Yesterday we discussed how Stanley (The Millionaire Next Door) gives us a benchmark for wealth. We also said the positive about his benchmark is that it correlates age and income with wealth. Somebody once said by age 45 the average white South African has managed to accumulate a net worth of minus R50 000. I don’t know if it is true or not. The fact is, Stanley gives us something to aim for. It is because we aim for nothing that we end up with minus R50 000!
My problem with this benchmark is that it still puts the focus on capital. The benchmark leads to a focus on net worth. I might be wrong, because I have not read the book, but the article that referred to Stanley definitely placed the emphasis on building capital.
My basic premise is: capital follows income. Focus on building income streams, as many as possible.
This is a different goal. At all times the goal is now to replace your current income with investment income. If you are 20 years old and earning R5 000 per month, how close are you to this goal? If you are 25 and earning R30 000 per month, how close are you to this goal? If you are 60 years old and earning R15 000 per month, how close are you to this goal?
Why, you may ask, do I prefer this? Because we need an income to live. Let me share a real life example:
Mrs V (I am responsible for managing her investments and finances) has a lot of capital that has to provide an income.
One investment we did 4 years ago, the capital is very, very safe, but the income is almost fixed. The growth is negligible.
There is one other investment that has to provide and income. The income comes from dividends, interest and capital growth. The income is stable, but with the markets dropping, there was no capital growth, so we had a choice – sell shares at a loss and at the lowest point, or reduce the income.
Fortunately Mrs V has more money. But if I now sell an investment, I am selling in a down market. If I invest in government bonds, I tie in at a relatively low interest rate, although future capital growth might be good. But all in all, it is like being between the devil and the deep blue sea.
Her expenses, on the other hand, is not tied to markets and interest rate cycles …
Now let’s assume she took my advice a few years ago and used 25% of her money to buy properties that would give her the income she needed. The value of the properties does not matter, because I am interested in income.
The rent is not subject to interest rate fluctuations and increases by more or less the inflation rate. There is no risk of “depleting a property” the way there is with capital. And there is no problem with maintaining the income through economic cycles, as with capital based income.
And that is why I still prefer an “income replacement” benchmark for measuring wealth.