Everything in personal finance seems to go around in circles. This post will discuss when income is more important than net worth for financial freedom.
In the past, I argued that it’s better to focus on net worth growth over income growth. Wealth is not taxed like income. Further, financial freedom is about living off your invested capital that generates passive income for life.
Given job income is the main source of income for the majority of people, by definition you’ll never truly be free if you mainly focus on income. Only when you build a large enough net worth can you truly be beholden to no one.
But over the past several years, I’ve noticed that focusing too much on net worth and not enough on income growth has created a scarcity mindset. Before I explain what I mean, here are eight reasons why focusing on net worth is important.
Reasons To Focus On Growing Net Worth
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 pay a total federal + state marginal tax rate over 50%. But if you have $10 million dollars, the ideal net worth for retirement, that generates $200,000 a year in dividends, you only pay a 15% tax rate. But eventually, the government will go after your wealth beyond the $11.7 million mark per person in 2021.
2) Subsidized health care.
Under Obamacare, if you make more than 400% of the poverty level as deemed by the government, you no longer get subsidized healthcare. 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 three has a $5 million net worth and nobody worked. You have no debt of any kind and all you need money for is food, clothing, and entertainment.
Let’s say out of your $5 million net worth, $3 million is an investment portfolio and $2 million is in real estate. Your $3 million stock portfolio produces $60,000 a year in dividends. Under the ACA, your family gets ~$3,500 a year in subsidy, despite being multi-millionaires. Meanwhile, a family of three earning $85,000 with 1/20th your net worth gets $0 subsidies. Hee’s a post on how to get healthcare subsidies, even as a multi-millionaire.
3) Alternative Minimum Tax (AMT) Exemptions.
The AMT exemption amount for tax year 2021 is around ~$60,000 for individuals and ~$90,00 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. Once you start making much more than $200,000 MAGI, you start paying a hefty amount of AMT.
4) Child tax credit.
The new enhanced benefits in 2021, provide for $3,000 in child tax credit, which specifically cover teens who are 17 for the first time. Th child tax credit is income-based and would start to phase out for individuals earning more than $75,000 a year or $150,000 for those married filing jointly.
From there, the credit would be reduced by $50 for every additional $1,000 of adjusted gross income earned. That means the $3,000 credit provided to parents of a child aged 6 to 17 would be phased out completely for individuals earning $95,000 and those making $170,000 and filing jointly.
A family of three with a $2 million net worth and income of $100,000 can get a child tax credit while a family of three earning $1700,000 a year with a $200,000 net worth can’t get anything.
5) Different wealth mindset.
If you have an income mindset, you’re likely a worker bee. If you have a wealth mindset, you figure out a way to build massive equity in your business or other people’s businesses for next level wealth. 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 stealth.
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. Nosy people can guess a portion of your net worth through visible holdings like your primary residence and your vehicle. 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 spend wastefully.
Income usually comes in a regular bi-weekly or monthly cadence. 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.
Your net worth is much more complicated and much less liquid. As a result, there’s much less temptation to pilfer your net worth for short-term desires. For example, I can’t withdraw from my private equity funds without paying a penalty. It also takes a lot of preparation to sell a property. With income, I can spend it instantaneously.
Related: Long Term Investing Is All About Saving Yourself From Yourself
8) Higher feeling of security.
The feeling of security might be the biggest reason to focus on building a large net worth 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.
Your net worth is generally much more sticky if you properly diversify. Your income can be extremely volatile, especially if you are in a revenue producing role where a bonus makes up a large percentage of total compensation. You can lose 100% of your income one day, but it is unlikely you will ever lose your entire net worth, unless you were over-leveraged.
Why Net Worth Might Be A Scarcity Mindset
So why can focusing on net worth be considered a scarcity mindset? The main reasons have to do with taxation and receiving government benefits.
By keeping your household income low, a lot of people can pay less than a 10% effective tax rate. Some households can essentially pay nothing due to child tax credits, pre-tax retirement contributions, exemptions, and deductions (standard or itemized).
Paying little to no taxes is fine, but it essentially means you’re too poor to financially contribute to the health of America. I know so many people who purposefully stop working, give up their side hustles, and physically let themselves go due to the desire to minimize taxes and get government healthcare subsidies. They’ve completely limited their potential.
Wouldn’t you much rather pay $100,000 in taxes and keep $200,000 than pay $5,000 in taxes but only keep $36,000 a year? I sure as heck would.
Minimizing our tax burden is one of the most important exercises given the government is so wasteful with our tax dollars. But purposefully limiting your income potential in order to pay less taxes and receive subsidies is backwards looking.
Income Growth Mindset
Between the age of 22 – 34, I had an income mindset. An income mindset is what made me take the risk of moving from NYC to SF with a new firm. Despite not knowing anybody in SF, the pay was too good to pass up. An income mindset is what made me work longer hours to get promoted faster. By shoveling up to 80% of my after tax income into investments for 13 years, an income mindset ultimately allowed me to exit the workforce early.
But after I left the workforce, my entire money ideology shifted towards a net worth mindset because I wanted to take a break and preserve capital. In essence, a net worth mindset reflected a burnt out man who didn’t want to hustle any longer. Related: One Of The Biggest Financial Mistakes Early Retirees Make
From age 34 – 36, my investments returned more than my income not because my investments were so great, but because my income fell by 80% after I left the working world. If I had not completely forsaken the income mindset, I would be in a financially better position today.
Publishing investing lessons from a surreal 2017 illustrated how important it is to focus on income growth. Contributions equaled 10X my expected annual return. In other words, even if there was a 50% decline in my investment returns, I could get back to even in six months time with continuous contributions.
Put it another way, investment returns are no longer the driving force behind my net worth growth, income growth is once again. It’s like going back to my 20s, but with larger dollar amounts at work. Being able to actively contribute to your net worth is huge.
Benefits Of An Income Mindset
Here are times when focusing on income is more important than net worth.
1) Helps eradicate laziness.
After a certain point, holding on to a net worth mindset is due to laziness. With an income mindset, you’ll always be thinking about ways to generate extra income for you or your family’s financial security. Once you’ve reached your net worth target, all the more reason to try something new. There are some people who work less than 40 hours a week and complain why hey can’t get ahead!
2) Provides a tremendous investment buffer.
Although the investment environment has been wonderful since 2009, having an income mindset allows you to continuously build your nest egg in downturns. Your income becomes most powerful when you can contribute more each year than the amount you could realistically lose each year, e.g. contributing enough in 2008 so that you are even in your stock portfolio even though the S&P 500 declined by 36.55%. During good times, you can run up the score.
3) Keeps you active and healthy.
To make money you need to interact with people. When you interact with people, sometimes you make friends and stimulate the mind. I’ve found that doing private 1X1 consulting, corporate consulting, coaching high school tennis, attending meet ups, and eating steak dinners with business partners have all helped keep me active and healthy. Often times the camaraderie is even more important than the money.
Once the pandemic is over, there will surly be an explosion of economic activity! We just need to make sure we maintain the ideal body weight so we don’t die young!
4) More immediately fulfilling.
Another reason to focus on income growth over net worth growth is that it’s more fulfilling to generate active income.
There are less grey areas when it comes to measuring income than when it comes to measuring net worth. For example, there’s a +/- 15% valuation range for my real estate portfolio, and likely a +/- 50% valuation range for my online business.
With income, what you see is what you get, and it’s likely all due to your effort. There’s something very fulfilling with earning more after trying harder. A strong correlation with effort and reward is why entrepreneurship is so rewarding, and why working at a big corporation or the government may be less fulfilling.
Here is the recommended split between active income and passive income for greater happiness.
5) Easier to demonstrate a good work ethic.
If you’re a parent, an income mindset will help you consistently demonstrate a strong work ethic so your children don’t grow up to be entitled brats. A strong work ethic will also engender admiration from your partner, friends, and family members. The more people respect you, the happier you will be.
Now that I have two young children, I really like alternating my time between work and playing with them. It feels good to tell my children daddy needs to go work to make money so they can eat and have their toys. Working to make more income will hopefully enable children to appreciate the value of time and money. I’m excited to help build their custodial Roth IRAs and get them to work as well.
Retirement Is A Curious Thing
I always thought that I’d live off my passive income and be done with this work thing. But early retirement has a funny way of letting you focus on things you really enjoy doing. In my case, it’s writing about personal finance online and being a stay at home dad.
Sometimes, you get so utterly enamored with your passion project that you unexpectedly make a healthy income. When you earn something unexpectedly, that’s when you finally feel rich. Now I’m back to investing most of my income in assets that will hopefully generate enough passive income to take care of my family forever.
Net worth is still more important than income when it comes to financial freedom. Just don’t get carried away by completely forsaking your income generating abilities once you’ve achieved a comfortable number, especially during a bull market. At least find ways to make money through activities you truly enjoy. Who knows. You might surprise yourself one day!
Recommendation To Build Wealth
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I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management. At the end of the day, it’s good to focus on growing net worth and income. Eventually, you’ll want to spend your money on a better life for you and the people you care about.
“3) Alternative Minimum Tax (AMT) Exemptions. The AMT exemption amount for tax year 2017 is ~$54,300 for individuals and ~$84,500 for married couples filing jointly. The AMT hasn’t been adequately adjusted to catch up with inflation for years”
Not only is it not being indexed, that 54K or 84K amount which is exempted itself also starts phasing out at a rate of $250 per each $1000 you are over the phase-out threshold, which is pretty low (120K for single, 161K for married).
I’m definitely chasing income at this point in my journey. However, I’ve been doing it in a way that allows me a lot of control over my time and stress levels. I’ve been skill-building in something that will double my take-home pay, and make me so valuable that even the temp market I am in must start adjusting to my desires. Work remotely for weeks at a time so that I can stay with my long distance girlfriend? Yes, you will allow that.
Hello Sam,
This is a very good post depicting the contrast between the net worth and income mindsets. I’d actually never thought of this before so it gives me new perspective.
On another note, I have been reading your blog for almost 9 months now and it has given me a lot of inspiration. You have done a lot of good work through your posts. I wish to meet you one day and thank you personally for all the help that you have been. I am a newbie just starting out on the path to financial independence and hope to learn a lot during this journey.
Great article as always, but this part is incorrect (and it’s actually better than you thought):
“If you are in the top tax bracket in places like California, New Jersey, or New York, you will be pay a total federal + state marginal tax rate over 50%. But if you have $10 million dollars that generates $200,000 a year in dividends, you only pay a 15% tax rate.”
If your only or primary source of income is dividends and your ordinary income is <$37,650, you pay 0% federal tax on qualified dividends. California does not have any special tax treatment for dividends or capital gains though (I don't know about other states), so if you have $200k in dividend income in CA, you will be paying 9.3% marginal state tax on that amount, or 7.3% effective – less than half of the 15% you thought you would owe. Not bad!
Hi Sam,
I disagree with the basic theme, not with the minute observations you made for a NW vs. Income Stream mindset.
I do not claim to have an answer either.
But lets take an example of “above average married couple NW” from your other article.
Jim, Joe, and Jeff are married. They are above average as per your methodology. They are 45, had the same income throughout their career, saved hard, and have a NW of $2M (I rounded it off).
Their NW is expected to be 1.2M in 401K, 500K in Post-Tax, and 300K in Home equity.
But here is the reality:
Jim-couple follows the conventional wisdom, saves and invests like the above average couple, and has the above breakup of his NW.
Joe, with the same NW, has his $2M invested in 3 rental properties i.e. he has more of his post tax income invested in income producing assets. His breakdown is:
500K in 401K, 1.2M in Rentals, 300K in Primary Home.
Jeff, with the same NW, chooses to live in a paid for $1M mansion/fancy cars/jewelry, and $1M in their 401K.
What are their income streams at 45, having saved at the same rate (so far):
Jim earns 4% of his 500K post tax account, $20K.
Joe earns 4% of his $1.2M rentals, $48K
Jeff earns 4% of….umm..nothing.
Who of these 3 can retire today?
Who can retire better when they reach 59.5 age to tap into their 401Ks?
NW means nothing if it is NOT invested in income producing assets, but in liabilities like primary home, BMWs.
I am like Jim, your typical above average married couple, but I cannot retire because my NW is all tied up in 401K, and I do not have any income producing assets now (not later), and isnt that financial “freedom” is about.
Thanks.
I think there should be a subdivision under income growth mindset.
While I am highly aware of my household net worth, I am more keen on income growth growth, specifically passive income growth. I think I am without a doubt in the camp of passive income growth mindset, where I firmly believe as long as I work towards increasing my passive income streams, I am both growing my income (without the burnout from active income seeking) and my net worth over time.
And for tax, I will not pay more than what I am due for, but happy to chip in even if it is not optimally spent in the ways I mostly desire.
A big thing could be laziness if focusing only on your net worth. There’s only so much saving you can do and once your properly allocated then what? Income generating is huge because it’s (hopefully) a regular occurrence that can be used to consistently provide inflows to your net worth and YES interacting with people, keeping engaged in society, etc.
Great article as always Sam,
We are just now starting to see the tipping point of focusing on net worth over income. With a large student debt load, the income is still necessary to finish paying those. We are now paying off the smaller loans and our cash flow has increased considerably.
This extra amount ($1,000) every month has allowed us to build up savings, investment, and extra debt payoff. It has also allowed my wife to work 1 less day a week to help take care of her family in ill health.
We have also done things like buy a foreclosure primary residence and started to remodel it to have equity building all the time. It is a potential option to rent this home out in the future. Having those extra options and flexibility even with a negative net worth should help us catch up later on in life.
I was just thinking about a similar topic since I’m deciding where to deploy my savings since I have some debts that will be paid off soon: cash flow vs net worth. I could focus on cash flow and get rid of some smaller student debt, or focus on net worth by throwing more money at my investments. This article provided me some good insight I think I will focus on maxing out my IRA’s and then get those debts down.
If I can find a way to make more money, I can find a way to minimize my income taxes. When you make more money, you have more freedom to make financial moves that can lower you income tax. Hence, I think it’s very foolish to give up on your earning potentials just to qualify for government assistance. This also means that my income will be at the mercy of any government policy. Not a very smart choice I would say.
For me, I am using both my income and net worth hand in hand to build one and another. To increase my net worth faster, I would have to earn more money. With more savings as part of my net worth, I can use it to buy more income generating assets, which in turns increase my income.
You may have covered this question elsewhere on this blog, but I am wondering if a pension should be included in net worth and if so, how do you calculate the value? If you are receiving a $100,000 annual pension for life, (assume that can be 20-30 years), how would you assign a value to this? In today’s market would probably need a few million invested in stocks to generate that $100,000. Do you add that amount to net worth? Assume the pension is fully vested. Thanks!!
Hi Ellen,
I have! Check it out: https://www.financialsamurai.com/how-do-i-calculate-the-value-of-my-pension/
Please Use the search box on my site or Google with “financial samurai” and chances are I’ll have covered the topic given I’ve been writing since 2009.
Thx!
Hi Sam,
This is a great article. Growing your net worth over the long-haul is important for financial sustainability, but you always need to have income. Being taxed by the government is a certainty, but it shouldn’t incentivize people to minimize their income potential.
On a side note, I’ve been trolling your site for a few months now and want to thank you for all your help and advise through your writing. I’m a young buck at 27 and I currently work in the corporate finance space. I needed to get out of this rat race and have taken your advise to heart. I finally got off my butt and started a blog at NinjaCapitalist.com. As a former finance guy yourself, you’ve been a great role model for me. Again, thank you for your insightful writing and helping others such as myself work towards financial independence!
-Dan
Congrats for starting your site and good luck! I hope you are here 3 years from now, b/c if you are, you’ve just created a ton of new optionality in your life.
Thanks for sharing your thoughts on the income verse net worth debate. It’s interesting to hear how you shifted from income minded to net worth minded and back again. You make a lot of great points about the benefits of both.
Personally, I’m much more of an income minded person because net worth doesn’t necessarily mean more flexibility. For example, anyone who has a mortgage probably has a higher net worth than me, but they also have higher expenses. I’ve also never really been a fan of the 4% retirement withdrawal rule. Sure it’s an easy calculation that gives the majority of people a frame work to work towards. But when planning for retirement, the bottom line is how much income you can receive. I’m not really sure why anyone would want to start depleting their assets.
On the other hand, I do understand a higher net worth can lead to more borrowing and income creating opportunities.
In terms of finding a balance between the two, as long as I continue saving and acquiring assets while keeping minimal debt, the net worth and income will grow. For peace of mind, I guess it’s important to diversify the assets to minimize the impact of a net worth decline in the case of a market correction.
Thanks again for sharing!
Good stuff Graham. I think you have the right mindset for your stage in life. Sooner or later, you will reach a net worth amount where you go into this “I don’t really care about income” funk. The sooner you get there, the more you’ve got to look out for the dip in motivation.
I’m still all about both income and net worth. While my desk job salary may not grow a whole lot more as I’m nearing 50, my ability to earn additional side income exists and I’m working it. As we get closer and closer to FI this may change but right now I’m still excited to see both grow. (I do really like your reason #8 above though). Thanks for sharing, Sam.
I am working on building up my NW so I can be FI within 10 years. I would like to continue working in a less stressful job (if there is such a job). The office politics are one of the main reason why people burned at work and corporate America is not friendly toward working mothers with a little one. Everyone is expected to work around the clock. Work and life balances are just lip services by management.
Even after entering 7 figure FI I still continue to work in my office job everyday that nets less than $50k after tax as per my life before FI because 1. It’s weird to not be going to work as a 20 something and 2. I want to set a good example for my children if and when they come and 3. It’s for my mental sanity and the only way I get to socialize with working adults at this point.
How did you reach 7 figures do early?
Great post!
Income is what makes the net worth possible.
People need to be made aware of this perspective. Perhaps they’ll look at things differently.
Really liked this post Sam. Net worth at the end of the day is more important (if one had to choose one or the other), but within the spartan-like lifestyle of the PF community, I think the income-making potential is not fully maximized due to this scarcity mindset. And yes, people overthink the tax thing. Their goal becomes more about not paying taxes than making more money. At the end of the day, if you’re paying a ton of taxes, it also means you’re taking home a ton of money. And whether it’s 70 cents on the dollar or 50 cents on the dollar, for every additional dollar you make, that’s still…in addition to what you would’ve otherwise not had!
Love this post and the benefits of each focus.
I think when someone is just getting started in their career, income should be the focus, and then the next focus is to take a percentage of that income and invest it to create passive income where you’re not trading time for money.
Income producing assets are the quickest way to financial freedom, in my opinion. An income producing asset (such as investment real estate) will always be valued at a multiple of the income stream that asset produces. So the asset adds to your net worth and produces income at the same time which is the perfect combination.
I found that when I focused on only buying assets that produced an income, and then created a strategy on increasing the income produced from each asset, my net worth went up as a result.
The double win of seeing principal appreciation and passive income appreciation is definitely awesome. It is amazing the difference in wealth that can be accumulated after 10 years, especially compared to those who simply spend and do not invest.
This is a defining post for this blog.
Too much of the FIRE blogs out there focus on cutting costs to the bone to hit a 6-figure nut that is 25x annual unrealistic spend…
I fear for what happens to all of those who are following it when the next big stock market downturn comes. Let alone a catastrophic unforeseen event.
Build a nut so big you have massive optionality and diversify. Build an income stream that brings you more optionality and lets you grow and have fun.
That’s what I take away from Sam.
It’s a good takeaway. I do believe in being frugal and seeking value. But I’d much rather focus on creative ways to earn because the upside is unlimited.
I don’t get proud living off $35,000 a year as some like to announce. I get proud creating something from nothing, creating multiple times more like it’s a game you can’t lose, living it up more, but still living within my means.
There is so much upside, to truncate this upside due to wanting to pay less taxes or get government subsidies is such a shame.
I agree – I feel like a lot of fire blogs just want to be as cheap as possible in life rather than enjoying it. I’d rather grow a nice stack while enjoying life along the way…
Interesting perspective. I agree, it is wise to have a net worth mindset while working to be sure to have something tangible for the time and efforts you put into work, no matter your income level.
Once reaching FI, it’s all up to the individual, whether they want to be lazy and sit on the couch, continue to hustle, or chase their dreams. Personally, I can’t see myself just sitting around.
We definitely have the scarcity mindset here. My husband and I focus on saving for our net worth more than income. I think it’s important to focus on both but for us it’s mostly NW.
We don’t ignore income completely…though and we both have pretty good work ethics. It’s just harder to control for income which is more likely determined by others.
Saving money is easy because we can control it all.
Our NW is north of 700K and we’re not lazy at all yet. It just feeds the fire for more muahaha!