Monday, June 18, 2012

Wealth vs. Income: Two Different Conepts

If you and everybody who earns an income in your family were fired today, would your family still be able to sustain a quality of life somewhat comparable to the one you live today? (If your answer is yes, then your family is wealthy!)

I believe my aforementioned question is the best way to explain the difference between wealth and income. As far as wealth is concerned, earnings do not matter but investments do. As far as income is concerned, earnings do matter but investments do not.

To illustrate by example, let's say there's a girl named Maya who makes $200,000 a year (her income). This is definitely a very respectable income, however Maya may not necessarily be wealthy.

For example, let's say Maya may spend almost all of her income and lives a lavish life. Perhaps she never puts money in the bank and she decides not to think of the future. As a result, the amount of money she has at the end of the years may be equal to zero.

Maya is not wealthy. She may have a huge apartment and lots of things to fill it, however she would not be able to maintain her quality of life if she were fired at a moment's notice. Maya would still have to pay rent on a monthly basis, and she would still need to put food on the table. Without an income, Maya would be in trouble.

However, let's take case B. Let's say Maya now puts away 15% of her income every month and invests that money intelligently. Maya lives below her means. She buys used cars, lives in a modest home where she has payed off her mortgage and makes sure she pays the bills on time.

Maya is very wealthy!

If she were to be fired today, she could fall asleep knowing that her life is in order. She has already saved for retirement and she doesn't really need to worry about bills.

Applying this example to other cases, you can see how doctors can either be wealthy or not and people who make minimum wage can be wealthy or not.

In fact, this concept can be very interesting to keep in mind if applied to the Lorenz curve (which I intend on writing a post on very soon!)

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