Riches beyond income: Why high earnings don’t always equal wealth

As financial advisors, we are frequently called upon to help our clients build wealth by mapping out strategies that empower them to leverage their earnings to increase their net worth. Retirement planning especially focuses on using a client’s current financial capabilities to build a strong financial future.

Common sense would tell us that the more a client earns, the easier it will be to improve their overall net worth. The reality, however, is that several factors can come into play that prevent high earners from building wealth. The term HENRY, which stands for “High Earner, Not Rich Yet,” has been coined to describe those affected by this wealth paradox in which net worth remains elusive despite high income.

For an idea of how this wealth paradox affects high earners, consider recent statistics that reveal more than one-third of people earning more than $200,000 a year live paycheck to paycheck. As a group, higher earners are also not focused on investing in their retirement. Another recent study found that nearly one-third of high earners — those making between $150,000 and $283,000 annually — are not significantly involved in their retirement planning.

Addressing this topic with clients is difficult but is crucial. It’s easy for clients to downplay the value of retirement planning, which they tend to see as something that only affects the distant future. Bring up the topic and you may hear them say something like, “We’ll worry about that later.”

Your clients’ financial situations will benefit from having someone in their corner who will challenge their thinking, especially when that thinking is keeping them from growing their net worth. The following are some thoughts you can bring to the conversation to help your clients develop more of a future-oriented focus.

Moving away from a high-consumption lifestyle

The 50/30/20 rule, which provides a solid starting point for financial planning, empowers building net worth by limiting consumption. By keeping living expenses and discretionary spending at 80%, the rule ensures that 20% is put away for future needs.

For HENRYs, the 50/30/20 rule is typically derailed by a high-consumption lifestyle that prioritizes their current needs and wants over their future needs, pushing living and discretionary expenses past 80%. When that happens, the capacity for saving and investing dwindles.

​​A recent report shows that most of the top 10% of earners in the U.S. save only 12% of their earnings. The exception is the top 1% of earners, who save nearly 40% on average. In comparison, the average amount of income saved by the bottom 90% of earners is only 4%.

Understanding the downside of misplaced priorities

HENRYs find themselves stuck in the wealth paradox largely due to misplaced priorities. Their spending typically follows the pattern of addressing immediate needs followed by immediate wants followed by future wants, with anything left over going to future needs. To increase net worth, future needs must be given a higher priority.

Looking at how an increase in earnings is handled can provide a helpful illustration of the value of shifting priorities. When a pay increase is used to finance a more expensive vehicle or a bonus is used to fund a spontaneous getaway, increasing net worth is clearly not a priority. That type of spending prioritizes depreciating assets over tangible wealth, and keeps someone locked in the wealth paradox.

It can be hard for high earners, who may be taking home $20,000 each month, to appreciate the impact an additional $800 per month spent on a new car lease will have on their overall financial outlook. To help show its value for building net worth, we can explain to these clients that $800 per month invested in an account earning 7% interest will grow to $935,000 over 30 years. If 20% of the client’s $20,000 monthly income goes into the same account, the total value after 30 years will be nearly $4.7 million.

Seeing the danger of over-dependence on earnings

Clients may not grasp that committing 100% of one’s earnings to support a high-consumption lifestyle means retirement will never be an option, regardless of how much they earn. This overdependence on earnings can also potentially place clients in difficult situations when unexpected expenses or negative earning adjustments occur.

For high earners, transitioning even a small amount of their income to saving and investing can help significantly increase their ultimate net worth. It can also provide a safety net that doesn’t involve taking on high-interest debt.

However, helping clients transition from high-consumption spending to high net worth takes work. The biggest challenge is convincing them that committing a portion of their earnings to saving and investing — preferably 20% or more — is just as important (if not more) as any of their other spending. Once they realize this, they will be on course to break free of the wealth paradox and begin increasing their net worth.

Aaron Cirksena is founder and CEO of MDRN Capital. Contact him at aaron.cirksena@innfeedback.com.

 

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