Why Are We Earning More But Getting Poorer?

Hazelle

I’m sure everyone has heard of Michael Jackson. Known as the “King of Pop”, his name was celebrated everywhere and he sold more than 100 million albums worldwide. In fact, he actually raked in millions of dollars as his annual revenue! With such an impressive income track record, nobody expected that he was actually drowning in millions of dollars in debt upon his death. Shouldn’t he have lots of wealth with his impressive income?

For a man as successful as Michael Jackson, you wouldn’t think that money was an issue for someone with his income. This is because many tend to associate having more income with an individual’s wealth. They think they are set for life if they get a higher salary, win the lottery or inherit a large sum of money. However, reality is not so black and white.

What comes with a higher pay is also the urge to upgrade consumption. Let me give you an example. When you are earning a mid-range salary, you would buy a less luxurious car that would match your salary such as a Kia or a Toyota. However, once you have started earning a higher salary, you would be enticed to upgrade your car to something more high-end (and expensive) such as a Mercedes or a BMW. The higher your salary goes, the more you chase after luxurious goods that can enhance your lifestyle. That’s simply because you have the mentality that ‘you can afford it’. You stop looking at the price tag and more of the social value that entails its purchase. In essence, having higher income leads to more spending. It’s Human Nature to indulge in what we feel we deserve after all.

So what is the issue? If there’s money, why not spend it to make your life better?

What many of these high-income earners fail to realise is that this type of luxurious lifestyle can be difficult to sustain over time. Their poor spending habits by buying expensive goods such as sports cars or bigger houses can accumulate, depleting earnings quickly. To make matters worse, these luxuries are only temporary as their income can vanish due to unexpected circumstances such as an economic recession or a pandemic. This can result in debt as they may not have the extra resources to pay maintenance for the luxurious properties they bought as well as for essential goods.

Another factor that prevents high income earners from building more wealth is their failure to keep track of their expenses. When you earn more, there are more purchases that may seem “small” and “insignificant” to you, especially essential expenses such as food, transport and housing. Thus, this gives you more room to purchase goods that you desire. However, high income should not be used as an excuse to splurge on whatever you want. There is a limit on how much you can spend realistically and this can be obtained by tracking your spendings. Having a clear understanding of where your money goes, especially for someone that has the capacity to spend more, can help put into perspective how much money you can actually spend to prevent overspending.

In short, if you carelessly splurge all your income on various luxuries and inessential expenses, you will not be able to build wealth.

How does one build wealth to ensure long-term financial stability?

Let’s first understand what wealth is.

Wealth is the abundance of financial assets or physical possessions that can possibly be liquidated for future transactions. The concept of wealth accumulation is often built upon long-term financial goals such as financial stability and early retirement. Having high income makes building wealth much easier because you have more money to spare for savings and investments. But as we have shared in our earlier points, having high income does not always necessarily equate to more wealth. In fact, it is possible to build up your wealth better than someone earning a higher income than you.

50-30-20 Rule

To begin, you can apply our 50-30-20 budgeting rule inspired by Elizabeth Warren’s very own budgeting rule as a general guide on how to spend, save and invest efficiently. There have been different variations of this rule such as the 70-20-10 rule and the 60-20-10-10 rule. However, the main takeaway for each of these rules are the same: you must portion your take-home salary wisely.

For The Joyful Investors’ version of the 50-30-20 rule, the 50% should be allocated towards needs and wants expenses. This is the percentage of money you spend on expenditures such as food, car payments, mortgage and entertainment. You can also further split this 50% into discretionary and non-discretionary expenses. Purchase of products you desire also falls into the discretionary expenses category.

The 30% is allocated towards investment. This is important as it allows your money to grow to a larger sum, boosting your income to fund your lifestyle and enhance your quality of life.

Lastly, 20% will be allocated towards savings. This will be used as your ‘emergency funds.’ In situations like when COVID-19 hit, it is pertinent that you have at least 6-months worth of expenses in the form of liquid cash. This can be used to maintain expenses during an emergency such as unemployment or medical accidents. As a general guide, it is definitely important for people to set aside sufficient funds as emergency funds for the rainy days.

It is up to your preference if you would like to continue with this rule after saving up enough for your emergency funds. You may allocate a bigger percentage for any of the categories based on your comfort level. Nevertheless, through the use of this rule, you can easily portion your money and budget at the same time without the stress of counting every dollar that you spend.

The 50-30-20 rule can also be adapted flexibly to suit your current stage of life and income level. For instance, if you are in the midst of renovating your new house, then perhaps you will have to increase the proportion of spendings while reducing the proportion on investments or savings. Realistically speaking, it may not be that easy for someone earning an income in the lower income bracket to just spend only 50% of his monthly salary. Hence, the 50-30-20 rule should be modified accordingly.

Earning more certainly gives you an advantage when building wealth. Be that as it may, if you don’t use it wisely, there is a high probability you will end up in debt. This is because expenses and emergencies will come up in the future and you might not have the money to pay for them if you have been spending carelessly. Though yes, there are good debts. If you want to know more about what is considered as good debts, do comment and let us know. To avoid this, the solution is just to save, invest and keep your expenses to a minimum. Regardless of your income, it is what you do with your extra dollars that matters, so look at the man in the mirror and spend wisely.

About Hazelle

Chief trainer of The Moneyball Investors Playbook program and founder of The Joyful Investors, a financial education firm that seeks to help avid investors learn to invest better and make the journey a joyful one. I graduated with a first class honors in Bachelor of Accountancy from Nanyang Technological University (NTU) and started my auditing career in one of the Big Four. I believe that once we know how to build our wealth sustainably, we can then live our best lives ever.