Everything in personal finance seems to come full circle. This post delves into why there are times when it’s more beneficial to focus on income over net worth for achieving financial freedom.
Historically, I’ve discussed the advantages of prioritizing net worth because it isn’t taxed like income. More importantly, financial freedom means living off your investments rather than working a day job. After all, if your income mainly comes from a job, you’re never truly free until you’ve accumulated enough wealth to live on.
However, in recent years, I’ve noticed a downside to focusing excessively on net worth without boosting income. Let’s explore why concentrating on net worth is crucial before we discuss the significance of income.
Why You Should Focus on Growing Your Net Worth:
1. Tax Advantages: In America, the more you earn, the more you pay, thanks to our progressive tax system. High earners in states like California or New York can face tax rates over 50%. However, investment income from a large net worth is taxed less. For example, $200,000 in dividend income from a $10 million investment portfolio might only be taxed at 15%.
2. Subsidized Health Care: Under the Affordable Care Act, earning more can disqualify you from receiving subsidized healthcare. Yet, a family of three with a $5 million net worth earning $60,000 in dividends could still qualify for subsidies.
3. Alternative Minimum Tax Exemptions: The AMT is designed to ensure that those with high incomes pay a minimum amount of tax. Once you start earning above a certain threshold, you’ll owe a significant amount in AMT.
4. Child Tax Credits: These are income-based and begin to phase out at higher income levels. A family with a lower income but high net worth could still be eligible for significant tax credits.
5. Wealth Mindset Versus Income Mindset: Having a wealth mindset focuses on creating and maintaining wealth through assets. This approach is often more advantageous in high-cost living areas like San Francisco or New York, where real estate and equity investments can outpace income growth.
6. Privacy and Stealth: Net worth can be diversified across various assets and is harder to quantify than income, offering privacy and security.
7. Spending Temptations: Regular income can often lead to regular spending. A large net worth tends to be less liquid and harder to access quickly, reducing the temptation to spend impulsively.
8. Security: There’s a psychological comfort that comes with having a large net worth. While income can fluctuate and even disappear, it’s less likely that you’ll lose all your net worth at once unless you’re highly leveraged.
The Risk of a Scarcity Mindset with Net Worth:
Focusing solely on net worth can lead to a scarcity mindset, where the goal becomes to minimize income to reduce taxes and maximize government subsidies. This strategy can limit your financial growth and potential.
The Importance of an Income Growth Mindset:
Between the ages of 22 and 34, I was all about growing my income. This mindset led me to take risks, like moving from NYC to SF for better opportunities, which paid off well. It also motivated me to work harder to advance my career quickly. But after leaving the workforce, I shifted towards preserving capital with a net worth mindset. This change reflected my burnout and desire for a break from the grind.
Why Income Can Sometimes Be More Important:
1. It Fights Laziness: After reaching your net worth goals, continuing to focus on generating income can prevent complacency and keep you engaged and proactive.
2. It Provides a Safety Net for Investments: In a volatile investment climate, having a strong income stream allows you to invest confidently, knowing that losses can be offset by what you’re currently earning.
3. It Encourages Active and Healthy Living: Earning income generally requires some level of activity, whether it’s consulting, coaching, or another form of engagement. This activity can keep you physically and mentally sharp.
4. Immediate Gratification: Unlike net worth, which can be abstract and less tangible, income from your efforts is immediate and gratifying, reinforcing the rewards of hard work.
Conclusion:
While net worth provides a foundation for security, focusing on income growth can lead to more dynamic financial progress and personal satisfaction. As I navigate my post-retirement years, I find myself drawn back to income-generating activities, not just for financial reasons but also for the structure and interaction they provide.
Ultimately, whether you prioritize net worth or income might change over time, but both are crucial in their own right. Each plays a vital role in achieving and sustaining financial freedom.
