There are more people making six figures a year than you know. Retired San Francisco police chief Heather Fong makes an estimated $250,000 a year in cash as part of her pension, not salary. My 43 year old union electrician makes $150,000 a year and is required to work a maximum of 35 hours a week. He spends another 20 hours a week making $50,000 doing side jobs. Meanwhile, 29 year old MBA graduates from the top 25 schools in America earn a median salary over $100,000 a year according to US News & World Report.
Although it’s estimated that only about 12% of the working population make over $100,000 a year according to the IRS, six-figure income earners seem ubiquitous in large cities such as New York, San Francisco, LA, and Chicago. It’s very difficult to raise a family making anything less with two bedroom apartments renting for $3,600 a month on average in SF, for example. Lob in child care costs and it’s no wonder why even some families who make over $200,000 a year feel like they are just getting by.
The Wall Street Journal profiled a 40 year old woman named Sylvia who earned $200,000 a year overseeing website content for tech firms, but racked up $300,000 in credit card debt. After amassing $500,000 in total consumer debt, she filed for bankruptcy. The article talks about her hiring of a personal chef and a housekeeper, and their frequent trips with her husband and two children to Hawaii as reasons for why she got into so much debt.
I used to always ignore stories about people who paid off $50,000 in credit card debt because the only way to get that much credit is to have a large income. But to amass $300,000 in credit card debt on “only” $200,000 in income is AMAZING. Even if I wanted to charge up $300,000 on my credit card, it would take maxing my card out to $30,000 and not paying a single cent towards principal for 10 years. I wonder how she did it.
IT’S NOT HOW MUCH YOU MAKE
It doesn’t matter how big your income is, if you are making $1 million a year, but are spending $1.1 million a year, you will eventually hit a wall and go broke. I was speaking to Jim Pavia, Senior Editor at CNBC Digital who came to our offices and he mentioned that 50% of people who win more than $100 million in the lottery go bankrupt within 10 years. A financial advisor like Personal Capital earns our keep by helping clients minimize financial disasters and maximize financial well-being.
The following are some things I recommend high income earners do to solidify their financial future. I used to be a high income earner once, but I gave it all up for more freedom.
1) Remind yourself the good times will not last. It’s easy to think your income will rise forever for the first 10-15 years of your career. Unfortunately, bad things happen all the time. Your firm could go under. Your new boss might hate you. You might get sick of your job and want to do something more fulfilling but pays much less. I used to think my income would hit “make it rain” status by the time I turned 40. Instead, my income got cut in half during the financial crisis and I ultimately left the finance industry to make no money as a writer for a year. As soon as you come to the realization that your income likely won’t grow to the sky forever, you’ll be able to better manage your lifestyle inflation tendencies.
2) Keep a progressive savings rate. The government is smart. They tax our incomes per paycheck because they know that if they left us to pay our own taxes at the end of the year, many of us wouldn’t! The progressive tax system is one small way to try and keep wealth inequality from widening in the same way that a progressive savings rate keeps our wealth and spending from inflating as quickly. I began saving roughly 20% of my after-tax income a year in 1999, and progressively saved up to 75% of my after-tax income during the boom years until everything fell apart in the 2008-2009 financial crisis. But by then, my savings buffer and passive income were enough to take the “hits” of saving less.
3) Focus more intently on building net worth vs. growing income. Focusing on both net worth and income is important. But building real long-term wealth comes more from focusing on net worth. Income is just one source of wealth creation. Once you stress net worth, you start focusing on developing multiple income streams, estate planning, tax planning, capital preservation, savings, insurance and a whole host of other things that will prevent you from ever having to declare bankruptcy while earning six figures. It’s what you keep that’s most important.
4) Do not count on anybody to bail you out. The more you can convince yourself there is no financial safety net, the more responsible you will be with your money. Social Security should be completely written off if you are under 40, and even our 401ks might get taxed at a higher rate by the time we get to withdraw at 59.5 penalty-free. If Social Security and our retirement accounts are still there during retirement, then fantastic. If not, we actively saved and invested our after-tax money all those years to achieve financial independence.
5) Lock your money away. If you have a propensity to spend everything you make and more, it’s best to lock your money away in an instrument other than a savings account. For example, you can buy a 5-year CD at a lousy interest rate. Even though the interest rate might only be 2.2%, you’re much less inclined to pilfer your money due to the withdrawal penalty. You can also hire a financial advisor to professionally manage your money as well. We’ve found that once people hire a financial advisor, they have a much lower propensity to spend money due to the financial oversight. Vanguard did a March 2014 study that said due to behavioral coaching by financial advisors, clients increased their returns by 150bps per year.
EVEN IF YOU AREN’T RICH AND BROKE
Naysayers used to tell me, “Of course you could save 50% of your after-tax income due to your income level” when I had my day job in finance. They weren’t shacking up with me in a tiny studio with a high school buddy and staying after 7:30pm every day to eat free food at the cafeteria. They weren’t driving to work in an eight year old Honda Civic or taking public transportation instead of Uber. Saving money takes discipline. The more you make, the more discipline you need because there will be many more temptations.
Even if you aren’t rich and broke like Sylvia, it’s absolutely worth it to delay gratification by adopting a savers mentality. Pay yourself first, focus on growing your net worth, and keep on investing. One day you’ll wake up and be amazed by how much you have.
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