Making Money vs. Building Wealth: What’s the Difference

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Making money and building wealth are not the same. Here’s why -

Here’s a simple thought to get started. What is wealth?

It is not your salary.

It’s not your bank balance.

It’s not even your investments.

So, what on earth is it? And do you have it, yet? Let’s find out.

Let’s say you own:

  • a house worth 1.1 Cr
  • a 15L car
  • a home theatre system, 55-inch flat screen TV with super Amoled display, & side-by-side door refrigerator

Is the above a good indication of your wealth status? Nope. The problem with it is this. A little more digging will show you that:

  • Your 1.1Cr house — has an outstanding 82L loan
  • Your 15L car — has an outstanding 11.5L loan
  • Your appliances — that you got on “Buy now, pay later” schemes, are now “Bought then, paying now” scheme worth 1.75L
Example for Assets vs. Liabilities

This, asset (all that you own), minus liabilities (all that you owe) is called your Net Worth.

And it is Net Worth, which is considered to be the most reliable indicator of your wealth — which like you saw, is entirely different from making money.

In simple words, if you spend money more than or faster than you earn it — you may be making money but you certainly are nowhere close to being wealthy.

Definition of Net Worth

But here’s a counter question you may ask basis the above logic.

What happens if I’m someone who — still stays with my parents, uses their house, car and appliances and, so on?

By the above logic, am I wealthy even if I’m earning only 30K per month?

Awesome — asking this question surely makes you a smart person — but no, it doesn’t still make you wealthy. That’s because apart from Net worth, there is something called ‘Ideal Net worth’ for every person.

This Ideal Net worth is based on a mathematical rule of thumb that is expressed by the following formula:

X*Y*0.1

Great — that is totally meaningless, right? Here, this is what it means in plain English.

Formula to calculate Ideal Net Worth

Your ideal net worth depends by and large on 3 things:

AGE (X)
Why is this important? That’s because as age increases, the number of active income-earning years reduce. And ideally, one should have higher NetWorth as age increases to ensure a comfortable post retirement life.

ANNUAL INCOME (Y) (Average for someone of your educational background):
This indicates the standard of living or the lifestyle you currently afford — the assumption is one would like to improve or at least maintain the same lifestyle even after retirement.

SAVINGS RATE (0.1 or 10%)
We all know the importance of saving money, and the ideal savings rate for everyone should be around 35–40% of their monthly income. However, given this is usually difficult in the early years of earning, a conservative estimate of 10% on an average is considered.

Let’s see this with an example:
If you are 35 years of age and have an MBA from a premier B-school, which as per market will earn an aveage income of 50L per year, then your ideal Net Worth should be:

35*50,00,000*0.1 = 1.75Cr

i.e. After deducting all your loans, taxes, credit card bills, etc — you should have assets worth 1.75Cr.

And what happens if your present Net Worth is only 80L? This means you have a Wealth gap of 95L.

And just like wealth, wealth-gap too is not directly proportional to making money or your active income. A person earning a higher income can have a higher wealth gap than a person with a lesser income.

But here’s the thing — many people under the age of 45 are likely to have a wealth gap — simply because they haven’t earned for enough number of years to pay off all their debts, which they may have taken to build assets such as property.

However, you must always be cognizant of the gap and you should actively work towards bridging it.

Now, there are two ways in which you can aim to bridge this gap -

  1. Creating an investment goal: Doing it of course requires factoring in a lot of information about not just you, but also in creating an ideal portfolio that will help you bridge the gap in the optimum time. Moreover, it should be mapped to the risk profile that is right for you. Read about how to discover the right risk for you.
  2. Increase your savings rate: A simple adjustment to your current lifestyle by cutting down on some non-essential or recreational expenses — especially if done from early on — can make a significant difference over time by investing the excess amount.

Elever has a ‘Wealth Builder’ goal advising you the right way to go about setting up your goal and helping you in each step of your Wealth Builder journey. Head to this link to explore the app: https://play.google.com/store/apps/details?id=com.elever.invest

Here’s how to go about creating a systematic investing strategy for improving your lifestyle.

Originally published at https://elever.app.