Even if you’re killing it at work, if you’re only focusing on what you earn, chances are you’re working for money but money isn’t working for you. Too many people forget that “last critical mile” in the road to wealth - investing. Income is only one “flow” into your “stock” of your net worth.
The bad news is if you’re not paying attention, nobody is going to do that work for you. The good news is by focusing on putting your money to work, it will likely earn even more than you can over your lifetime. In this post, we breakdown how your money could (and should!) earn more than you individually can over your lifetime.
Table of contents
How much gas is in your tank?
Defining Stocks vs. Flows
Let’s take a step back and define the whole ‘stocks’ and ‘flows’ finance jargon in plain-English. Think about filling-up gas in your car.
- The stock of gas is how much gas is in your tank-- it could be 4 gallons, 8 gallons, etc. depending on the time and day at which it’s being measured.
- The flows of gas are the amount of gas you burn while driving, and the amount of gasoline you fill-up each week -- you might burn a gallon per day from driving during the week, and fill-up 5 gallons per week each Saturday.
A good driver knows how much gas is in the tank in addition to their gas burn rate and how much they fill up each week. And yet when it comes to wealth, too many people completely forget that logic, focusing just on income (paycheck, raises, bonus etc.) vs. the whole picture
You’re in the overly-focused on income camp if:
- You can name how much you earn each year, but…
- You’re not exactly sure how much you spend each year and/or
- You’re not sure what your current net worth, or wealth, is.
Any MBA could tell you the basics to track the financial health of a company :
(1) An income statement (what you earn minus what you spend) to track flows
(2) A balance sheet (what you own minus what you owe) to track stock.
And yet, most people (including MBAs! And maybe you!) have never built an income statement or balance sheet for their own households. If the old adage “what doesn’t get measured, doesn’t get managed” holds – this does not bode well for your personal financial health.
Do you have an income statement or balance sheet for your own family? We recognize this takes time to build, and that's why we've taken that "nitty-gritty" of your plate as one of our offerings at Steward
Income Isn’t Your Most Powerful Wealth Generator
Two Ways to Fill Up The Tank
This isn’t just about building transparency. This is about turbo-charging your wealth creation. Imagine that you had not one, but two ways, to fill your gas tank:
(1) filling it at the gas station and
(2) at the end of each week, your gas tank would magically add 7% more gas to however much gas was already in the tank. The extra magic – this growth would “compound”. Next week, that 7% extra gas would grow at 7% too!
That’s a pipe dream for gas…but the reality for wealth. An investment in the S&P 500 (a proxy for the overall stock market) earned ~7.5% annually over the last 30 years. Compounding interest often generates wealth far beyond the impact your income could have. This’ll be easier to see with an example.
Comparing: Auto-Investor vs. Auto-Saver
Alice and Bill, have already built up a nest egg of $500,000 each.
- Let’s assume Alice and Bill have the same high-earning job ($200K in take-home income a year growing at 3%), same annual expenses ($100K).
- Their only difference is, Alice is automatically investing her savings. She's put her $500K nest egg in a low-cost index fund, and putting the additional $100K in savings automatically into her investment account each year (7%). In contrast Bill has held onto his $500K in cash, and is keeping his $100K of savings each year in cash (0.01%).
- If we were to check in with them in 25 years, we’d see that Alice ends up with $7M more in wealth.
Let's go more extreme. Comparing an Autor-Saver with a "½ as wealthy" Auto-Investor
Now let’s compare Auto-Saver-Bill with 1/2-as-wealthy-auto-investor-Charlie.
- Charlie is in a middle-income job, earning only half as much as Bill ($100K) and spending half as much too ($50K), and with only half as much in his nest egg ($250K).
- But unlike Bill, Charlie starts investing his $250K nest egg from the get go, and adds $50K in savings to investments each year, unlike Bill who keeps his savings in cash.
- If we were to check in on them 25 years later…with those investments unleashed, Charlie is $1.5M (30%+) more wealthy than Bill…even though Bill earned 2x as much as Charlie their whole lives.
It turns out, the most significant driver of net worth is the ability to start compounding on wealth through investments early on! No wonder Albert Einstein called compounding interest the eighth wonder of the world.
Three things to do about it:
1) Treat your household like a business:
Think of your household as a small business. You need the two documents that every business has.
- An income statement (which…by the way…tracks not just income coming in, but spending going out). Steward can help you build this in < 15 minutes.
- A balance sheet (which looks at what you own today [minus] what you owe = net worth).
2) If you have starting assets:
If you are fortunate camp of having assets to start with, your top goal should be to preserve & grow your asset base. This means: ensuring you’re getting a fair rate of return on your investments at a low cost, and you’re reducing unnecessary expenses
3) If you’re a HENRY = High Earning Not Rich Yet:
If you are in the process of building your wealth, the key becomes making sure you're investing vs. just saving, particularly early in your career. Reframe your job as two-fold: Job #1) Earn money. Job #2) To ensure that money is earning money for you.
Interested in unleashing your money to earn even more than you can?
Steward is a personalized to-do list for how, where and when to invest and save on taxes in plain-English, with minimal time and effort. Steward can act as your household’s CFO support, building you the basic financial statements described above. Give it a try here.