I found an article that had an interesting story on net worth versus income that I wanted to share with you. Here it is:
Test: who’s better off?
Hine and Harriet, both aged 23, work out their net worth. Harriet, who has been working since age 16, has savings of $15,000, a car worth $10,000 and furniture and personal possessions worth around $25,000. She has no debt, so her net worth is $50,000. She's earning $25,000 a year and that could increase to about $35,000 with promotion over time.
Hine has just completed a law degree, has $5,000 of personal assets and a student loan of $20,000 - her net worth is negative $15,000. She has just started her first full time job and is earning $30,000 a year – but after 10 years she expects to be earning about $150,000 a year.
They discuss who is better off. On the basis of their current net worth, Harriet is better off by $65,000 and Hine feels envious of her friend’s financial freedom.
Harriet laughs and offers to swap any time. She works out that if she works for another 35 years, she’s likely to earn around $1.1 million before tax - Hine’s likely to earn $4.1 million.
Hine realises that even though she has student debt right now, getting it was an investment in future earning capacity. Her education is a valuable asset – even if it doesn’t show up in her net worth calculations right now.
It's an interesting piece that reinforces some key principles and leaves a question or two still hanging. My thoughts:
1. In the end, net worth is what matters. As you approach retirement, income usually dwindles. Then all you have is what you've saved over the years (net worth).
2. When you're young, net worth matters less since there's a lot of time to "make up ground." This story emphasizes this fact.
3. Education can pay off big and is usually worth the investment. I've talked about this in the following posts:
- The Value of Education
- Facts on Education (and the Value of It)
- The Value of an Education
- College Majors that Boost Your Paycheck
4. It doesn't really matter how much more Hine actually earns. What does matter is how each of them SPEND. For instance, even if Hine earns $150,000 a year, if she spends $150,000 a year, she makes no ground. Harriet could make $35,000 but only spend $30,000 and end up gaining on Hine by $5,000 per year. As stated before, it's not what you make that determines your net worth (primarily) but what you spend. See these posts for more details:
Hi FMF,
It's not what you make, it's what you keep. As the owner of a Michigan Mortgage Company, for the last 15 years, I have seen many thousands of people "financially undress" in front of me. Unfortunately, most spend what they make. Many spend more than they make. I am sad to annouce that many families would be bankrupt if they went without income for 6 months. Our nation seems intoxicated with how much you make and how many things you have.
As our business began to prosper years ago, we decided to keep our standard of living at a certain level. As our income grew, so did our savings. Our lifestyle grew as well, but not in proportion to our savings.
The exciting thing is that after 15 years we have well over 7 figures of cash net worth. Even more exciting is the fact that I am still in my 40's. Cash gives you options that income never can. Let me say that again...Cash give you options that income never can!
How did I do this? It isn't that I make millions each year. It is a simple commitment to keep my lifestyle reasonable, save no less than 10% of my income each year, give 10% of my income away each year, and do my level best to share with others my journey. This simple behavior and time will produce significant savings.
I have enjoyed reading your blog and watching the huge growth of your readership. You are fast approaching 100,000 readers of your blog. That puts you in a very elite group!
I salute you!
David Porter
President
Pacesetter Mortgage Company, Inc.
Okemos, Michigan
Posted by: David Porter | October 27, 2005 at 06:03 PM
I don't think it's a valid comparison, really. If you were traveling from California to Florida, which is more important--how far you've gone, or how fast you're going? Certainly if you're in Oregon (negative net worth), you've got a ways to go and need to at some point turn that around. But if you're in Texas but walking, someone flying might end up getting there before you do.
Certainly both high income and high positive net worth are good things, but unless you've "arrived", both are going to factor into the rest of your "trip". If there's one thing I'd add to this, it would be looking at net savings instead of just income or net worth. There are plenty of high income people who spend everything they make (or more), and rachet up their spending with each new raise. And if you have a high net worth but it's declining from one year to the next, you're not going to have a high net worth forever.
Also, comparing these things without the context of personal goals, circumstances, and lifestyle can be misleading. A low income person (e.g., $25,000) with a high net worth (e.g., $750,000), unmarried with no kids, and who is happy living within a $25,000 yearly budget can retire and live a pretty much carefree life, barring any major financial calamities or a radical change in circumstances. But another person who's making $100,000 per year with that same $750,000 net worth, but who has a wife and 6 small children he wants to put through school at top private universities, who spends almost every dime of that $100,000 every year, and who wants to live a luxurious and expensive lifestyle in retirement, is probably nowhere near retirement yet.
Posted by: Mike | October 27, 2006 at 04:15 PM
I know in the end it matters how much you save and not how much you make... but honestly, it's a heck of a lot easier saving 20% of your salary on a $100,000 income than a $30,000 income.
For people that did not inherit wealth, income is the most important factor in building wealth. So you can minimize your expenses, but in the end maximizing the top-line probably would be more beneficial to your wealth, PROVIDED, of course, that you save and not ratchet up your spending wildly with every increase in income.
Posted by: wanda | October 27, 2006 at 06:08 PM