Income vs. Wealth; Expenses vs. Investments

Income and expenses sure do look an awful lot like wealth and investments (they can all be represented by dollar bills, after all), but they are not alike.  And the difference matters to your clients’ financial security.

Good day, Talking About Money Community, I am wishing you well. ☘

In this post I want to parse out the differences between income and wealth, and between expenses and investments.  They are similar, for sure, as they all can be represented in currency.  Indeed, I have noticed that some of my students in my community workshops think of them as the same…or more frequently, classify all dollars as income or expenses, without considering what it takes to build lasting wealth.

Let’s break down what each of these four terms mean, and their significance in wealth building for your clients.

What is income?

According to Investopedia, income is the amount of money, property, and other transfers of value received over a set period of time by individuals or entities as compensation for services, payment for products, returns on investments, pension distributions, gifts, and myriad other transfer of value.

Your clients may think of income as their earnings, in salary, hourly wages, or in contract or gig work.  I think that lots of people think of income as what you receive in exchange for labor, full stop.  If you serve small business owners, their definition of income might be slightly skewed, as they might define income as receipts for products sold.

It gets even clunkier when you consider that you can receive income that is not a direct result of selling your labor.  As you can see in the definition above, returns on investments is income.  Pension distributions is income.  Receiving a cash gift (or something that can be easily converted to cash) is income.  Selling personal possessions on Craigslist is income. 

What I see in my community practice is that most folks do not associate receiving money in this way as income.  Even more, most of my students do not have stores of wealth that can generate income, but we will get to that in just a moment.

What is wealth?

Now let’s turn to wealth, which is distinct from income.  Going back to trusty Investopedia, wealth is the value of all the assets of worth owned by a person…Wealth is determined by taking the total market value of all physical and intangible assets owned, then subtracting all debts.  Wealth is tabulated by how much valuable stuff (in either cash or other resources) that you own.

Wealth differs from income.  While income ebbs and flows over time, wealth is how much you own at a particular point in time.  The amount of wealth you have is in the eye of the beholder, meaning that you only feel wealthy if you own more money or stuff than the people around you.  If others own more than you, then you tend to not feel that great about yourself.  As you know, keeping up with the Joneses (or the Kardashians, or the Bezos’s) is a real thing.

What does your client need to do to become wealthy?  Wealth-building is a long game, as it typically involves holding back a portion of income at regular intervals over a period time and then investing that unused income in all the right places.

What do you think that your clients would give as examples of wealth?  Home ownership is a typical marker of wealth.  Having a nice car might also symbolize wealth (though cars are depreciating assets that sometimes how off wealth that isn’t really there…but I will save that for a future blog post).  Owning a business can be a source of income as well as a marker of wealth.  Today the business owner can sell products and services to generate income; tomorrow the business owner might sell the business assets that have increased in value over time. 

Then there are the more invisible examples of wealth, like investments.  And here’s the rub: your clients might not have investments in the stock market and therefore don’t consider them as an effective wealth-building tool.  They observe the wealthy and don’t quite understand that stock market investing contributed to their fortune.

What are expenses?

You know that I am using Investopedia for all four definitions, right?  Household expenses represent a per-person breakdown of general living expenses. They include the amount paid for lodging, food consumed within the home, utilities paid, and other costs.  You are an expert in expenses, so I don’t need to go into great detail here.  Household expenses are things that your clients pay for, such as housing, utilities, healthcare, childcare, transportation, entertainment, and so on.

How do your clients pay for their expenses?  Most frequently, they pay their bills with the income that they earn in exchange for their labor.  They use all—if not more—of their monthly income, leaving them treading water at best or saddled with credit card debt at worst.  And this cycle continues until they retire, or worse (you get the picture).

What are investments?

According to Investopedia, an investment is an asset or item acquired with the goal of generating income or appreciation. Appreciation refers to an increase in the value of an asset over time. When an individual purchases a good as an investment, the intent is not to consume the good but rather to use it in the future to create wealth.

The key in the above definition is “the intent is not to consume the good, but rather to use it in the future to create wealth.”  This is why you tell your clients to save and invest!  So that there is more capital (read: more money) in the future then what there is today.

As you can see here, an investment vehicle (like real estate, a business, or stock market investments) can lead to increased wealth over time.  In fact, the goal of investing is to create wealth over time.  But it is important to note that investments carry with them risk of monetary loss, as anyone who lived through the Great Recession remembers.

I think that investing with the intent goal of generating wealth is where a lot of working households get stuck.  First, making an investment requires that you withhold income that you would otherwise use to pay for expenses.  This can be hard for anyone, but is especially difficult for folks who do not make a living wage, or who are battling the high costs of housing or health care. 

Second, you need to apply this capital to the investment and ride it out for a long period of time (likely five years or more).  If your client is having cash flow problems, keeping capital in investments rather than using it for household expenses can be a tall order.  The focus on the hear-and-now is one reason why it is so difficult to build wealth – daily firefighting to keep a roof over your head and food on the table keeps you distracted from the long game.  Until it is too late.  

Not only do we need to do a better job of explaining the difference between expenses and investments, we must also work to promote effective social policies that inhibit wealth stripping from the clients that we serve.  Policies that promote affordable housing and comprehensive health care would put back dollars in the wallets of working households.  They could then take that recovered money and invest it in an appreciating asset like a home, a business, or a retirement fund.  Our job is not an either/or but a yes/and. 

What do you say…

Do you feel that you clients have a clear understanding of the difference between income and wealth, and between expenses and investments?

What do you think is the most effective way to support your clients in building wealth for the long term?

Share your thoughts with this insightful and supportive (and did I mention good-looking?) community, either in the Comments below or on LinkedIn.  Thanks, stay safe, and be well.