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You see it over and over again out there.
People pining to get to the near-mythical “6-figure income,” as if that’s the holy grail of wealth.
Newsflash… it’s not!
You see, high income, wealth, and financial independence are tightly woven together and interrelated, but they’re not at all the same.
Don’t Confuse High Income with Wealth
If someone makes $500,000 annually, does that mean she’s wealthy?
It doesn’t.
Say what?!
Absolutely not. Of course, it means she has a much better chance of becoming wealthy if she manages her money well. But if she spends every dollar as soon as it comes in (if not sooner, hello credit cards!), all she’s doing is getting used to “la dolce vita,” and setting an impossibly high bar to ever being able to stop working.
And heaven forbid she ever loses her income!
Because wealth is not defined by your income.
As described by Investopedia, income is the flow of resources or money into your possession, wealth, usually measured by net worth (the difference between what you own and what you owe), is the reservoir of assets in your possession or under your control.
However, as alluded to above, it’s far easier to build wealth with a high income than with a lower one.
Say you can save 10% from a $75k annual income. If your income doubles, your net income will increase less than double (since income taxes in the U.S. are progressive), but your after-tax, after-expenses money available to invest would increase far more than two-fold.
What It Takes to Be Wealthy in the U.S.
Let’s first clarify some terms.
Many people differentiate between being rich and being wealthy, but there doesn’t seem to be a consensus as to what those differences are.
Some think you’re rich if you make and spend a lot of money, regardless of your net worth. Others believe that being rich means you have a high enough net worth to not have to work if you don’t want to while being wealthy means you can do things like buy a mega yacht, donate enough to have a building named after you, or perhaps develop an actual spaceship.
However, as stated above, making a lot of money and spending it all has nothing to do with wealth. And as for being able to afford outlandish expenses, let’s just agree to call that being “uber-wealthy.”
According to Charles Schwab’s Modern Wealth Survey of 2022, a survey of 1000 Americans aged 21 to 75 said that to be “financially comfortable,” in their neighborhood you’d need a net worth of $774k while being “wealthy” required a net worth of $2.2 million.
Over the past five years, the former number plummeted by 45% from $1.4 million, while the latter stayed within a much tighter band of ±15% (the lowest was $1.9 million in 2021 while the highest was $2.6 million in 2020, pre-pandemic).
According to DQYDJ (using 2020 Federal Reserve data), a net worth of $2.2 million (counting the equity in your home) would place you in the 94th percentile in the U.S. To make it to the 99th percentile, you’d need $11.1 million.
What Financial Independence Means
Quick, do you need to be wealthy to be financially independent?
Actually, you don’t, if you measure wealth by net worth, and your needs are few.
Because financial independence means you’re not driven by your finances. You’ve reached what some term a “work-optional” status.
If your finances provide enough passive income to cover your spending forever, you’re financially independent.
So, if you’re happy living on, say, $30k a year, and you have $36k coming in from a combination of your portfolio and/or rental income (net of expenses including property management), you’re financially independent.
What Does It Take to Achieve Financial Independence?
Say you buy properties worth $150k each, which cost you about $40k each in down payments, closing costs, repairs, etc., each with a $120k mortgage.
Say you then charge $1500 a month in rent and have monthly expenses of $500, including property management, plus another $500 for mortgage principal and interest. This leaves you an annual cash flow of $6000 from each property (in addition to the slow reduction in mortgage balance owed, and neglecting any property value appreciation).
Six such properties could provide you the $36k income you want from a net worth of just $180k. The caveat is, of course, that if your properties stay vacant for an extended period, your income may drop to unsustainable levels and you’d be forced to sell the properties to avoid bankruptcy. Also, over the long term, as you pay off the mortgages, your net worth will climb (ignoring appreciation) to about $900k.
If you invest in stocks and bonds, you’ll likely need about a $1 million portfolio to get $36k a year on average.
Here the caveat is that the markets can and do suffer downturns, sometimes severe enough to deplete a portfolio if you don’t adjust your spending down.
In either of the above scenarios (or a combination of the two), you can be financially independent with less than the $2.2-million “wealth threshold.”
But that’s if you’re ok living on less than $3000 a month.
Based on DQYDJ’s U.S. household income percentile calculator, that would place you at the 26th percentile of income.
But what if that’s not enough for you?
Say you want at least the median income of $70,500. You might need almost double the above examples, say 12 properties renting out at $1500 a month with a cash flow of $500 a month each, or a $1.96 million portfolio.
And if you want a more luxurious retirement, with enough passive income to be in the top 10%?
Bringing in the $212,110 annual income you’d need to be in the 90th percentile you’d need six times as many rental units or about $5.9 million invested in the markets. Clearly, that’s far above the “wealth threshold.”
Note that I’m using a “3.6% rule” here, rather than the more common 4% rule.
Interestingly, if your idea of a comfortable retirement requires that $212,200 income, you can be wealthy (net worth above $2.2 million) without being financially independent!
Relating Wealth and Financial Independence
For this next illustration, let’s assume 100% of your retirement income comes from your portfolio, and that you count on the 4% rule to estimate the income you can count on (this is not necessarily workable for early retirement, but we’ll set that aside for our purpose here).
First, let’s see what net worth percentile you’d need to be in to achieve certain household income percentiles:
The above table shows you’d need to be in the top 11% by net worth (excluding your home’s equity) to manage a retirement income that puts you in the lowest quartile of household incomes!
Want to have the median household income to retire on? You’d need to amass an investable net worth in the top 6%!
In fact, you only reach approximate parity between desired retirement income percentile and the net worth percentile required to achieve it if you’re in the top 1%!
Now, let’s flip this on its head and look at what income percentile you can achieve for a certain set of net worth percentiles.
If your net worth is in the 25th percentile, the “retirement income” you’d be able to generate from your nest egg would place you in the lowest percentile of income!
If your net worth is at the median, (sarcasm alert) congratulations! You can generate enough retirement income to place you in the 2nd percentile.
To be clear, that means 98% of households would have a higher income!
How about if you were successful enough to make it to the top 10% of the net worth distribution? Your $906k nest egg could generate enough income to place you in the (drum roll please…) 26th percentile of income.
And again, you’d need to be in the top 1% of net worth to generate enough income to at least come close to the top 1% of household income.
A Few Caveats
In the above, I wanted to include the possibility of early retirement, which so many strive for.
If we were to look solely at retirement in your 60s or later, which I plan to do in another article, I’d do a few things differently.
- Look at net worth percentiles for people 65 and older instead of the overall adult population.
- Account for Social Security benefits.
- Reduce required income by 20% (33% if you’ve paid off your mortgage).
These three changes change the picture significantly, which is why retirement is still somewhat possible for the middle class (upper middle class if you want a more comfortable retirement).
The Bottom Line – Putting It All Together
To summarize, here’s how high income, wealth, and financial independence are woven together:
- High income doesn’t mean you’re wealthy because it measures your money flow, not your assets (which is what wealth measures), though it does make it easier to set aside and invest more money, which lets you build more wealth more quickly
- Being wealthy doesn’t mean you’re financially independent, because you may want a higher retirement income than you can get from a $2.2-million net worth
- Being financially independent doesn’t mean you’re wealthy, because you may be fine with such a small income that you don’t need a $2.2-million net worth to achieve it
- If your retirement expenses are close to the median household income, being wealthy and being financially independent are more closely correlated
- Due to the extreme wealth inequality in the US, a comfortable retirement (say 75th-percentile income) based on an investment portfolio would require a net worth in the highest 4%! Kind of explains why so many say they expect to never be able to retire…
Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the Author
Opher Ganel
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.
Connect with me on my own site: OpherGanel.com and/or follow my Medium publication: medium.com/financial-strategy/.
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