One of the main problems that many people encounter in their personal finance journeys is converting their income to their net worth. Many people do not understand the big difference between being rich and being wealthy.
As Morgan Housel puts it,
“Rich means, you have the cash to buy stuff. Wealth means you have unspent savings and investments that provide some level of intangible and lasting pleasure.
Independence, autonomy, controlling your time, and doing what you want to do, when you want to do it, with whom you want to do it with, for as long as you want to do it for.”
Yes, you have a high-income job or business, but what assets do you own? Where would you stand financially if you lost your job, retired today or got sick that you could not work again?
If you wanted to quit your job and focus on a side passion or project that doesn’t guarantee monetary returns shortly, would you pursue it since you are already financially secure?
Or would you continue working on the job you don’t love since you do not have the financial security?
Converting Your Income To Your Net Worth
It doesn’t matter how much you earn; what matters is how much you keep.
Let’s take a scenario of two people.
Person A earns 150K per month but only saves 10K. Person B makes 60K per month but can save 25K.
As much as person A earns way more money than person B, Person B is more likely to be wealthier than person B if they keep on the same trend for the next 20 years.
Person A will have saved around 1.4M in 20 years (not adjusted for inflation), while person B will have saved around 6M (not adjusted for inflation)
If these two people invest their savings and average a return rate of 9% per annum within the 20 years, person A will have accumulated around 7 million while person B will have gathered around 16million.
If these two people were to retire after 20 years, person B, despite earning less than half of person A, would be more than two times wealthier than person A. That’s the difference between rich and wealthy.
Or Perhaps, as Morgan Housel put it,
“Wealth is what you don’t see. It’s the cars not purchased. The diamonds not bought. The renovations postponed, the clothes forgone and the first class upgrade declined.
It’s assets in the bank that haven’t yet been converted into the stuff you see.”
Steps of Converting Your Income To Your Net Worth
1. Have a High Savings Rate
In the Psychology of Money, Morgan Housel narrates a story:
“Singer Rihanna nearly went bankrupt after overspending and sued her financial advisor.
The advisor responded:
“Was it really necessary to tell her that if you spend money on things, you will end up with the things and not the money?”
Morgan continues and writes,
“When most people say they want to be a millionaire, what they actually mean is: “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire
As he illustrates, building wealth has little to do with your income or investment returns and lots to do with your savings rate. You can build wealth without a high income, but you cannot create wealth without a high savings rate.
2. Invest Your Money in Cash-generating Assets
After saving comes investments. As Nick Maggiulli writes,
“Just keep buying. These three words can make you rich. What I’m talking about is the continual purchase of a diverse set of income-producing assets.
You should think of buying investments like you buy food- do it often. Make it a habit to invest your money like you make it a habit to pay your rent or mortgage.”
This is the only way to convert your income to your net worth. By buying income-generating assets. Whether it’s government bonds, dividend growth stocks, real estate or REITs. Just Keep Buying.
As Robert Kiyosaki famously wrote in Rich Dad, Poor Dad, the rich buy assets, while the poor buy liabilities.
3. Concentrate Before You Diversify
“Diversification may preserve wealth, but concentration builds wealth.
When you get too diversified at the beginning of your investing journey, you indirectly change your goal from building wealth to preserving wealth.
The wealth which you are yet to amass.”
Your goal is to grow wealth, not to preserve it as you are not wealthy. Don’t get over-diversified and end up delaying your journey of wealth creation.
The Bottom Line
The best way to secure your financial future is to make sure you save whatever you can each time you get paid. When making significant expenses like buying a personal car or any other luxurious item, make it a habit to invest a similar amount into a cash-producing asset.
By doing that, you will be on your way to bridging the gap between your current and future wealthy self.
