Why income is the key to financial success
What is most important in building wealth and economic success? Is that what you are investing in? Is that when you start? What about your mindset?
As time has passed, I have become increasingly convinced that the best predictor of whether someone is likely to build wealth is – their income. It is not their asset allocation, their investment knowledge or their financial objectives that matter. Tell me someone’s income and it will tell me more about their ability to build wealth than just about anything else.
I can already hear the responses pouring in, “What about someone’s expenses? There are plenty of celebrities who had very high incomes but still ended up broke!” I disagree. Income is not a sufficient condition to build wealth, but for most people it is a necessary one. In other words, a high income in itself does not make you rich, but almost every person who is rich had a high income.
Are there exceptions? Of course they do.
Morgan Housel’s The Psychology of Money
highlighted the case of Ronald Read, a gas station attendant/caretaker who gave away most of his $8 million fortune when he died at the age of 92. Unfortunately for you, it would require a combination of extreme frugality and replicating his success and a very long time horizon.
Read invested for 69 years (and worked for 50 of them), during which time US stocks generated an annual return of 6.7% (including dividends and adjusting for inflation). If we assume Read adjusted his monthly contributions for inflation, he would have needed to invest $40 a month in US stocks starting in 1946 to have $8 million in 2014. 40 dollars a month may not seem like much, but in 1946 the average income was around 100 dollars a month. month.
This means Read needed to save 40%+ for 69 years while matching the market’s total return to build his wealth! This may sound simple in theory, but it is incredibly difficult in practice.
Whichever way you look at it, the story of Ronald Read shows that building wealth without a high income requires you to be an outlier on several other dimensions. You need more time, less spending, better performance or some mixture of the three to generate such a large fortune.
But there is a much easier way – find ways to increase your income. After all, income levels are more correlated with savings rates than any other measure I have seen.
Researchers found the same positive relationship between income and savings in the Consumer Expenditure Survey (CEX), Panel Study of Income Dynamics (PSID) and Survey of Consumer Finances (SCF) in their article “Do the Rich Save More?
After examining each of these independent data sources, the researchers concluded: in summary, the results presented so far strongly suggest that savings increase with lifetime income among working-age households.
If you’re still not convinced, consider this analysis from the New York Times which found that the lowest-income households in the US saw the biggest increase in their checking account balances immediately after the COVID-19 stimulus checks were sent out:
There is anecdotal evidence to support this too. As one lower-income woman said in this NYT article after receiving two stimulus checks, “‘This is the most money I’ve ever seen in my bank account.'”
Her experience mirrors that of millions of Americans who received federal stimulus checks, reducing poverty by the largest amount in five decades.
It may seem obvious that the easiest way to make people save more money is to give them more money (or make them earn it), but this is not obvious to everyone. How do I know? Because I still see many arguments to the contrary.
This suggests that the rich and the poor earn the same amount of money, but the poor simply cannot control their spending. This means that poor people have a behavioral problem, when what they really have is an income problem.
But this is what the personal finance industry does not want to admit. They don’t want to talk about the income problem, because it is much easier to blame the “spending problem”. It is much easier to demonize lattes than to address income inequality. It is much easier to talk about behavior when simple math is enough. As I like to say:
No mindset in the world can compensate for an inadequate balance
You can disagree as much as you like, but at the end of the day you have to prove your point. You must provide evidence to support what you say. And I know you haven’t. You can’t prove that mindset matters, but I can prove that income matters.
Income matters to everyone. It is important for the young and the poor. It is important for those who are currently building their nest egg. And it even matters to the rich who can make a lot of money from their investments today because of the money they earned (and saved) in their past.
Income is the mainstay of most prosperity for most people. This doesn’t mean that your asset allocation doesn’t matter or that your mindset is worthless, just that your income is more important. So if you really want financial success, you need to focus on paychecks, not portfolios.
Finally, before you claim that expense tracking or goal setting or “manifesting” your future wealth is more important than income, remember to bring data.
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