Forget Net Wealth, Think Income Producing Wealth
Net wealth is often bandied about as the primary measure of wealth. It’s the reason to give yourself a big pat on the back if it’s a pretty big number. The problem though is most people’s net worth is tied up in their own housing. Yes, it’s worth something, but that house does nothing for you. It costs you money to own and live in and earns you absolutely nothing. That is, your home is not an asset that makes you money, but an asset that costs you money, even if it appreciates. It not income producing wealth, but expense creating wealth. For that reason it shouldn’t be considered part of your true wealth. A better picture of your wealth is the amount of assets you have that make money and produce additional wealth. It’s this wealth that you can potentially live off in the future. Your own home will only ever cost you. So forget net wealth, think income producing wealth.
So here’s how to work out your true wealth.
- Add up every asset that generates income and makes you money, your income producing wealth (think investment homes, shares, businesses, super, cash in the bank) – every debt you currently owe (loans, credit cards, mortgage, etc) = your true wealth.
Now traditionally net wealth would include your home and even depreciating assets like cars. But these are assets that cost you money. Sure you get a far more impressive number by including them, but it does nothing for you. Your true wealth is really only those assets that can generate future income for you. That’s the number you want to grow and build as you move towards financial independence.
This can be a humbling reality. It may mean your true wealth is far less than you imagined. For me, you move from a whopper of a 7 figure number to a far less impressive 6 figured one, a big drop. Chances are it’s the same for you. You may even have a negative number! But this is the number you need to work off and work on. So forget net wealth and instead think income producing wealth.
Income producing wealth grows itself. Shares, businesses, investment homes all grow more wealth that can produce more income. This is compounding wealth. The aim is to produce more income from income producing assets than your expenses to live on. At this point you are financially independent and can passively grow your wealth. Smart people focus, not on owning a big house, but increasing their income producing assets. This is what you should do.
What About The Home?
Am I saying you shouldn’t buy a home. No! You need to buy and own a home before you retire. A home is a good investment, it’s just not one you can live off, just live in! You can check out my post on this here. There are a few practical implications though. It may not be the best idea to go for the biggest house on the street. When you understand that it’s just a place to live and something that costs you money and doesn’t make you money. Then you won’t be tempted to put all your money into this one thing. The foolish move is to keep upgrading into a home you don’t really need, somehow thinking you are generating wealth. You’re not, your wasting wealth that could be put to better use. It’s smarter to have a moderate home and plow more money into income producing assets. Or if you own your home, to leverage that asset to buy other income producing assets. So don’t put all your eggs in your house. You want to move on from that as quickly as possible to generating true wealth with income producing assets.
Now some might say, ‘When I retire we’ll downsize and release all that value in our home.’ That seems like a good idea. But here’s the reality. When most people downsize later in life, they want to live in a nicer location. That costs more for less. In addition the price between a family home and an apartment isn’t nearly as large as you’d think. Chances are you won’t free up as much as you think. I’ve seen this happen a lot! But the worst thing with this is the opportunity cost. You’ve had so much capital tied up in an asset that as made you nothing for a long time. If a small portion of that was invested in income producing assets instead. And that income was reinvested over time, the amount of income and wealth you have missed out on can be mind boggling. Certainly far more than the tiny figure you get when you downsize. Better to go a modest home, pay it down to something easily manageable and start investing in income producing assets as soon as you can. Don’t miss the opportunity!
This is something I wish I had been taught earlier. The Aussie dream is to own your own home and then upgrade it. So most Aussies only ever own one asset that never makes them anything and costs them their whole life. This is a mistake you can avoid. Don’t go for the dream, go for income producing assets. And that means living in a suitable home, not a mansion. The irony of all this is, once you have lots of income producing assets, then you can afford the big home and the nicer car. Most Aussies just go about it the wrong way round.
The Best Income Producing Assets
Historically the best income producing assets are businesses that generate positive cash flow, real estate and shares (a small slice of income producing businesses). All have risks, all can increase and decrease in value. This, by the way is why most people miss out, it’s just too scary. But over time, income producing assets will beat cash in the bank or cash tied up in assets that cost you money (ie. your home). So you want to work at growing income producing assets. Maybe buy some shares (get good advice) or start a business on the side. But make sure you think income producing wealth, not net wealth.
as always this is only my opinion and not personal financial advice, please read my disclaimer.