Income v Wealth

Income is certainly important to our individual financial health and without adequate income we are in trouble. Income however, but its nature, is very temporary. Income is what we earn today, this week or this month. When no income is saved or invested it provides no long term financial security.

Michael Hiltzik wrote on 10.24.14 in The Economy Hub, an LA Times blog, about the loss of wealth among middle class Americans and how that is different than income disparity.

He writes:

“Emmanuel Saez, that assiduous tracker of economic inequality in the U.S., has been shifting his attention away from income inequality to a broader, thornier and more intractable issue: wealth inequality. As he observes in a paper published this week at the blog of the Washington Center for Equitable Growth, wealth inequality is “exploding,” constituting “a direct threat to the cherished American ideals of meritocracy and opportunity.””

Here is a graph Saez uses to illustrate this disparity:


Saez found that while the so called super rich, the top 1%, gained significant wealth, the no so rich, those in the top 10% but not the top 1%, had lost wealth.

The bottom 90% had gained wealth, mostly in the form of pensions, by a significant margin between 1930-1970.

He continues with this conclusion:

“Wealth inequality is also an artifact of income inequality; the two trends work together to magnify the former. As the bottom 90% struggle to make ends meet on stagnant incomes, they’re unable to accumulate savings. “Today, the top 1% save about 35% of their income,” the authors write, “while bottom 90% families save about zero.”

Statistics Never Tell the Whole Story

I cannot vouch for the accuracy of Saez’ data in any of this. However there has been a lot written about the failure of the middle class to save as much as in times past. I also am not addressing the political issues that arise in connection with this and take no position here about the “solutions” that are suggested.

Rather I suggest that to the extent the data is correct it is over simplified and deceptive and to the extent it is deceptive it ignores a solution that requires no government action at all.

The deception, or at least the over statement which leaves out something important, is the statement that 90% of families save about zero. The problem here is the danger with statistical aggregation. In truth some of the 90% do save, some do not, and some incur substantial debt instead of saving or in addition to saving. Because Saez is trying to demonstrate stark economic disparity it would not serve him to acknowledge this more complex reality.

For those in the bottom 90% who are poor (live at or below the poverty level) saving much of anything is very difficult. It can be done but only through the most austere living and self-discipline. Most people are not willing to exercise such disciplined frugality. A portion of the 90% are able to save and a portion of them do save and invest. We all know people who do both, save and invest. It is also very feasible for people earning enough money to meet their basic needs and having some surplus.

Spending vs. Saving

Saving and investing for the middle class requires discipline. It requires a recognition that all things we consider buying fall into one of three categories: wishes, wants and needs. The more we limit the wishes and wants and limit ourselves to the needs the more money that is left over to save and invest.

Consider this: to live the middle class dream 50 years ago meant a one car garage and one car. It meant one television in a home and perhaps a couple radios. It meant on telephone. It also meant about half the kitchen appliances and devices that a typical kitchen contains today.

Today’s middle class believes it needs a two or three car garage in a house much larger than we lived in 50 years ago. They seem to believe they need multiple TVs and a score of other devices that either did not exist 50 years ago or were owned only by the very well to do. It is beyond the scope of this article to examine all those differences, though it might be a good idea for another post, but in fact today’s middle class has so much more stuff and often in multiple versions, that after it is all paid for, maintained and power provided for its operation, there is little money left over to save.

It is not so much that the middle class has less wealth today, it is more how they choose to spend it. Or more to the point that they elect to spend all or most of it on stuff rather than to save and invest it. Show me a family that lives frugally and you will find a family that saves and invests.

The Questions We Should Ask Ourselves to Build Wealth

When people understand that the stuff they buy depreciates rapidly and has no lasting value and that the money they save and invest builds wealth they can then make intelligent decisions about what to buy and what not to. For most people this analysis rarely occurs. The question that most consumers ask is “can I afford this”, which means either do I have enough cash to buy it or worse do I have enough credit to borrow to buy it?

The questions that people too rarely ask are these:

Do I need this?
Do I need this many of this item? (Do you need four televisions in a house?)
How could I save and invest the money this would cost to increase my true wealth?

The reality is that we do not need many of the machines and devices that we buy. We do not need as many of them as we buy. We do not need to replace them as often as we do. We choose to spend our wealth to buy all these things – no one forces us to. And when we buy them we decrease the amount of money we have left over to save and invest.

It is a matter of choice for the middle class. You can have an unnecessarily large house with an unnecessarily large number of things in it, or you can live more frugally and save more.

For just one month try this exercise: every time you are tempted to buy something new ask yourself is this something I truly need? If the answer is yes and you can afford it then buy it. However if the answer is “no, I do not need it, I just want it” then do not buy it. You will find that at the end of the month you will not miss the thing you wanted and you will have some money left over at the end of the month – savings.

This is not the best way to save. The best way to save is to pay yourself first – to save a set amount of money each month, and then allow yourself to only spend the rest. But we must crawl before we run. So try the month long experiment and you will find that you can live just fine with less and there will be money left over at the end of the month. Which means that at the end of the month you will actually be wealthier.

Try it. You will learn a great deal in the process and you will be able to plan to save and invest and gain true wealth, not the collection of stuff that has little or no value and adds little or nothing to the enjoyment of life, but rather the money you will have saved and you can invest.

Wishing you well,

Daniel R. Murphy
Educating people for building wealth, adapting to a changing future and personal development.