2013-03-22

Wealth And Income

Prologue:
Many people try to make the point I am about to try to make, and most of them fall flat. So it should prove to be no surprise if my attempt also falls flat. Despite my probability for failure, I am going to give it the old college try, in hopes that what I am about to say resonates with you in a way that was never true of other authors who have attempted to make this point before me.

Defining The Issue:
Most of us have a vague notion of what I mean when I contrast the terms "wealth" and "income," but few people have ever bothered to think through the differences and their implications. Let us begin by simply defining the terms.

  • Wealth (at least, according to Wikipedia) "is the abundance of valuable resources or material possessions."
  • Income (same source) "is the consumption and savings opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms."
If you are a human being with normal cognitive functionality, then your brain has already jumped three steps ahead and you are finding some ambiguity between the two concepts. After all, what is a "consumption and savings opportunity," if not an "abundance of resources or material possessions?"

And yet, we must resist the urge to jump ahead. The key to the definition of income is not merely the opportunity to consume or save, but more specifically that opportunity which has been gained within a specified timeframe. For instance, you have no new opportunity to consume or save now than you did five minutes ago. Thus, while you maintain the same opportunity to consume or save now versus then, you have no additional opportunity specifically attributable to that five minute period. 

No, the only way you can gain an additional opportunity to consume or save - i.e. an income - is by generating some sort of income through labor or investment. Otherwise, all we are really talking about is the potential consumption of your acquired wealth

Get it?

The Superficial Relationship Between Wealth And Income
Any six-year-old with a weekly allowance knows the difference between the pennies that are already in your piggy bank and the new ones you are about to put there. Our inner six-year-olds also understand that income is the means by which we can acquire wealth. A six-year-old will, unfortunately (and forgivably - after all, six-year-olds have much to learn) conflate wealth and income in precisely the same way our brains were trying to do so when we read the definition of those words above. 

It is our inner six-year-old who is trying to conflate those terms. It is our inner fifty-six-year-old who has the wisdom and restraint required to understand how important it is to keep things separate. Let's take a look at a couple of examples.

First Example - John:
John is a twenty-year-old day laborer on a construction site. He works very hard, from before dawn to after dusk, building homes, roads, offices, and so on. He's not rich, by any means, but he's making good coin for his age. He gets his paycheck on Friday, cashes it, and heads to the local sports bar for an evening of drinking, rabble-rousing, carousing, and so forth. He works up a hefty bar tab, pays in cash, and goes home. The next day, he hits the grocery store and pays off his urgent bills. He spends much of the rest of his money on video games, beer, his girlfriend, and the occasional tattoo. By Wednesday, he is extremely low on cash and compelled to eat Instant Noodles for lunch and dinner until the following Friday, when he can begin the cycle anew.

Although John is making what many would consider a nice middle-class income, many of us would say that John is not very wealthy. Our common-sense reasoning would be that John is not "putting anything away." He's spending his money as it comes in, living paycheck to paycheck despite the fact that he has ample ability to save. Technically, we could say that John has access to the same things of value to which anyone with his income has access - but John chooses to spend his money on things that do not retain value over a long period of time. The value of his beer expires as soon as his buzz wears off, for example. 

John has plenty of income, a good degree of wealth, but his cognitive time-horizon is more reflective of his inner six-year-old than of his inner fifty-six-year-old.

Second Example - Ralph:
Ralph works at Starbuck's and studies anthropology at the local university. Ralph's income is much lower than John's, and yet like John, Ralph lives in a modest apartment. Ralph might not own John's nice Ford F-150 truck, but he does own a pretty cool bike, which reliably gets him from his apartment to work, to school, around town, and anywhere else Ralph needs to be. He saves a lot of money this way, since he doesn't need to shell out valuable money for gasoline, car payments, and auto insurance. Ralph does his fair share of drinking, but usually does so in the form of house parties with his friends. They'll all bring over a bottle of something and a dish of something homemade to eat, put on some music, and have a long night of fun. 

Even so, Ralph's pattern of behavior is a lot like John's. He gets paid on Friday, heads to the grocery and the farmer's market for some fresh groceries and a couple of bottles of alcohol. He enjoys his house party or whatever, pays his rent and utilities bills, his tuition or student loan installments, maybe buys a few new pieces of trendy vintage clothing from the second-hand store, and by Wednesday, he's feeling the squeeze. He'll have to spend the next couple of days scrounging for hummus in the back of his refrigerator and maybe eat some pasta without pasta sauce in order to last until Friday. Still, he's happy with his life. After all, he's got friends, he's got food to eat and a roof over his head, and he's doing just fine. He doesn't need more than what he already has. John could learn a thing or two from Ralph.

Ralph has scant income, but about the same amount of wealth that John has. Even so, his cognitive time-horizon reflects more of his inner six-year-old than his inner fifty-six-year-old.

John And Ralph - A Discussion:
Despite the difference in their incomes, John and Ralph live very comparable lifestyles. If we understand the word "lifestyle" to involve the same kind of things involved in wealth - abundance of valuable resources and material possessions - then these two guys are about equal. John has a truck, which might represent wealth that Ralph does not possess. But Ralph's lifestyle also precludes him from needed a truck. In that sense, Ralph might not feel any wealthier if he owned a truck than he does now; and it would certainly cost Ralph a lot of income that he is not currently generating.

Our knee-jerk belief is that Ralph is investing more in his future than John is, since Ralph is pursuing a college education. That may or may not be true. For one thing, a degree in anthropology is not particularly valuable on the labor market. For another thing, John's investment in a truck is helping him build a higher credit score, which will prove very valuable to him, should he ever choose to make more long-term investments in real estate, financial instruments, or a wedding ring. On this, I would again put them at about par, since they are both engaged in activities that may prove modestly fruitful in the future, even if they are not as fruitful as more savvy and longer-term investments.

The key point here, though, is that the approximately the same level of wealth can be had within a broad range of income levels. 

A follow-up question might be this: would raising John or Ralph's income make a significant difference to their overall level of wealth? How about their standard of living? Personally, I do not think so. 

For one thing, I believe that if John were given a raise, he would consume more of the same sorts of things: More tattoos, more accessories for his truck, more beer, and so on. There are a few key areas that John could improve if he took the time to do so: (1) he could apply his raise almost exclusively to groceries and enable himself to enjoy better meals all week long; (2) he could upgrade his truck, which may potentially save him gas money or improve his job performance, if he buys the right kind of truck; (3) he could radically extend his cognitive time-horizon and invest in better tools for his job, enabling him to perform better, win better job contracts, get better bonding, or potentially start up a contracting business of his own some day. But three is the least likely scenario for a guy like John, thus it seems most likely that a raise will not make a major impact on him.

As for Ralph, it strikes me as unlikely that he has any immediate upgrade to his lifestyle, other than John's number (1), above. A raise may enable Ralph to greatly expand the scope of his existing consumption, such as better quality food, better alcohol, trendier clothes, etc. But his lifestyle precludes him from making any immediate upgrades, and this may be the one wealth differential between Ralph and John. Nevertheless, there is always the remote possibility analogous to John's (3). Ralph could always radically extend his cognitive time-horizon, change his major to something more practical, while he simultaneously trades his barista job for a stint running accounts receivable reports at the local bookstore. This would open up a whole new world of wealth-generation possibilities for Ralph - and I have known many Ralphs in my life who have opted for this choice. Nonetheless, that kind of choice is more than just a change in Ralph's cognitive time-horizon - it is a change to his whole way of life. In a sense, he'd no longer be Ralph if he applied himself in that particular way. I have also known my fair share of Ralphs who deliberately chose not to do something like this, because they valued their bohemian lifestyle more highly than their potential for greater wealth.

Conclusion
There is much to say about a topic like this, but I think I will leave it at that for today. The crucial points I am trying to make are:

  • There is a difference between wealth and income
  • The same level of wealth can be experienced over a broad range of incomes
  • This implies that some low-income people are potentially experiencing more wealth than some middle-income people.
  • Changes to a person's income have a less important impact on their relative wealth than changes to a person's psychology.

To increase wealth in the long run, both John and Ralph would have to go through a bit of a catharsis. As I mentioned above, John would have to resist the urge to spend through his paycheck quickly and instead start investing his money in ways that yield higher returns in the long run. Ralph would have to reevaluate his bohemian life choices and decide that he might be better off pursuing more "mainstream" life choices. The unfortunate thing for both of them is that this is plainly and simply a choice between their current chosen lifestyle and a lifestyle that is drastically different.

The new lifestyle may or may not be what John or Ralph need to experience "true happiness." It is entirely possible that they are happier in their current state than they would be if they pursued greater wealth. But if they decide that greater wealth is a key to their own future happiness, they must be willing to make the corresponding life choices.