Chris Rock once said, “Shaq is rich, but the white man who signs his check is wealthy.” – Chris Rock, Bring The Pain, 1996.
So what’s the difference?
What does it mean to be rich vs. what it means to be wealthy? Maybe Chris Rock’s implication is that you can be rich and have a lot of money but still not be wealthy. It’s the business owner, the one calling the shots, the one who doesn’t have to worry about money, that’s the wealthy person.
Shaq, for all the millions he made, was still an employee and like a lot of athletes probably spent a lot of his income on frivolous expenses. I’ve noticed this distinction in my own circle of friends and associates. I know many individuals, including doctors and lawyers who make good income but still live paycheck to paycheck because they have substantial expenses and debt. A big house, fancy cars, nice clothes, and the best schools have a tendency to drain resources.
Here is what I’ve learned from my readings about the distinction between being rich and being wealthy.
Dr. Stanley Riggs in his article Wealthy People Make Different Choices With Their Money Than The Rest Of Us for businessinsider.com, (Jan. 7, 2015) distilled the difference between the poor, middle class/rich and wealthy into three convenient diagrams. And the difference all comes down to spending habits. The wealthy just spend their money differently than everybody else.
Cash Flow of the Middle Class
Cash Flow Path of the Poor
Cash Flow Path of the Wealthy
So what can we deduce from these three diagrams? Comparing the amount of earned income that goes toward expenses, the poor spend a disproportionate amount towards expenses and liabilities and the middle class/rich allocate more of their income towards expenses and liabilities relative to the wealthy.
“The poor spend nearly all their income towards expenses.”
But the most glaring difference between the wealthy and the other three groups is the wealthy do not only allocate their income towards expenses but also towards assets, but just not any assets – assets that produce passive income. In fact, they allocate a majority of their income towards those passive income producing assets. If you follow the arrows for the wealthy, that passive income is then used to reduce liabilities AND for reinvestment into more income producing assets.
So, while the poor have negative to zero net worth and the middle class/rich are barely staying afloat, the wealthy are the guiding light. Like a lighthouse, they lead others. They own businesses, they employ others, they don’t have to worry about money.
The wealthy understand the true distinctions between assets and liabilities.
Assets put money in your pocket, liabilities take money. If you lost your job, the liabilities don’t go away and your net worth depletion is accelerated. If you had assets when you lost your job, you would still receive the income from those assets. Interestingly, Dr. Riggs singles out investment real estate as one of the premier income producing assets, pointing out that, “As an asset class, investment real estate has the advantage of providing rental income, appreciation and other tax advantages.”
So passive income, income with regular distributions, is the key to being wealthy.
Regular distributions from passive income can be used to reinvest into other income producing assets and reduce liabilities, further freeing up more income for investment. The rich may make a lot of income but all of that income usually comes from a job. If they stop working, so does their income. The wealthy don’t derive their income solely from a job. If they stop working, they still have their passive income.
Another difference between the rich and the wealthy is knowledge. They know how to make money in more ways than one. A doctor knows how to fix people but if something happens to a doctor’s hands that prevents him from being a doctor, he can no longer generate income. With the wealthy, their knowledge base is not restricted to one source of income generation. If one venture fails, they pick themselves up and with their investment experience and ability to analyze potential opportunities, they move onto the next venture. That knowledge didn’t fall out of the sky. The wealthy are knowledge seekers and are constantly learning. And because the wealthy allocate funds for investing, they’re always prepared for downturns.
I know it’s not as easy as it sounds but to become wealthy, one should start by absorbing knowledge, learning about different types of passive income producing assets so that when you’re in a position to invest, you can invest with confidence. Then by taking the regular distributions from your passive income investments and reinvesting them, you’ll begin to compound your assets and income just as the wealthy do.