If you want to achieve financial independence, focus on building net worth even more than growing income. A big net worth gives you more flexibility. You are also taxed at a lower rate.
A high income is great. But W2 income is taxed at the highest rates. Instead, you want to generate as much investment income as possible to live free.
Day job income is uncertain. We all think our income will continue to grow to the sky for decades, but one day it'll likely stop growing.
We might get a new boss who doesn't like us. Our company might get sold or go bankrupt. Departments might shutdown. We might absolutely burn out. All sorts of things could happen that will assail our income growth.
Income Comes And Goes, Net Worth Is More Sticky
I thought my income was going to keep on growing to “make it rain” status by the year 2017 (age 40), but my income was slashed in half during the 2008-2009 downturn. It recovered in 2010 and 2011 before getting completely cut in 2012 after I left the finance industry. Only after two and a half years of working online has my income finally got back to my day job income days.
Needless to say, my income is highly volatile and should not to be counted on at all! The only thing I have counted on is my consistent discipline to put away at least 50% of my after tax income every year, no matter what.
As a result, focusing on growing my net worth into a stable behemoth has been my main goal for the past 10 years.
Focus On Building Net Worth More, But Your Day Job Is the #1 Source Of Income
In an ideal world, one will have a sizable income and large net worth. I suggest everybody try their hardest to get that promotion and raise throughout their career, methodically max out pre-tax retirement accounts and sock away at least 20% of their after-tax income no matter what so that your net worth continues to get fed.
Your net worth growth rate might speed up or slow down over time, but the goal is to always have it go upwards.
It's great to focus on super-charging your income. What's equally important is figuring out how to re-invest your income (savings) into other asset classes that have a high potential of providing you a return.
Sooner or later, you will not want to work all that hard for your money. When that time comes, you'll hopefully have multiple asset classes working for you so you don't have to.
Main Reasons To Focus On Building Net Worth Even More
1) The government goes after income, not wealth.
We have a progressive tax system in America. The more you make, the more the government will take away. If you are in the top tax bracket in places like California, New Jersey, or New York, you will be paying around 50% or more of every dollar earned beyond $200,000 to the government ($200,000 income = 33% Federal + 10% State + 6.2% FICA + other taxes).
But if you have $5 million dollars that generates $150,000 a year, the government will only tax you on the $150,000 at 28% maximum, depending on how your income is generated (dividends, rental income, etc).
Once you build a sizable net worth, you can invest in tax friendly income streams such as dividend-producing stocks. Meanwhile, your heirs don't have to pay taxes on $5 million per spouse if you die.
2) Subsidized health care.
A great example of the government focusing on income and not wealth is Obamacare. If you make more than 400% of the poverty level as deemed by the government, you no longer get subsidized healthcare under The Affordable Care Act. For singles, that income limit is roughly $46,000, and for families of three or four, that income limit is roughly $78,00 and $94,000 respectively.
But imagine if your family of 3 has a $2 million net worth and nobody worked. You have no debt of any kind and all you need money for is food, clothing, and entertainment. Your family's dividends earned from a $1.5 million stock portfolio amounts to $40,000.
Under the ACA, your family gets $4,000 a year in subsidy, despite being millionaires, while a family of 3 earning $78,000 with 1/20th your net worth gets $0.
3) Alternative Minimum Tax (AMT) Exemptions.
The AMT exemption amount for tax year 2017 is $53,900 for individuals and $83,800 for married couples filing jointly. The AMT hasn't been adequately adjusted to catch up with inflation for years because the government knows this is a great way to generate more tax revenue from the middle class.
Calculating AMT is not very straightforward as well. But if you use H&R Block or TurboTax, it'll figure it out for you and you can work backwards to understand how much you're getting porked.
4) Child tax credit.
To keep things simple, the phase out threshold is $55,000 for married couples filing separately, $75,000 for single, head of household, and qualifying widow or widower filers, and $110,000 for married couples filing jointly. For every $1,000 of income above the threshold, your available child tax credit is reduced by $50.
Therefore, if you are thinking about having children, keep these income limits in mind if you want to extract more from the government or not pay more to the government. A family of 3 with a $1 million net worth and income of $40,000 can get a child tax credit while a family of 3 earning $60,000 a year with a $25,000 net worth can't get anything.
5) Different wealth mindset.
When you just focus on making more money every month or year, chances are you're a worker bee and more short-sighted than the person trying to generate wealth through equity in a business. Again, it's not bad to focus on maximizing income, especially when you're first gaining experience.
But the truly wealthy are the ones with massive equity stakes in businesses. Shareholders of companies think more holistically and longer term compared to income-only employees. Some are now arguing that the only way to buy property and raise a family in expensive places like London, Hong Kong, San Francisco, and New York is through equity, not income. Unfortunately, this is becoming more and more true the longer this bull market lasts.
6) Net worth is more easily concealable.
Net worth can be spread across many different companies and investments. It's much harder to calculate one's true net worth than one's income. I'm just looking at all the entries I've put into my free Empower net worth tracker and I'm shaking my head because there are over 25 entries.
Thank goodness for free technology because I've even forgotten some things I own. Nosy people can guess a portion of your net worth through visible holdings like your primary residence. But they will have an impossible time figuring out the whole thing. For folks who like privacy and following the Stealth Wealth mantra, net worth is much more important.
7) Less temptation to go crazy.
Income comes in bi-weekly or every month usually. Each time there's an injection of income, there's a temptation to spend. There's a reason why casinos are much more full during the middle and end of the month. The higher your income, the more temptation you have to go crazy and not give a damn.
Your net worth is much more complicated. As a result, there's much less temptation to pilfer your net worth for short-term desires. I can't withdraw from my CD early without paying a penalty. The cost to sell real estate is high. I can't take money out of my private company investments or private funds before there is a liquidity event.
With income, it's so much easier to spend.
8) Much higher feeling of security.
The feeling of security might be the biggest reason to focus on building a large financial nut vs. building a large income stream. Everybody's number is different, but I promise you that you will feel MUCH more secure once you reach your wealth number vs. once you reach your income number.
I thought I would feel rich once I hit $100,000. I did for a nanosecond, but saw temptation and taxes take a lot of it away. I've made much higher incomes and thought I would feel more secure too, but I didn't really. Instead, every single dollar I put away towards savings or stable investments made me feel much securer instead. The ideal withdrawal rate in retirement doesn't touch principal.
There's something very freeing about spending only the money that is being produced by principle, and never seeing your principle decline, unless we enter some horrendous bear market. Even then, your income properties, dividend paying stocks, and CD income will likely remain quite sticky.
Focus More On Building Your Net Worth
Income is just one part of the equation to financial independence. Once you focus on building your net worth, you'll become much better at focusing on multiple ways to build wealth.
The next time someone share's their income, ask them how they are deploying their income. See if you can figure out the structure of their net worth. It's all fine and dandy to have a $20,000 a month income. But if they've got no assets to speak of, there's a high chance that not only will their income go away one day, they'll end up back to square one because people have a tendency to spend everything they earn.
Growing your net worth requires a higher level of financial acumen than growing your income. Plenty of people are making six figures a year. But plenty of people who make such incomes are still destined to work forever given their lack of focus on net worth.
The less you have to rely on your income, the more secure and happier you'll be! Everything you start doing will be because you want to, not because you have to.
Once you build up your net worth, then you can figure out tax-efficient ways to pass it on. One way is to open up a 529 plan for generational wealth transfer purposes. Another way is to set up a revocable living trust.
Even though I no longer make a lot of money from a day job, I'm happier. The time saved not working has been mostly spend taking care of my young children.
Grow Your Net Worth In A More Stable Way With Real Estate
Get into the practice of saving and investing as much of your income as possible into real estate, especially if you already have a 401(k) and company stock. Real estate is a more stable asset class that generates income and provides utility. If you don't own your primary residence, all the more reason to invest in real estate.
Here are my two favorite private real estate investing platforms.
Fundrise: A way for all investors to diversify into real estate through private funds with just $10. Fundrise has been around since 2012 and manages over $3.3 billion for 400,000+ investors.
The real estate platform invests primarily in residential and industrial properties in the Sunbelt, where valuations are cheaper and yields are higher. The spreading out of America is a long-term demographic trend. For most people, investing in a diversified fund is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. These cities also have higher growth potential due to job growth and demographic trends.
If you are a real estate enthusiast with more time, you can build your own diversified real estate portfolio with CrowdStreet. However, before investing in each deal, make sure to do extensive due diligence on each sponsor. Understanding each sponsor's track record and experience is vital.
I've invested $954,000 in real estate crowdfunding so far. My goal is to diversify my expensive SF real estate holdings and earn more 100% passive income. I plan to continue dollar-cost investing into private real estate for the next decade.
Manage Your Finances In One Place
Once you've achieved financial independence, then you need to focus on growing cash flow more than net worth. Cash flow is what will maintain your lifestyle so you don't have to work.
The best way to become financially independent is to get a handle on your finances by signing up with Empower. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize.
Before Empower, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Empower to see how my stock accounts are doing and how my net worth is progressing. I can also see how much I’m spending every month.
The best tool is their Portfolio Fee Analyzer which runs your investment portfolio through its software to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was paying!
They also recently launched the best Retirement Planning Calculator around, using your real data to run thousands of algorithms to see what your probability is for retirement success. Once you register, simply click the Advisor Tolls and Investing tab on the top right and then click Retirement Planner.
There's no better free tool online to help you track your net worth, minimize investment expenses, and manage your wealth. Why gamble with your future?
About the Author:
Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $210,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
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