This article was published in Live mint on Tue, 25 Apr 17
If a more expensive lifestyle consumes all of your higher income, in the long term, you will miss out on creating wealth
I have met countless smart, highly educated and hard-working professionals who believe in a myth: If I work hard, earn a higher salary (or a promotion), then I am on the path to becoming wealthy. If you are one of those who believe this statement, read on.
The fact is that most people keep running on a treadmill of more work, faster career growth and higher salary. All of these may be desirable but may not necessarily create the life you want or give you a secure financial status.
Let us break the myth into the implicit assumptions made in the above statement:
Assumption 1: Smart, highly educated = doing well financially
Wrong. I have met some of smartest managers and professionals (doctors, lawyers, and others) in India and seen the mess their financial matters are in. They do not have any clue about what to do and how to manage their money. They invest in an ad hoc manner in whatever opportunity arises at the moment; they manage their money by default, doing whatever others are doing or saying. They have not created the wealth they want or deserve. A is a successful medical practitioner in Mumbai. He has an established practice of 20 years.
Yet, apart from a few fixed deposits in the bank amounting to Rs20 lakh and one small property, he does not have any substantial assets to count as wealth. This is someone whose income should be worth crores by now. A is a happy go lucky sort of a fellow and says, “Why bother when I am leading a good enough life?” The point is that our Doctor will get old soon and his income will stop the moment he stops going to his clinic. He has not given that much thought.
I have met very senior people in the financial services industry who have not managed their own money well enough. The truth is that most salaried people do not have the basic understanding of how wealth is generated.
Assumption 2: Higher income = Savings and wealth generation
Wrong. This point got illustrated to me one day when I met two persons, both working in the same company. One was a CXO level senior executive with an annual income more than Rs1 crore, and a middle level executive with an income of around Rs15 lakh. Believe it or not, if one eliminated the residential home from the net worth calculation (the CXO understandably had a bigger house), the junior executive was worth more in liquid assets. Much, much more. This example proves the point that income actually has no co-relation to wealth generation. The habit of saving and investing in the right products is what leads to wealth generation. The junior executive had been investing part of his salary saved in a family business operation giving him more that 30% returns per annum. Even if you can’t generate that kind of returns, you can at least develop the habit of regular saving and tracking your investment returns.
3: A higher salary will lead to saving and investing right
This is one of the most common excuses people give when they are asked what stops them from investing and creating a portfolio income. Most upwardly mobile executives are busy upgrading their lifestyle—a new car, a bigger house, fancier branded clothes, eating out, and more. This is a signal that they have ‘arrived’. Ambitions get higher and higher; for themselves and for their spouses and kids. The family no longer wants a holiday in Mahabaleshwar, Kodaikanal or Nainital. It has to be Switzerland. So all the raises, bonuses and promotions are consumed by the demands for a luxury lifestyle.
There is nothing wrong in wanting to enjoy one’s success and money. In fact, it should be a motivator to do well and earn well. However, there has to be a plan for the future also. Spend 80% of your income on your needs and wants, but surely you can save 20% for a financially secure future. This is for the family. You can lose your job, or get a hair-cut on your salary, or you may have to shift to your home town to take care of an ailing parent. In many scenarios, you may not have the current income that your lifestyle requires. So be careful of how much you raise your lifestyle. It is easy to get used to an upgrade but psychologically difficult to get used to a downgrade. Freedom lies in creating a sustainable lifestyle that one can easily maintain. This requires two important things, which many smart professionals lack: planning and discipline. The lack of good money habits and lack of clarity on their financial goalposts leads them to run along in the corporate world, fooling themselves that they are doing well.
That is why they keep running on the treadmill to earn their salary without actually creating wealth for themselves.