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People often use the terms income and wealth interchangeably when talking about money. While they are related, each provides a different look into your financial health.
For instance, a doctor may have a substantial income, but due to student loans and other debt may not be as wealthy as an electrician that started working straight out of high school.
The Difference Between Income and Wealth
Income
Income is the amount of money you earn.
This could be from your normal day job or career, side gigs, sales commission, realized investment returns, etc.
Wealth
Wealth or net worth is the value of your assets minus your liabilities.
An asset is something you have of value. Some examples include cash, investments, house, car, truck, etc. Essentially anything that you could sell for cash should be considered an asset.
A liability is an outstanding debt or obligation. Some examples include a mortgage, student loans, personal loans, vehicle loans, outstanding medical debt, taxes due, etc.
Examples – Income vs. Wealth
For the following examples, I’ll consider the personal finances of Jack and Jane to show that income and wealth aren’t necessarily dependent on one another. In fact, they’re not as highly correlated you might think.
High Income/Low Wealth
Jack is a big-shot surgeon at the beginning of his career. Let’s say he has a salary of $250,000 per year. Unfortunately, he also still has student loans and spends extravagantly. He often spends as much as he earns if not more. Because of this he has a low net worth.
Low Income/High Wealth
Jane is a retired school teacher. Her salary in retirement is $35,000 per year. Jane is frugal by nature and doesn’t spend excessively. Through her 25+ years working as a school teacher, she methodically paid off her student loan debt and mortgage, and contributed religiously to her pension and other deferred compensation. Because she lives almost completely off of her pension, her deferred compensation has slowly grown to a sizeable amount. Her net worth far exceeds Jack’s.
Correlation Between Income and Net Worth in America
Don’t Quit Your Day Job (DQYDJ) has a great article focused on the correlation between income and net worth.
What this means is that there is a correlation between income and wealth, however there are many other factors at play than just income as it relates to wealth building.
Also from the same article, please see below a graph of individual responses in the 2016 Federal Reserve SCF with income on the X-axis and net worth on the Y-axis (and a logarithmic scale).
Other than Income, What Factors Contribute to Wealth Building?
Time
Time plays a huge factor in wealth building. If you’re a high earner, but have only been making that salary for a year or two, you haven’t had a long time to take advantage of those earnings.
Likewise, if you’ve been saving and investing even a small amount for 30+ years, the power of appreciation and compound interest can have a huge impact on your wealth.
Spending Habits
Since income is most people’s biggest wealth building tool, wealth can be heavily influenced by how much of your income you save and invest.
For instance, Jack in our example above spent the majority of his money and had little left over for saving and investing.
However, Jane was frugal and used the majority of her money to pay down debt and invest.
Spending habits also includes what you buy when you do spend money. If you’re focused on building wealth, you need to spend more on assets, preferably appreciating assets (house, land, etc), and avoid liabilities, depreciating assets (cars, trucks, boats, etc.), and worthless stuff.
Luck
Whether we’d like to admit it or not, luck plays a factor in wealth building.
Some folks inherit their wealth. Others end up with a winning lotter ticket. Still others pursue businesses at just the right place and time.
On the flip side, medical bills, failed businesses, divorces, etc. can play a huge role in eliminating or preventing wealth building.
Conclusion
Hopefully this article has shown you that income and wealth are two related, but different financial terms.
Income is how much you earn. Wealth or net worth is how much you’re worth at any given point in time.
Income is important to the wealth building equation, so you should focus on increasing your earning power, however, income is not the only variable.
Other variables include time, spending habits, and luck.
Both time and spending habits are mostly in your control. Saving and investing early, and minimizing your spending will both contribute to your wealth building efforts.
Luck also plays a role in wealth building. You can’t completely control it, but you can be aware of and take advantage of good opportunities when they arise and try to prepare for those inevitable bad times (squirreling away emergency funds, having insurance, setting up a business as an LLC or other favorable business structure, etc.). Plan for the worst and hope for the best.
How do you view the relationship between income and wealth?