A few months ago, I was discussing the topic of spending and saving with a friend. I suggested that the larger the income, the larger the savings. Think: “Progressive” saving. The more you make, it seems, the more you save.
My friend responded differently, saying that if you make six-figures then you’ll find a way to spend six figures. If you get a nice laptop, and you’ll want a nice laptop bag. If you get a nice car, then you’ll want to accessories. If you get a new TV, and you’ll want more channels. Of course, I thought this was crazy. People don’t really do that, right?
Turns out he was right.
Statistically speaking, life-savings have almost nothing to do with income. Free Money Finance referenced the conclusions of two economics professors (from Dartmouth and Harvard) who did a study for the National Bureau of Economic Research.
The professors studied a little under 4,000 households near retirement, looking to see a correlation between life-savings and income. The results were surprising, at least to me: Income only explains about 5% of the net worth of the households studied.
This means it doesn’t matter if you are making $50k or $150k; what does matter is what you do with your money once it’s yours. MSN Money also summarized the study:
- Theres a huge variation in wealth at every income level. Many low-income families have almost nothing. But the same is true of many high-income families.
- Income alone doesnt explain wealth disparities. Some of the lowest-earning households had managed to accumulate significant wealth.
- In fact, income differences explain just 5% of the wealth dispersion the researchers found.
- What the researchers called chance events — inheritances, medical bills, marital status, number of children — explained about 4% of the dispersion.
- Investment choices explained about 8% of the variations.
In other words, about 8% of building wealth is choosing the right stock, 4% is about raw luck, 5% is about income — but a good 75% of it is to just save money. Deciding to do save is over half the battle. This directly supports the philosophy here at Financial Planning:
Rich is a choice.