Co-produced with Treading Softly
Studies of wealth development, wealth generation, and historical norms of being “wealthy” have always interested me. So do surveys on people’s views on this.
What amazes me is how many people struggle to define “being rich” and how many misunderstand how to achieve it.
Consider these data points from a 2010 study:
- 70% of respondents say it’s harder to get rich in America today than it used to be.
- 15% of respondents believed that wealth was the result of winning the lottery or an inheritance, ie being lucky.
- Only 20% thought it was by opening their own business.
- 33% defined Wealthy as: “having just enough money not to worry”.
- 26% defined Wealthy as: “having enough money not to need to work”.
A more modern to study conducted by Schwab in 2021 shows more interesting data:
This was before inflation was recognized as a major factor in personal finances. It shows that thresholds or perceived thresholds for financial success and “wealth” can change depending on external economic impacts.
Today I want to say that you can be rich without having a net worth of 1.9 million dollars. You can also feel secure and happy financially. The key is to understand what “being rich” is all about and to change your mindset and your goals. You see, many of us have wandering goals tied to big “net worth” goals instead of being grounded in practical reality. I’m not surprised Charles Schwab asked the “net worth” questions. They perpetuate a common misunderstanding that helps to enrich them. The higher your balance, the more they earn, regardless of its income generation.
Defining wealth and “being rich”
Before we can set goals and frame our mindset, we need a working definition of “being rich.” What is Wealth?
From our point of view, wealth is going to be composed of two aspects. They work hand in hand but are unique in their existence and operation. These are static richness and functional richness.
Static wealth is the value of your assets minus your debts. This is often referred to as your “net worth”. If you were a publicly traded stock, we would call this your NAV (net asset value) or “book value”.
Your Static Wealth or SW can change daily. The value of your home goes up and down, your investments can change in value when others buy and sell the same stocks, and your car depreciates over time.
Having a high SW isn’t the only key to being rich. Why? Because if you have a large stash of money and no way to replenish it, you will live in fear that it will run out. Have you ever heard stories of lottery winners going broke? Maybe you know someone, maybe even yourself, who received a large sum of money as part of a lawsuit settlement or inheritance, and the money ran out. . No matter how much SW you have, your spending can deplete it if you’re not careful.
So many retirees love a thrifty and frugal lifestyle, not because they have to, but simply because they fear their cash reserve will run out before they die. I would call someone with a high SW “rich” but not strictly “wealthy”.
So why do all wealth studies focus only on your SW? Well, they are often conducted by Wealth Management Companies or Brokerage Houses that benefit from high amounts of SW deposited into their accounts, they charge fees and earn interest based solely on account size. Large accounts increase their revenue. It’s a win for them, but sadly, it often leaves countless retirees panicking and feeling like saving for retirement is a hopeless and fruitless endeavor.
The second aspect of “being rich” is what we call functional richness. Functional wealth is the income or cash flow that you personally produce – your greatest asset – and your assets. Functional wealth, or FW, is your cash flow. This cash flow pays your debts, bills, expenses and leaves you with play money or excess income. This excess income when saved or invested increases your SW and if it earns income it increases your FW.
Do you own a rental property? The value of the property is its SW, the income it produces is your FW. The same goes for your investments. This is how these two concepts go hand in hand. Unfortunately, we often focus so heavily on SW that FW is missing from the equation. Yet, if you think about it, what is more precious? A vacant rental property or an identical rental property with a reliable tenant who takes care of the property and pays the rent on time? Obviously the latter. The two identical properties have the same SW, but the FW of the occupied property is higher.
We set goals like “have $1 million in my retirement account,” but we never consider how much that could or should bring us. This is partly due to the common tendency to buy stocks with no return and expect to sell some of your SW each year to pay your recurring expenses and bills.
If you visualize all the SWs on one level platform, the value of your investment portfolio, the value of your home, and the value of your car are all on equal footing. Yet we blindly agree to sell off our wallets to pay for our home insurance. It’s like removing your front door to pay your electric bill. It does not mean anything.
This is why so many retirees live with financial worries, even though they have what many would consider a large amount of SW. They are afraid of running out of money. When the market dips 10%, 20%, 30% – as it does and always will – they begin to worry that their nest egg will shrink. They don’t enjoy their retirement because they try to time their sales to get the best price and minimize the number of shares they have to sell for their income. They are told to do so by people who profit from these actions. This contradicts everything they have learned from life experiences.
How do you think they built that retirement savings balance to begin with? They saved him from the FW that their life produced. They made more income than their expenses and put it aside. So why do we suddenly have this idea that retirement should work on a whole new strategy?
As a result, we should no longer worry about keeping our income above our expenses. Instead, we should sell assets, cross our fingers, and hope that our declining asset base increases in value faster than we are spending it. It doesn’t seem natural because it is.
If you are one of those people who worked and dipped into their savings to have $500,000, a million, two million dollars, you have achieved something that many do not. And you know how to manage your budget. You have a strategy that has worked for you. If the strategy works, don’t change it!
Retirement should be no different. You have income and you have expenses. The only difference is that instead of income from work, it comes from your investments. We must maintain a perspective of having a high level of FW, so that our SW can grow!
Investing for/during retirement
Whether investing for retirement or retirement, I suggest the same approach. Make your money work hard to generate excellent levels of income. Raise your FW as high as possible as SW will follow as a side effect. Interestingly, in the survey at the top, the way to get rich was to open a business or win the lottery. One creates an FW that can last for decades, while the other is a unique infusion of SW.
We know that to be rich, you have to have a high level of income at a given time. Yet we seem to forget that our PS can earn income on its own. Nothing pays as much as money. Take a look at the price returns of the S&P 500 relative to “total return,” which takes into account dividends paid:
Returns on SW alone are impressive over the life of the S&P 500 Index, but dividends or FW make those returns even better. I recommend investing in holdings that produce high levels of FW, so when that income exceeds your expenses, that excess can be reinvested to grow your SW.
Having $1.9 million in your savings account is good. It’s even better when it brings you 7-10% revenue per year. Then your almost $2 million generates plenty of dollars without you having to open the proverbial door to your house to pay your electric bill. But you don’t need $2 million to enjoy a reasonable income and a rich retirement.
Being wealthy means having more income than your expenses and a cushion of assets to fall back on in times of need. In other words, enough cash so you don’t have to work and a big enough cushion so you don’t have to worry about unexpected expenses. While a bigger cushion and vast sums of excess income are nicer, you don’t need them to be rich.
Many of you have large retirement portfolios that earn you next to nothing. You have worked hard and diligently to establish this balance and you leave it idle. Of course, its value can go up and down with the market, but this SW does nothing to generate FW to make even more SW, which, in turn, more FW, and the cycle continues.
Dividends are the fuel that propels your portfolio to new heights in terms of income and value. This is the means by which retirement can find meaning. Do you know if your portfolio will be up 20% or down 20% by the end of the year? No.
What you can know is how much income your portfolio will produce with great accuracy whether your portfolio is up or down. With dividends, you know what your income is and can plan accordingly to ensure that you grow your SW and FW.
None of this by selling my assets to finance my life, we were sold. Unfortunately, some have been so indoctrinated by this perspective that they will reject the concept out of hand. I know I can’t help everyone, but those of you who knew in your heart that these commonly recommended steps were uncomfortable and alien, they were, and there’s a better way:
Buy income-generating assets. Let the dividends pay the expenses of your life. Reinvest excess dividends to further increase your income. The same formula you’ve used throughout your life: income, expenses, savings for the future.