Having a high income does not guarantee wealth

The recent debates over tax policy and the “fiscal cliff” have raised a pet peeve of mine.  My peeve is when people, use the word “wealthy” interchangeably with “high income”.  I do agree that there is a correlation between the two, but there are people with high incomes, with much lower wealth than people with significantly lower incomes.

I will draw a couple of examples based on a composite of my clients.

High Income/Lower Wealth

John and Mary Smith both age 42, work at high paying jobs and have a combined income of $400,000.  They have two children, ages 6 and 2.  They have high housing expenses, child care expenses, retirement savings, and college savings.  They also spend money on home improvements, eating out and vacations.  They have a net worth of $200,000 equal to a half a year of their income.

Lower Income/Higher Wealth

Doris and Boris Johnson, retired, are 67 and 65.  They both collect pensions and Social Security which total $90,000 which provide enough income for them to live the lifestyle they wish.  They spend time on volunteering, visiting friends and family, and some travel.  They have lower housing costs than the Smiths, even though they have a second home, and do not have to worry about saving for retirement or college for their children.  They have not spent any of their retirement nest egg of $1.8million, and plan to help their grandchildren with college expenses with some of it. Their total net worth is $2.3million or 25.5 times their annual income.

Factors that I have seen that are associated with a higher net worth besides income include.

  1. Age, the older you are the more time your investments have had a chance to grow.  In early retirement expenses may also be lower if you are in good health then they were if you were saving for retirement of college educations for children.
  2. A strong ability to delay gratification.  People who find it easy to delay gratification tend to spend a lot less.  They spend less both on shorter-term expenses (vacations, eating out, ‘stuff’), and longer-term expenses (housing, cars).  This is also manifested in a “pay yourself first” attitude when it comes to their income.
  3. Think about their future often and though generally optimistic, know that financial reversals do occur and want to prepare for them.