I was recently reading The Millionaire Next Door by Thomas Stanley and William Danko and came across something that seems fairly obvious but still gave me tinglies in my butt.
As consumers we all earn money for the purpose of either consumption OR investment. Consumption is the stuff we spend to live on and enjoy life. After we’ve spent on consumption the money is gone and we’re left with nothing. Consumption is by no means a bad thing because it can enhance our lives and provide us with meaningful experiences. However, typically consumption is spent on fleeting enjoyment that is short lived and doesn’t really increase our happiness. All of these purchases require a constant flow of money (or debit) that we receive from our jobs known as realized income that is subject to a large percentage of income tax.
When the word investment is used we typically think of Wall Street stuff (stocks, bonds and Michael Douglas).
Investment is the purchase of any items that will hopefully appreciate in value down the road. This can be our house, mutual funds or even education (self investment). An investment only requires an initial input of realized income and then provides unrealized income during the remainder of the investment. Think of a house purchased for $100,000 that could now be sold for $150,000. There is a $50,000 unrealized gain here until the house is sold.
Great, now here’s the catch: Over the past few years there has been increasing discussion on the distribution of wealth within developed countries. The rich get richer, the poor get poorer and the middle class shrinks. Wealthy people with a high net worth are masters at maximizing their unrealized income; that is increases in personal wealth that is not subject to tax. The tax man absolutely HATES these people because the vast majority of their wealth is untouchable for taxation purposes since it has not been realized, thus saving them from a massive tax expense. All the while allowing them to continually increase their wealth.
While it’s true lower income households typically enjoy a lower tax bill (as much as one can “enjoy” tax), however, the majority of their realized income goes towards consumption and living so it’s damn near impossible to join the rank of investor. The problem is also compounded with poor spending habits and lack of investment knowledge.
A high realized income seems to be the main priority for most young adults starting their careers. Thousands are spent on tuition for higher education for the purpose of landing that job with the high salary. Education and a great job are awesome, but far too often consumption quickly catches up with the salary and there’s not much left to put into investment. More focus is put on the realized income maximization than consumption versus investment. Realized income is a great start on the path to being wealthy but unrealized income from investment will help you get there faster.by