“Income” and “wealth” have incorrectly become synonymous in American culture. While the two concepts often go hand in hand, using the terms interchangeably is misleading. America’s most wealthy individuals don’t necessarily draw the highest levels of income.
For example, while professional athletes, top executives, doctors, and lawyers have reputations for high salaries, their obligations can make accumulating significant wealth very difficult. Many wealthy individuals, on the other hand, have never earned an exceptionally large paycheck.
Income vs. Wealth – Different Definitions
I like to think of income as the amount of money someone receives on a regular basis, while wealth is the length of time that person (or family) could maintain their current lifestyle without receiving compensation for performing additional work.
Why is there such a difference between income and wealth? Earning a steep salary in a high profile job or career usually comes with financial commitments – to get the job in the first place and to maintain a higher standard of living. Some of the major factors are:
- Paying back student loans
- Mortgages, homeowners insurance, home improvements, etc
- Spending on children, saving for college education
- Luxury spending and travel
Learning by Example
To explore the distinction between income and wealth in context, I’ll use two fictional 50-year-old characters: Adam and Bill.
Adam is wealthy, but has never earned a large income. Adam began working at age 22, after earning his bachelor’s degree paying in-state tuition at a state university. Although his starting salary was fairly low after graduation, Adam has managed to live well below his means. He committed to investing at least 10% of his income, and diligently shunned credit card debt. Through hard work and an excellent reputation, Adam has worked his way to a management position and now earns $60,000 a year.
Adam’s family lives simply, and they’ve remained in their small, three-bedroom house in a working class neighborhood. He and his wife paid off the mortgage a few years ago. Their children attended public schools, and when the kids grew up and needed cars, they got used cars and paid cash. They may not live a lavish life, but the family is not only comfortable – they’re debt free. And after 28 years of investing 10% of his income, Adam has built up an investment portfolio worth close to $1.5 million.
With a simple annual budget of $45,000, Adam’s family could sustain their current lifestyle for more than 30 years, without Adam or his wife ever needing to work again.
Bill earns a large income, but he isn’t wealthy – at least not yet. Unlike Adam, Bill attended an expensive private university, which, after financing, cost about $200,000. Bill is highly intelligent and hard working, and with his stellar record he gained admission to one of the best medical schools in the country, incurring another $200,000 in student loan debt to earn his M.D. After completing medical school, residency, and a fellowship, Bill got a job as a physician, starting out earning over $200,000 per year.
Especially with the comfort of a high annual salary, Bill’s family lives extremely well. He qualified for a jumbo mortgage on a $750,000 home in an exclusive gated community, complete with a golf course. Bill’s children attend the most prestigious local private schools, and Bill and his wife drive current-model, imported luxury vehicles.
A highly-proficient physician, Bill has worked his way up to an annual salary of $350,000. But Bill’s family’s expenses – the large mortgage payment, payments on two new cars, the children’s private schools, his own student loans, club memberships, luxury clothing, and expensive vacations – add up. The total cost of indulging is equal to Bill’s yearly salary. Some years the end up spending even more than Bill makes.
Bill’s family ends up living paycheck to paycheck, despite his huge annual salary. If Bill were to stop working, his family would soon be destitute.
This example isn’t a knock on the medical profession or the financial habits of physicians, but the amount of debt that many doctors must take on for school and training certainly tempers the perception of their high salaries. It costs a lot to get to that income level, and decades can pass before a doctor makes more money than the degree cost in the first place. This simplified illustration helps to clarify the differences between wealth and income.
While a high salary can help an individual or family appear wealthy, it takes commitment and sacrifice – regardless of income - to attain real monetary wealth. Building wealth does not require a large income; it requires a conservative, long-term mindset.
Money Crashers has plenty of tools to help educate you and your family on the best ways to increase your earning potential, reduce debt, and save more money. With a passion for personal finance and the will power to defer your immediate desires for material possessions, you can build true wealth.
Do you feel you’re poised for wealth despite a mid-level salary? Or do you have some bad disposable income habits that you need to get rid of?
(photo credit: Shutterstock)