What do you consider wealth?
The other day I was a guest panelist for a regional NPR call-in show dealing with personal finance problems. One topic for discussion was the different value people put on living within their means and saving money. It was interesting hearing how far apart different people’s views are on this topic.
During this discussion, one thing became clear: besides the fact that different households have a range of means and circumstances that dictate how much money they can save, there seems to be an even bigger difference in what people think it means to be financially secure.
Like motorists with different destinations, it is no surprise that people end up with such vastly different results when they have such varying takes on financial goals. A big part of how people manage their household finances seems to stem from what they consider to represent their wealth. Here are some thoughts on several of the possible components of wealth:
- Available credit. If wealth is the ability to spend money, then certainly the amount of credit available is one way to measure wealth. It is true that maintaining a good enough credit history to be able to borrow when needed gives you a valuable degree of financial flexibility. Unfortunately, it seems too many people take this to the extreme of letting the available credit limits on their credit cards define the wealth at their disposal. There has certainly been a generational change in how people view borrowing vs. saving in this country. From 1950 through 1995, the annual personal savings rate in the U.S. never dropped below 5 percent. In the 17 years since, it has reached as high as 5 percent only twice. Meanwhile the total amount of consumer credit outstanding, after contracting briefly as a result of the Great Recession, has rebounded to reach new heights over the past two years.
- Income. How much you earn is certainly an important component of wealth. The only limitation is that you can’t assume that your income stream will go on forever. I know of people late in their careers who have little or no retirement savings because they don’t plan to retire; we can only wish them the good health to follow through on that plan. Even with younger people, for whom health is not as big an issue, it is important to recognize that economic or personal circumstances can suddenly cut off or drastically reduce an income stream. It’s best to set some money aside during the good years, rather than assuming that success will continue forever.
- Home equity. It’s true that for most people, their home is their single most valuable asset, so it is natural to look at home equity as a form of wealth. However, that wealth needs to be regarded as something that will provide shelter for decades to come, rather than as a liquid asset available for spending. One of of the saddest things about the housing crisis was how people gave away their home equity by borrowing against it, only to find this put their most valuable asset in jeopardy when times got hard.
- Retirement account balances. It takes a large amount of money to fund a retirement, and too often the amount of money accumulating in a retirement fund is a temptation, causing people to borrow against it or even incur tax penalties by tapping into it early. Retirement savings are part of your wealth, but only if they remain intact to pay for your retirement.
- Emergency savings. Having money set aside outside of a retirement account is important, because it gives you ready access to funds should an emergency occur. The trick is to be disciplined in how you define an emergency, rather than treating your emergency fund as a piggy bank.
- Non-retirement investments. If you have investments above and beyond your retirement accounts, then you have an added avenue for building wealth. In measuring this wealth and planning for the future, it is important to remember the cyclical nature of the financial markets. In the late 1990s, too many people assumed that huge stock market returns would continue for years, and this dulled the sense of urgency about continued saving. Instead, growth not only became scarce but asset values shrunk, demonstrating why the risk of any investment has to be considered alongside its current value.
All of the above are valid components of household wealth, but each one is incomplete by itself. Rather than focusing on any one of these to define wealth, I would suggest that wealth is more of a mosaic, a picture made up of all these different pieces. Let any of the pieces drop out, and the picture is incomplete.
The question is, are these the right pieces, and are they the only pieces? That brings us back to the original question: what do you consider wealth? Your comments will help add to the picture.