.

Let us proceed with a simple review of what money can do. If you had one million dollars, and you invested those funds in prudent investments, you should be able to obtain an annual return of roughly $60,000.00 to $120,000.00 a year, or translated monthly, $5,000.00 to $10,000.00 a month. This is wealth (although depending upon your situation and needs, it may or may not be considered enough to make you “wealthy”). The funds produce income, and the assets which represent those funds can be transferred to others in exchange for fair value.

Now there are three things that are commonly confused with wealth:

1. A prestigious job with a high salary;

2. An expensive house; and

3. Ostentatious displays of wealth (i.e.; bling, expensive cars, clothing, consumer goods, etc.).

In the case of the high paying job, earning power is closely linked with the cost of living, so someone earning a “good living” in Houston, Texas, would most likely barely be able to survive on those same earnings in New York City. With that in mind, I think it is safe to say that someone who makes $20,000.00 a month would be considered “wealthy” almost everywhere.

And that would be a mistake almost everywhere since earnings from employment are not wealth, at least not according to my definition above. No matter how much you make from employment, since the job cannot be transferred in exchange for fair value, it cannot be considered a wealth building asset. That is not to say getting a high paying job is bad, only that it is not in and of itself something that can make you wealthy.

Another thing that is often confused as wealth is housing. People have a tendency to identify someone as wealthy because he or she lives in an expensive house in a nice neighborhood. Again, these people would be mistaken if the house was the only consideration. Buying a house may often be a safe and wise way of providing you and your family with shelter, particularly if the long-term cost of buying a house is less than the long-term cost of renting, but it is not a source of wealth. It is not wealth even if the property value of the house increases during the time in which you live in the house. This is because no matter how cost effective it may be to buy versus rent, and no matter how much the property appreciates in value, it cannot produce income for you while you are living in it. So, although it may be wise to put your money into buying a house instead of renting, and buying a house may result in the value of the asset appreciating, such an investment does not make someone wealthy per se.

Finally, the issue of ostentatious displays of wealth, often referred to as obscene consumption, clearly should not be confused with wealth, although often it is, if not on an intellectual level than on an emotional level. Who does not see someone driving a beautiful new car that costs more than the average house and shake their head thinking, “I wish I could afford that”? However, if there ever is something that is the very opposite of wealth, it is the barbaric display of wealth. In ancient times people would “invest” in gold and other movable items of wealth because of two reasons: the world was not safe enough for more permanent investments, and such displays could generate awe and admiration in others that would often translate into position and power. No doubt there are similar issues at the heart of ostentatious displays today, but I think it is fair to say the purpose of such displays have essentially disappeared, and as such they represent an anachronistic view of the world.

So, after all that, are we any closer to understanding wealth? And more importantly how to become wealthy? It is clear that earning a large salary will not in and of itself make you wealthy. It is also clear that owning a large and valuable home will not make you wealthy. And it should go without saying that ostentatious displays of wealth do not make you wealthy.

The answer is that the wealthy person possesses “wealth building assets”: assets which either generate “rents” (i.e., the money that is produced by the asset in question), or appreciate in value.

In the case of the person who makes $20,000.00 a month, if this persons converts that salary into an expensive home and ostentatious displays of wealth, then he or she will never be wealthy. Such a person may have a very nice lifestyle as long as the employment lasts, but nothing is being created that will create income or can be transferred in exchange for fair value. But this is exactly what most “wealthy” people do. A job will never make you wealthy since a job can never be considered an asset which generates income and can be transferred. If anything, it may be more akin to a form of slavery, particularly if the person becomes wholly dependent upon 100% of the earnings from the job to maintain a lifestyle. The only way a high salary can lead to wealth is if one of two things takes place: the person lives on a percentage of the earnings and invests the rest in true “wealth building assets”, or if the person is able to convert the job into a significant equity position in the employer (i.e., a partner). Anything else is just a mirage of wealth.

Often people will assert that investing most of their free money in a house is a “good investment” since the long-term costs of buying is less than renting. In most cases this is true. However, this does not mean that buying a house creates wealth. It simply means it is better than renting. Now if you take the excess income that you earn at your job, and invest it all in a house that may be more than you really need for your purposes of shelter, then you are most likely never going to be wealthy. You may have a very nice house, but you will never be able to get anything out of the house until such time as you are willing to move out of it. And then, if you are like most people, you will want to take the money from the house you are selling and put it into another house in which you will move into. A house may be a wise use of funds as compared to renting. A house may be a safe place to store your money since it may actually appreciate with time. But a house will almost never make you wealthy since it cannot generate income, and requires you to abandon it in order to get your money out of it.

In order to become wealthy you must have “wealth building assets” that either produce income from the nature of the property, or which tend to appreciate over time, and of course these assets must be liquid to the extent that you can sell them at fair value. If the above three items are often mistaken for wealth, I suppose the real way of becoming wealthy involves saving money, investing wisely (in something other than your house), and living frugally within your means. And that is it.

Wordle: Wealth vs Income