So many choices, so many voices, so little clarity. With a single click from your laptop or smartphone, you can buy shares on a foreign exchange, get competitive quotes for insurance, analyze years of financial data, verify on-the-spot prices of precious metals, and execute hundreds of other financial transactions – all by yourself. In this open access environment, financial institutions recognize they must differentiate themselves from their competitors; companies can’t simply present and explain their products and services, they must market them. Marketing may help consumers remember the name of
the company or its products, but it is questionable if it provides consumers with any clarity regarding their financial decisions. Truth be told, most mainstream financial “information” does little more than add noise to the cacophony of emotional images and conflicting financial perspectives competing for your attention.
To block out the noise, and get clarity in your financial life, you need a unifying principle, one that provides a framework for evaluating all possibilities. This principle is simple, yet it addresses your most pressing financial challenges, and allows for opportunities. Quite simply… It’s all about income.
It is not about total return, net worth, or determining your risk tolerance, or any other idea that says “if you do this one thing, everything will be just fine.” There is only one thing, and it is income. When you solve for income, everything else is possible. The Compelling Case for Prioritizing Income Most Americans do not live in a closed, self-sufficient economic system where all material needs and desires can be met by growing our own food, making our own clothes, generating our own electricity, etc. In order to acquire both the necessities and luxuries of life, we use money. Every day, we need more money to support our standard of living. We need income, i.e., “money received, especially on a regular basis, from work or through investments.”
The economic, social and political centrality of money received on a regular basis cannot be overstated. Every election cycle, politicians of every stripe inevitably tout “jobs creation” as one of their legislative priorities. Is this because more people want to work? No, it is because people want – and need – the income that comes from having work. The debates about Social Security, Medicare and health insurance are ultimately concerns about providing and preserving income, and the costs of doing so. Income is the fuel of government; 90% of federal funding is derived from various taxes on income.
In personal finance, there are three primary actions you can take to improve your income. You can generate income, accumulate deferred income, and protect income. While a large segment of the financial service industry focuses heavily on accumulating deferred income, one could argue that most households would experience greater success if they placed more emphasis on generating and protecting income.
1. Generate Income
The foundational element in every personal economy is the ability to generate income. In a June 2020 commentary, “How to Live a Stress-Free Financial Life,” Jared Dillian observes that one of the hardest things in personal finance is “‘How do I get more money?’ In fact, it’s so hard that most financial gurus skip right past it.” For most of us, the default option for income generation is work, getting paid for services rendered. But a focus solely on employment for income generation may be short-sighted. Interest, dividends, royalties, rents and other forms of passive income can significantly boost current income. Andrew Carnegie, one of the richest individuals of the late 19th century, said his life changed when he received his first dividend. “I shall remember that check for as long as I live,” Carnegie wrote in his
autobiography. “It gave me the first penny of revenue from capital—something that I had not worked for with the sweat of my brow. ‘Eureka!’ I cried.” Many households might benefit from using their financial
assets to generate more immediate income. For example, it’s possible that saving for a down payment on a rental property might deliver more lifetime income value than simply adding to your 401(k).
2. Accumulate Deferred Income
Setting aside money for future consumption – in a savings account, a 401(k), a mutual fund, etc. – is simply deferred income. In this context, a key question is “how much income will these deferred assets generate?” But we tend not to calculate the value of our assets in the context of income. The conventional measurements are typically lump-sum valuations, like:
“What’s the market value of your house?”
“How much do you have in your retirement account?”
“What’s your net worth?”
Robert Merton, in a 2014 Harvard Business Review article, “The Crisis in Retirement Planning,” says this deemphasis of income as a metric in measuring one’s financial fitness is one of the reasons
many Americans are so poorly prepared for retirement. “Investment decisions are now focused on the value of the funds, the returns on investment they deliver, and how volatile those returns are. Yet the primary concern of the saver remains what it always has been: Will I have sufficient income in retirement to live comfortably? The trouble is that investment value and asset volatility are simply the wrong measures if your goal is to obtain a particular future income. Communicating with savers in those terms, therefore, is unhelpful—even misleading.” Whatever you save, and wherever you put it, you should
consider the income value of these assets, not just their market value. A person with a $500,000 home and $250,000 in saving has the same net worth as a person with a $250,000 home and
$500,000 in savings, but their deferred income potential is not the same.
3. Protect Income
Since most income generation comes through work and employment, it makes sense to protect both the generating asset (i.e., the individual) and its income potential. One of the reasons health insurance is such a prominent political issue is because almost everyone’s income is affected by their health, and the cost of maintaining it. The same rationale extends to obtaining both disability insurance and life insurance: when individuals stop generating income, everything else usually grinds to a halt. Income protection is more than protecting the individual’s ability to earn income. As recent history shows, sudden changes in markets can turn profitable investments into sizable losses. Given this volatility, individuals may consider it prudent to keep some deferred income in insured accounts that guarantee future income.
Bringing Clarity to Your Financial Decisions
When your framework is income, most financial issues can be easily understood and resolved by answering the question:
“How does this affect my income?”
Any answer that increases your income potential, adds to your deferred income or protects your income is probably a good one.
There are nuances and art in using income as a clarifying principle. You have to find a balance between planning to increase today’s income or accumulating more deferred income. Likewise, protecting existing income, typically with insurance, may also mean forgoing opportunities for even more income. But if you keep income as a guiding principle, it will likely change your mindset about many financial decisions. For example, when income is forefront…
−You might buy a $250,000 personal residence instead of a $500,000 one in a more-affluent neighborhood, because a $500,000 home produces the same income as the $250,000 one: zero. It may be better to live in a less expensive home and either increase your current income or add to deferred income.
− You might weigh the advantage of developing passive income today, rather than assuming/hoping your work will provide both current income and enough deferred income to eventually retire.
− You can easily determine your “retirement number”; it’s when your accumulated assets can produce an income sufficient to support your standard of living. Consider making decisions that increase your income benefits and your financial life will make steady progress.