Income and wealth are two distinct concepts in personal finance. Income refers to the money earned regularly, while wealth represents the accumulated assets and net worth. Understanding the difference between income and wealth is vital for effective financial planning. It guides budgeting, investment decisions, and long-term wealth-building strategies.
When it comes to personal finance, the terms “income” and “wealth” are often used interchangeably. However, they represent distinct concepts that play a crucial role in one’s financial journey. Income refers to the money earned regularly, whether through employment, investments, or other sources. On the other hand, wealth encompasses the accumulated assets and net worth of an individual or entity.
Understanding the fundamental difference between income and wealth is essential for effective financial planning.
While income represents the flow of earnings or gains generated over time, wealth reflects the overall value of one’s assets minus any liabilities.
Income is vital for meeting day-to-day expenses, managing debts, and maintaining a comfortable lifestyle. It provides the necessary cash flow to cover essential needs, savings, investments, and discretionary spending.
Wealth, on the other hand, is more stable and accumulative in nature. It includes a wide range of resources, such as financial assets, real estate, business ownership, and personal possessions.
Why is it important to distinguish between income and wealth?
Differentiating between income and wealth is important. It helps individuals understand their financial situation more accurately and make informed decisions.
Many people mistakenly assume that a high salary automatically translates into high wealth. However, this is not always the case. Here’s why:
Expenses and Lifestyle: A high-salary earner may have significant expenses and a lavish lifestyle. Such a lifestyle is supported by their high income. A significant portion of their income goes towards maintaining their lifestyle. As a result, they may end up saving and investing less. Only significant investments can lead to wealth creation.
Overspending Using Debt: Some high-salary earners may carry significant loans. Why? Because they can afford to pay the monthly EMIs. They wrongly correlate their EMI paying ability with their affordability. Suppose, my monthly salary is such that I can easily pay one lakh in EMI. As a result, I will assume that I can easily buy a home worth one crore (assuming, a 1 Crore loan = 1 lakh EMI). But in reality, my bank balance was only five lakhs. It means, what I’m assuming is affordable is a fallacy.
It is actually not our fault. Society has been tuned to think this way. Lavish spending and having the ability to pay the loan EMIs make us feel wealthy. But the reality may not be the same.
Hence, is it important to distinguish between income and wealth. The readers of this article, by the end of it, should self-assess if they are actually wealthy or not.
[P.Note: Individuals with moderate incomes can accumulate significant wealth. If they practice diligent saving, make wise investment choices, and manage their expenses effectively, they can also become wealthy. Wealth is built over time through a combination of income, savings, investment growth, and debt management.]
The Definition of “Wealthy” in India
I have a theory that I use to distinguish a normal person from a wealthy person.
As per data published by the World of Statistics, on average, professionals in India earn an income of about Rs.46,900 per month. We’ll use this figure as our basis to define who is wealthy in India. Please note that I’m assuming Rs.46,900 as the net take-home salary and not the CTC (Cost to the Company). It means Rs.46,900 is the amount that gets credited to one’s bank account each month.
Let’s define the minimum characteristics of a wealthy Indian person. A person who is starting to show these first characteristics is beginning to become wealthy.
- Characteristic #1 (Earned Income): The minimum earned income of the person should be at least two times the average world data (Rs.46,900). It means, if the person is earning an average take-home salary of about Rs.95,000 per month, he is satisfying the first parameter of being wealthy. Please note that by earned income I mean income from job, business, etc.
- Characteristic #2 (Passive Income): The minimum passive income of the person should be at least equal to the average world data (Rs.46,900). It means, the person must have an investment portfolio that consists of enough passive-income-generating assets. Assuming an income yield of 6.5% per annum, the size of the asset base should be at least Rs.87,00,000. To know the difference between earned income and passive income, read this article.
- Characteristic #3 (Growth Portfolio): There are two components of an investment portfolio. The first takes care of the passive income (#2 above). The second takes care of the necessary growth that makes a person wealthier time after time. The minimum size of this growth portfolio should be at least 50% of the passive income portfolio. As we’ve fixed the minimum asset base in #2 as Rs.87 lakhs, the minimum size of the growth portfolio is Rs.45,00,000.
- Characteristic #4 (Own A House): The person should also own at least an affordable house for herself. It can be a self-occupied house or otherwise. One can use this house affordability calculator to check the size of the required house.
For me, these are the four characteristics that become a starting point for a person to be tagged as wealthy. Pictorially, a wealthy Indian individual should at least look like this:
Who can be called as wealthy in India? A person is wealthy if he/she is showing at least these two characteristics in tandem. First, his/her investment portfolio is at least Rs.1.3 crore. Second, his monthly earned income is at least Rs.95,000 per month.
So, taking this as our basis for being wealthy, let’s try to answer a tricky question.
A person who earns Rupee four (4) lakhs per month is wealthy?
Suppose there is a fresh graduate (Mr.ABC) whose starting salary is Rs.4,00,000 per month. Can he be treated as a wealthy individual? As we have already seen, to become wealthy, the person must fulfill the following characteristics.
As a starter, earning four times as must as the requirement is great for Mr.ABC. But considering that he does not fulfill other characteristics, he cannot be called wealthy. No matter how high is one’s monthly paycheck, if all requirements are not met, a person is not wealthy.
But a high monthly income can assist in building the required investment portfolio faster. Such a person can also buy a small home as per his affordability very early in life. This way, his path to a wealthy life becomes a tad bit easier.
Compare it with a person whose earned income is only Rs.50,000 per month. This person will find it harder (compared to Mr.ABC) to climb up the wealth ladder and eventually become wealthy.
But I would like to clarify a point here. Here, the above explanation may give the impression that a high paycheck is the only key requirement to becoming wealthy faster. A higher paycheck is certainly helpful, but it does not mean that people with lower incomes cannot become wealthy.
How lower-income people can become wealthy?
Here is an example of two people. First is the high-earning person who makes about Rs. 4 Lakhs per month income. Second is a normal average person who earns an income of about Rs.1 Lakhs per month.
- High Income (Rs.4 Lakhs / Month): The person invests about Rs.1.5 Lakhs per month. As he is not very conversant with investments, he found it better to invest in a diversified equity mutual fund through the SIP route. This mutual fund scheme yielded a return of close to 16% per annum in 15 years. At the end of the 15th year, he built a corpus of about Rs.11.2 Crores.
- Average Income (Rs.1 Lakhs / Month): The person invests about Rs.15,000 per month. The person is conversant with investments, hence he invested directly in quality shares. As this person was wiser in investing, he also started investing five years early than his peer. He very carefully built his stock portfolio which yielded him a return close to 26% per annum in 20 years. At the end of the 20th year, he built a corpus of about Rs.12.0 Crores. Read: Test your knowledge of stocks.
What we can conclude from this comparison? A smart investor can use his refined investing skills to earn a high return on investment. I know few people who regularly invest in quality mid-cap and small-cap stocks. These stocks have the potential to grow at a massive rate (like 25%+ per annum) and become multi-baggers over time.
But it is also true that the majority of mid and small-cap stocks are of low quality. Hence, identifying quality stocks among this lot is a very precise skill. Learning this skill gives the ability to even low-income earners to become wealthy over time.
The idea is to use one’s intelligence and knowledge to identify quality stocks. Investing one’s money into such stocks and staying invested for the long term can help one become wealthy over time.
Degree of Wealth
Out of all people in a nation, only a handful of people are rich.
In order to judge how wealthy is a person, we can use this scale to judge the degree of wealth one has accumulated. What is the requirement to be tagged as wealthy? Check here.
- Grade 0 – Not meeting the criteria
- Grade C – Just Rich (Just meeting the criteria).
- Grade B – Moderately Rich (Income and Assets at least 10 times the requirement).
- Grade A – Really Rich (Income and Assets at least 50 times the requirement).
- Grade A+ – Filthy Rich (Income and Assets at least 100 times the requirement).
Understanding the difference between income and wealth is crucial for achieving financial success. Income refers to the money earned regularly, while wealth represents the accumulated assets and net worth.
While income is important for meeting day-to-day expenses and maintaining a comfortable lifestyle, wealth is more stable and accumulative in nature.
Differentiating between income and wealth is essential to avoid common misconceptions. Simply having a high salary does not guarantee wealth, as expenses, lifestyle choices, and debt can hinder wealth creation.
It is important to manage expenses effectively, make wise investment choices, and practice diligently saving to build wealth over time.
Moreover, it is essential to recognize that wealth can be achieved by individuals with moderate incomes as well. By making informed financial decisions, focusing on savings, and investing wisely, anyone can accumulate significant wealth.
I’ve also provided a practical definition of wealth in the Indian context, based on specific characteristics such as earned income, passive income, a growth portfolio, and property ownership. These criteria serve as a starting point to assess one’s progress toward wealth accumulation.
Higher income can facilitate wealth creation, it is not the sole determining factor. Even individuals with lower incomes can become wealthy by leveraging their investing skills, making informed investment choices, and focusing on long-term growth.
By understanding the distinction between income and wealth and implementing effective financial strategies, individuals can pave their way to financial prosperity and secure their long-term financial well-being.
Have a happy investing.