Income and net worth are probably the two most talked about financial metrics in personal finance. When talking about the ultra wealthy, we tend to use net worth to describe their wealth. But when talking about ourselves or others in our close circles, we are much more likely to talk about income as the metric of financial success.
As we all know, net worth and income are usually correlated but there are some notable outliers. These are the people that never had impressive amounts of income but still managed to build impressive net worths. There are surprisingly many stories of federal employees who never had 6-figure incomes yet still managed to retire as millionaires.
Here are 3 big reasons why you should focus on your net worth more than your income.
Debt Does Not Count
One of the main reasons that net worth is a powerful metric to track is because you have to subtract your debt. For those that aren’t familiar with formula, here it is:
Net Worth = All of your financial resources (assets) – All of your debts
We are living in a very consumer driven economy. It is not uncommon for many to spend beyond their means and to take on debt to do so. Now, not all debt is bad but as a general rule, debt slows down our financial progress.
This net worth formula reminds us that even if we are saving in our TSP and building equity in our home, our networth won’t increase if we are racking up credit card debt, auto loans, and other debts just as fast. Having a large sum in your TSP is a great thing but if you have a lot of debt (especially credit card debt), it will erode your financial position no matter how much you have saved for retirement. Of course we want to grow our assets and our TSP, but we have to keep our debt under control at the same time.
The IRS Comes After Income
Here in the United States, we have a progressive tax system. This means, the more money you make, the higher your tax bill. The more you earn as regular income, the less (percentage-wise) you’ll actually be able to keep. The tax system is often much more lenient on net worth. For example, when you save in your TSP, you not only get a tax break today (assuming the traditional TSP) but your investments will grow tax deferred until you take it out. By giving more attention to building your net worth, you will often improve your financial position while also paying less taxes in the process.
The Mindset For Success
When it comes to reaching your financial goals (or any goal for that matter), your mindset can make all the difference. Becoming financially free often happens only after we start focusing on the long-term consequences of our short-term decisions. Net worth is the long-term game while income is the short-term. Income may allow you to buy and do cool things, but net worth can bring you long-term freedom. Income is important and can help us reach our financial goals faster. But without building our net worth, it is almost impossible to build a better life for ourselves and our families.
