A common trap for many people is to think that income is the same as wealth. But earning a good income doesn’t necessarily make people wealthy, says Jonathan Philpot, partner of wealth management at HLB Mann Judd Sydney.
“It may sound contradictory, but it is possible for someone to be earning a very good income and yet still be in financial difficulty, whereas someone on a lower income could be well on their way to becoming wealthy.
“The reality is that if people are spending what they earn then they are not building wealth – or worse, if they are spending more than they earn, they are actually reducing their wealth.
“Someone on a good income who spends it all may have an enviable lifestyle, but they don’t have wealth,” Mr Philpot says.
He says that having a high income can in fact lull people into a false sense of security – they start to believe that they can spend whatever they like because they will always have a high income in the future. However, as retirement approaches, the future years of high income become fewer and fewer, and people realise that they don’t have sufficient wealth to support their current lifestyle once they retire.
“Rather than income, it is the ability to save that creates wealth,” Mr Philpot says.
“Wealth is what you accumulate, not what you spend. It doesn’t really matter how much people earn – whether it is hundreds of thousands of dollars a year, or the average salary – the only way that they will have ‘wealth’ is to save a small part of their weekly paycheck.
“This can sound boring and time consuming to some. They would rather believe that it is beyond their own abilities to build wealth and that there’s not much they can do without earning even more money, or winning the lottery, or stumbling across a miraculous investment opportunity,” Mr Philpot says.
So how does someone become a good saver?
Mr Philpot says good savers have some common characteristics:
“For those people who struggle to understand where their money goes, starting a monthly budget that tracks what has happened over the past few months will quickly give them a better understanding of what happens to their income.
“It also allows a future budget to be developed, which can be updated on a regular basis.”
A trap many-high income earners fall into is failing to build investment wealth once their mortgage is repaid, Mr Philpot says.
“High-income earners that commit to purchasing a home tend to meet their repayments, due to a greater fear of losing the home if they do not. But once the mortgage is repaid, some are unable to build investment wealth, and instead focus on lifestyle expenses such as new cars, home renovations or even holiday homes
“However once the ongoing high-income ceases, it is the investment wealth that will be needed to live on.”
Mr Philpot said the aim should be to work towards financial independence.
“Financial independence is when sufficient wealth has been built so that income from work is no longer required to provide the type of lifestyle that is desired.
“This doesn’t necessarily mean that people should stop working. However the aim is to ensure that financially they do not need to work. It takes a long time to build a level of wealth that will provide ‘financial independence’, so saving should begin today.”
HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and a member of the HLB Mann Judd Australasian Association.
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