A lot of investors get confused about wealth building vs income but these terms are the starting point for investing.
Don’t get me wrong: More income is always good to have! And it can be saved to build wealth over time. But, as you’ll see below, it can make sense to forego a focus on investment income to focus on wealth building instead.
And you can often achieve both wealth building and income when investing, depending on the asset you choose.
I like to call this having your cake, and eating it, too. It gets even better when you factor in the tax benefits which many wealth building and income strategies have.
When this happens, an investment becomes what I call a triple wealth builder since many assets build wealth, generate income and lower expenses through tax benefits.
Wealth Building Vs Income Defined
Before we go any further, let’s define income and capital gains to clarify the difference.
This was the first thing my dad taught me about investing in the 1980’s. I still remember he wrote “Income” and “Capital Gains” on a little piece of paper, and explained both to me.
In financial lingo, wealth building typically comes from having realized capital gains. A realized capital gain occurs when you buy and asset and sell it for less than you paid.
Wealth Building and Net Worth
It’s super important to note here that your net worth will increase while you own an asset that increases in value. Note that in this case, you have an “unrealized capital gain” in financial lingo.
On the other hand, if you sell the asset after it has increased in value, you’ll have a “realized capital gain”. Every investor loves realized capital gains since they lock in that increase in value and it becomes true wealth.
Note that the love for capital gains can decrease a little around tax season, as they often require taxes be paid on them, albeit at a lower rate. As I like to say, taxes are a “good problem” since they mean that you made money.
Read my post Assets That Build Wealth for more about this.
Income is amounts paid to you while you own an asset (or for performing a service). Income can come from many different sources.
Here are some common income sources which I write about here at Retire Certain after being fortunate enough to have personally experienced them at some point in my life:
- Stock dividends
- Bond interest
- Real estate rentals
- Alternative investments, such as REITs and MLPs
- Selling covered calls
- Business ownership
Read my related post How to Get More Income from Investments.
Note that income alone does not build wealth. Income does the following:
- Support your lifestyle
- Provide funds that can be saved and used to build wealth
Read my related post How to Live Off Investments During Low Interest Rates.
Stability for Wealth Building Vs Income
Income tends to be more fixed than wealth building. This is because the value of many assets that are used to build wealth fluctuate in value, often daily.
On the other hand, income from stock dividends, may have some fluctuations from one year or quarter to the next, but there is no day to day variation.
This same steadiness can be said for income from all the assets listed above. For example, rental income and bond income usually remain steady.
While covered call income definitely fluctuates every time you sell a covered call on an underlying stock, you know exactly how much income you’ll get when you sell the call option. The amount doesn’t change once the call is sold.
(You may enjoy my related post How Do Covered Calls Work?)
On the other hand, you don’t know how much a stock that was bought for a capital gain will go up or down within minutes after you buy it! This isn’t good or bad, it’s just the reality when it comes to stocks used as wealth building assets. (Read my related post Are Stocks Safe for Retirement?)
While most stocks fluctuate in value within one second, the value of other wealth building assets fluctuate much less. This is true of bonds and real estate, making their value more stable even though they can build wealth when purchased under the right circumstances as explained more in my post How to Evaluate an Investment.
Income investing doesn’t come without risk, however. You can read my post on the risks of income investing for more about this.
Time Frame for Wealth Building Vs Income
Wealth building usually takes years. Income, on the other hand, is usually received weekly, monthly or quarterly.
You can even buy an asset and get income immediately. An example of this is income from covered calls.
And many proactive investors buy stocks a few days before the dividend record date just to capture the dividend. (Note that the stock tends to drop in value immediately after the dividend record date.)
On rare occasions, an investor can buy a stock that immediately jumps in value. This may happen as a result of an earnings or merger announcement.
Usually, however, growth from stocks is a slow process. This is especially true of older companies, those which icon fund manager Peter Lynch called stalwarts.
Read my related post Are Dividends or Capital Gains Better?
But smaller nimble startups have changed the time frame for wealth building from owning equity as you’ll see next.
Saving Income to Build Wealth
Most investors assume wealth building comes over time from saving income and investing it in stocks but this isn’t the only way to build wealth.
First, income isn’t always necessary to build wealth. And, second, stocks certainly aren’t the only way to build wealth.
For example, here are ways an investor can build wealth regardless of whether they have income.
- Build a business, and sell it for a profit
- Inherit money and subsequently invest it successfully
- Sell real estate for a profit
Think of the many entrepreneurs under 25 who have made millions jumping from no income to millionaire status in a short time! This powerful investing phenomenon has changed the way that wealth is built.
But don’t think for a minute it is overlooked by Wall Street and smart investors with the surge in private equity lending through various methods. You can read more about this in my post How to Invest in Startups for Individuals.
The internet allows this dynamic opportunity more than it has ever existed in the past in my humble opinion.
Having clarified that years of steady income isn’t necessary for building wealth, let’s circle back to stocks since most investors own them, many through an employer retirement savings plan.
You may enjoy my related post, Start a Business or Invest in Stocks?
The Most Common Way to Build Wealth
Saving income and investing in stocks is the most common way that investors think of when it comes to wealth building. Again, for most investors, this strategy occurs over many years, but this isn’t always the case.
There are several factors that affect the speed of wealth building from saving income and investing it into stocks.
First, there’s the amount being saved.
Then, the time frame an investor holds stocks determines if wealth building will occur as a result of saving income and investing it in stocks.
Read my related post Predictors of Bear Markets for more on this.
Assets that Build Wealth and Generate Income
My favorite assets are assets that build wealth and generate income, too. This is true of many assets.
- Dividend Paying Stocks
- Real Estate Rental Properties
- Online Business
When bought at low valuations and subsequently sold, many assets that are commonly bought only for income can build wealth, too.
Even bonds, primarily known as income assets, can sometimes build wealth when bought at low valuations.
You may have read the story here that inspired me to note valuations and economic cycles, which is the perfect example of this. My dad bought municipal bonds in the early 1980’s paying high income with stated interest of up to 25%, tax free.
How crazy is that in this day and age?
And he was able to buy the bonds for steep discounts off face value. Not only did this mean the income yield was higher than 25% since his cost was under the bond value, but the value of the bonds eventually rose as investors saw the opportunity and risk from the bonds lessened.
Of course, he didn’t dare sell the bonds as they provided excellent retirement income.
Unfortunately, the bonds were all eventually called by the issuer over the next decade and a half. But, during this time, they could have been sold by my parents as a way to build wealth.
So these bonds provided both wealth building and exceptional income. They were a rare opportunity. I have learned that these opportunities come along for prepared investors a few times in the life of an investor.
Read my related post What Are the Risks of Bonds?
Wealth Building Vs Income for Taxes
Wealth building and income are treated differently for tax purposes. And each have different categories which affect the rate at which they are taxed.
A core principle of wealth building is minimizing taxes. By being aware of how both wealth building from capital gains, and also the various types of income are taxed, you can lower your taxes and thus be able to put aside more money to grow.
Read my related post Owning a Business Vs. Real Estate.
Summary for Wealth Building Vs Income
As you have seen, wealth building and income are different aspects of investing your money. Used strategically, however, both can have a powerful impact on your ability to achieve financial independence.
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Disclaimer: Nothing in this post is meant to be taken as personal financial advice. Only you are responsible for your own money.