According to the Merriam Webster dictionary the definition of ‘rich’ is:
“having abundant possessions and especially material wealth”
In Australia this could mean having a high income, and perhaps more appropriately, having a high net worth. If we define high income as being in the top 10% of household income levels, this would mean earning an income of $2,630 per week after tax, or $136,760 per year (ABS 2019).
However, to fit the dictionary definition more appropriately we’d probably want to look at the top 10% of households by net worth. In this case, having a net worth (after liabilities removed) of $2.23M would put a household in the top 10% (ABS 2019).
Expenses and passive income
Because financial independence is about expenses relative to passive income, being rich, as defined by income or net worth, doesn’t say much about financial independence. As is often the case, high income households have high costs of living which not only slows the activity of building passive income streams, but also means they need more passive income to be financially independent.
In addition to this, much of a household’s wealth is often accounted for by non-productive assets such as their principal residence, dwelling contents and vehicles. In the 2017-2018 financial year the average household’s net worth was $1.205M with 49.6% of this figure was represented by non-productive assets (ABS 2019) (note 1).
What are the lessons from this?
Compare your position to your goals, not other people
There are no courses for this, but, in my opinion, it’s one of the most difficult skills to learn in personal finance. Remember that when you see someone with a high paying job; nice car and fancy house your brain automatically makes assumptions about their wealth. What to remember is this information reveals almost nothing about their financial situation. Even the statistics from the ABS, as interesting as they are, don’t really reveal much about how close households are to achieving financial independence.
Focus on your savings rate, not solely your income
When working towards financial independence, having a high income makes building a portfolio easier. However, household income should always be considered relative to household expenses. Savings rate has a huge impact on the speed and likelihood that a household reaches financial independence. In my opinion, learning to live below your means is the most important aspect of personal finance to get right.
Focus on building a portfolio, not solely on building net worth
Net worth is the sum of all of a household’s assets minus their liabilities. Many of these “assets”, such as the principal residence; cars; furniture and appliances; often do not contribute to passive income. This implies that you should only acquire enough of these items to live a comfortable life and focus primarily on building a portfolio that can fund your early retirement i.e., give you a slice of some that that delicious financial freedom.
Concluding thoughts
Earning a high income and having a high net worth gives a household an increased chance of being financially independent but it is far from a guarantee. For me, being rich (whatever that means), is of little importance when compared to being financially independent. I acknowledge that building wealth, and increasing our household’s net worth, is an important part of achieving financial freedom but I also recognise that it’s means to an end, rather than an end in itself.
Engineer your freedom
Notes
- Non productive assets are counted as owner occupied dwelling, contents of the dwelling and value of vehicles
References
Merriam Webster, 2021, Rich, adjective, Merriam-Webster, available from: <https://www.merriam-webster.com/dictionary/rich#:~:text=1%20%3A%20having%20abundant%20possessions%20and,3%20%3A%20magnificently%20impressive%20%3A%20sumptuous>
ABS, 2019, Household Income and Wealth, Australia, Australian Bureau of Statistics , available from: <https://www.abs.gov.au/statistics/economy/finance/household-income-and-wealth-australia/2017-18>