What do you consider wealth?
The other day I was a guest panelist for a regional NPR call-in show dealing with personal finance problems. One topic for discussion was the different value people put on living within their means and saving money. It was interesting hearing how far apart different people’s views are on this topic.
During this discussion, one thing became clear: besides the fact that different households have a range of means and circumstances that dictate how much money they can save, there seems to be an even bigger difference in what people think it means to be financially secure.
Like motorists with different destinations, it is no surprise that people end up with such vastly different results when they have such varying takes on financial goals. A big part of how people manage their household finances seems to stem from what they consider to represent their wealth. Here are some thoughts on several of the possible components of wealth:
- Available credit. If wealth is the ability to spend money, then certainly the amount of credit available is one way to measure wealth. It is true that maintaining a good enough credit history to be able to borrow when needed gives you a valuable degree of financial flexibility. Unfortunately, it seems too many people take this to the extreme of letting the available credit limits on their credit cards define the wealth at their disposal. There has certainly been a generational change in how people view borrowing vs. saving in this country. From 1950 through 1995, the annual personal savings rate in the U.S. never dropped below 5 percent. In the 17 years since, it has reached as high as 5 percent only twice. Meanwhile the total amount of consumer credit outstanding, after contracting briefly as a result of the Great Recession, has rebounded to reach new heights over the past two years.
- Income. How much you earn is certainly an important component of wealth. The only limitation is that you can’t assume that your income stream will go on forever. I know of people late in their careers who have little or no retirement savings because they don’t plan to retire; we can only wish them the good health to follow through on that plan. Even with younger people, for whom health is not as big an issue, it is important to recognize that economic or personal circumstances can suddenly cut off or drastically reduce an income stream. It’s best to set some money aside during the good years, rather than assuming that success will continue forever.
- Home equity. It’s true that for most people, their home is their single most valuable asset, so it is natural to look at home equity as a form of wealth. However, that wealth needs to be regarded as something that will provide shelter for decades to come, rather than as a liquid asset available for spending. One of of the saddest things about the housing crisis was how people gave away their home equity by borrowing against it, only to find this put their most valuable asset in jeopardy when times got hard.
- Retirement account balances. It takes a large amount of money to fund a retirement, and too often the amount of money accumulating in a retirement fund is a temptation, causing people to borrow against it or even incur tax penalties by tapping into it early. Retirement savings are part of your wealth, but only if they remain intact to pay for your retirement.
- Emergency savings. Having money set aside outside of a retirement account is important, because it gives you ready access to funds should an emergency occur. The trick is to be disciplined in how you define an emergency, rather than treating your emergency fund as a piggy bank.
- Non-retirement investments. If you have investments above and beyond your retirement accounts, then you have an added avenue for building wealth. In measuring this wealth and planning for the future, it is important to remember the cyclical nature of the financial markets. In the late 1990s, too many people assumed that huge stock market returns would continue for years, and this dulled the sense of urgency about continued saving. Instead, growth not only became scarce but asset values shrunk, demonstrating why the risk of any investment has to be considered alongside its current value.
All of the above are valid components of household wealth, but each one is incomplete by itself. Rather than focusing on any one of these to define wealth, I would suggest that wealth is more of a mosaic, a picture made up of all these different pieces. Let any of the pieces drop out, and the picture is incomplete.
The question is, are these the right pieces, and are they the only pieces? That brings us back to the original question: what do you consider wealth? Your comments will help add to the picture.
Only comment is I’d actually combine “Available credit” and “Income” in one category of 1(a) & 1(b), reasoning is when credit is used and becomes debt, it always is money plus interest against future income. Thus the two are very much linked in ways the other categories are not. A point probably many on FCN already know, but in broader culture I am not so sure.
This proves just how hard it is to define wealth. I hate when politicians say people making $X are rich and therefore should pay more taxes. It all depends on where you live. I do like your pieces for making up the wealth pie.
Usually I think of net worth. But as far as what makes me feel wealthy, it’s these:
1) Stuff – having access to all the stuff I need makes me feel wealthy. Some of the first things I bought when I was on my own were things like my very own nail clippers, so I would always know where they were. So you can measure this by the current value (how much you could sell it for) or the replacement value, but that’s not what really matters. What really matters is things like–do you have what you need to get a good night’s sleep (bed that is comfortable but doesn’t give you a backache, an environment without too much noise or light or pollution, a good alarm clock, etc.). A new bed that gives you a backache may be worth more on paper than an old bed that doesn’t hurt you, but it doesn’t feel like wealth.
2) Cash flow – being able to get to cash when you want or need to buy something instead of having to do without or let good opportunities go by. Obviously savings feels better than credit, but both do serve this purpose.
And then Tim made a good point about health. It certainly helps to have a body that can do what you want it to do. And it’s good to be happy. But I don’t consider those things to be wealth, though wealth can make it easier to have those things.
Something not mentioned in this post and previous posts is real estate investments beyond the home we live in. I’ve always considered having rental properties a big part of my retirement plan. I currently have two rentals, one paid off and I expect to pay the second one off in 2014 and will then sock away the rents to help augment my retirement cash savings. The bulk of the mortgages on these were paid by my tenants and with rare exception, they have always cash flowed. Once retired, the rents paid will contribute to my monthly income. But unlike an IRA or 401k, the cash generated does not deplete the asset. Plus there is a chance of appreciation. I hope not to do so, but if during retirement a large amount of cash is needed, one of them could be sold.
I’ve never read anything that gives guidance as to how to consider rentals in a retirement portfolio. Should I add the current value of these properties to my IRA totals to give me my ‘number’ so that I have an idea if I’m at or getting close to the amount I’ll need to retire safely?
Regarding working past traditional retirement age….I am self employed with a micro business where I do not need any employees. I was concerned about having enough to retire (I’m 57) but recently realized that since I run my own business, I could continue working but scale the business back so that I could work only half time or so but still generated 50% of my current income. Or maybe have a partner buy into the business and one day sell the whole thing to them. Another option is to sell the business outright to generate investment income for retirement. Your posts seem directed toward those who work for others. I’d love to see some input for those of us who are self employed!
I completely agree with you Betsy. I would still define that as part of the Income / Future Income category, but more of an an addition what is already there. Being able to set current income aside for a time when one is out of work is great! I have been quite fortunate to be gainfully employed in the Aerospace industry the past 7 year right out of college. I personally think it is very naive to think that I will be gainfully employed in my current capacity for the next 25-30 year.
In 2008 it was kind of scary as the company I worked for laid off around 30% of the work force in Aerospace. Since then I have be educating myself to go into completely different markets if / when the time does come that I am unemployed from the Aerospace Industry. Those areas being finances and investing, as well as the tourism industry.
I don’t expect to make nearly as much in either of those industries as I currently do but certainly have a shoot a remaining employed in different areas.
Post 2008 and experiencing so many colleagues of mine getting cut from the work force. I am now saving 47% of my income across multiple avenues 401K, IRA, HSA, and taxable investing.
In the even I come to a work loss in the future I am already setup to fully sustain my current life style for 3 years with out getting into my retirement savings and another 3-4 years if I tap into retirement savings.
That all being said.. I have tons of available credit extended to me much like other people in my relative category but I have chosen not to dip into any of that. I am building my own credit fund in the event I even need it.
I would also propose some sort of addition of ensuring the security of adequate health care funding for the future. The current trend shows that will likely be one my largest expenses in the future. And your health is SO important to EVERY other aspect of your life, with out you health you will deteriorate in the world very rapidly. I switched to a consumer plan in 2009 and currently I have $10K in my HSA and I have an out of pocket max on an annual basis of $5K so I could have 2 very bad years of health and still make it though without any further contributions to my HSA.
By far the best health care anyone can provide to themselves it so stop eating like crap and being too lazy to exercise. I have a quite healthy diet, and supplement that with exercise 4-5 days a week of 1-3 hours at a time. My health is great and allows me to do and keep up with my busy active life. It also promotes ones sex life as well.
Great post!! BTW. Often times we associate wealth with a number. The magic million or whatever your number is, but there is so many more aspects to life that create well rounded wealth, security, and happiness!!!
I agree with Betsy. I would say “wealth” is a combination of how much you have saved in all accounts minus all debts, plus the approximate value of vested pensions you have coming, plus your annual income, plus your ability to earn more annual income if you choose.
I would remove “Available Credit” from the list above because “credit” means the wealth you’re trying to tap isn’t yours. The ability to borrow someone else’s resources doesn’t make you rich. On the contrary, if you use that ability and incur a debt, it makes you less rich.
Not sure exactly how to put this, I would add a category related to knowledge/marketability. It relates to income, but not exactly the same thing. I think that having a secondary skill set (that is also marketable) adds to financial security – if job/career-1 falls through, you have something in your back pocket that will help pay the bills.