Saturday, March 20, 2010

Personal Finance Part 16 – The Measurement of Wealth

Traditional methods for measuring wealth are to look at the absolute amount of assets which a person has, and compare this to other well-endowed people, in order to arrive at some basis for comparison and benchmarking. Interestingly, Singapore happens to be the country which generated the highest number of new millionaires, and everywhere one goes, we see beautiful luxury cars and people carrying branded goods. All these serve to reinforce the notion that Singapore is a country filled with rich and wealthy people who are ready to flaunt their assets. But how rich are we in actual fact? This post intends to poke some holes in the theory of “wealth” (note the quotation marks) and how it is generally perceived; and to suggest some measures of my own!

The first quirk of being wealthy is the often quoted “Asset Rich, but Cash Poor” syndrome. Essentially, this refers to a person owning many assets (most often, real estate), but having very little cash savings. Such people often plough a significant chunk of their funds into real estate or other assets, leaving them with very little cash buffer. Others purchase such assets using leverage, and thus have high monthly capital commitments to service. On the surface, these people would be classified as “rich”, but then again they do not really “own” the property or properties as these are all on loan. Eventually, one has to liquidate in order to justify the investment, but lack of liquidity can severely stymie a person’s ability to get cash fast. In the interim, one may suffer from a serious lack of working capital if they do not manage their cash flows well. Thus, this definition of “wealthy” is contingent upon a person being able to manage his cash flows very well, while at the same time juggling a (highly) leveraged Balance Sheet. Risky, admittedly; but sometimes that is the price to pay for being able to tag on a label “Wealthy”; however ephemeral that may be.

Let’s face it: what most people in this world seek is material comforts and financial abundance. Money can buy one many items which can enhance one’s quality of life, and in industrialized, capitalistic countries like Singapore, materialism has gone on hyperdrive. Ask any young person these days on how he measures one’s wealth and he will not hesitate to quote a number, usually in the six to seven-digit range. But the pursuit of absolute wealth is meaningless unless we have an idea of how that wealth is able to sustain us in times of emergency, or in a downturn when we lose our jobs. Therefore, I propose an alternative method of measuring wealth. By the way, this method is not new and has been mentioned on some personal finance websites; however it has generally not been widely acknowledged and recognized because of its difficulty to measure. Wealth should be defined as a function of how long your current savings can last you assuming you lose your income-generation capability.

Sounds harsh? Not really. Let me illustrate with a simple example. Person A has $50,000 worth of savings and his monthly expenses come up to $2,000; while Person B has $200,000 and his monthly expenses comes up to $10,000. Using my definition above (in bold), Person A can last for 25 months without income ($50,000 divided by $2,000) but Person B can only last 20 months ($200,000 divided by $10,000). Hence, Person A is “wealthier” than Person B even though the absolute value of his savings is 66% less than Person B. I am sure we have seen this in real life – people who own many nice cars and gadgets and have a high “maintenance” cost, so in reality they are “poorer” than people who have lesser savings but correspondingly much lower fixed monthly expenses. So, going by this definition, how well do you fare?

Another definition of wealth is that it is an amalgamation of more than just material goods and money. This is a more holistic definition of wealth and seeks to separate it from merely being “rich”, which implies materialistic possessions. Being wealthy in life means having rich and loving relationships, people who love you; as well as fun and laughter every day. In a way, this translates into true happiness – having more than just money and material goods; but also love and life which transcends the cold, grey loneliness of money. Where money is cold (coins), relationships are warm. And this is where we should strive towards.

I guess this sounds extremely clichéd, but I have to say it anyway. Use a different definition of wealth from the rest of the world, and one will always feel rich and successful.

26 comments:

Createwealth8888 said...

Wealth as measured by time

Wealth has also been defined as "the amount of time an individual can maintain his current lifestyle for, without any new income."

For example if a person has $1000, and their lifestyle dictates $1000 per week of expenses, then their wealth is measured as 1 week.

Under this definition, a person with $10,000 of savings and expenses of $1000 per week (10 weeks of wealth) would be considered wealthier than a person with $20,000 of savings and expenses of $5000 per week (4 weeks of wealth).

Createwealth8888 said...

Sustainable wealth

According to the author of Wealth Odyssey, Larry R. Frank Sr, wealth is what sustains you when you are not working. It is net worth, not income, which is important when you retire or are unable to work (premature loss of income due to injury or illness is actually a risk management issue).

Ricky said...

That's why it's important to build up different sources of passive income while you are still able to work.
When passive income = expenses, that person has achieved financial freedom.
This is an important aspect of financial planning. Usually can buy some form of insurance to cover this aspect.

Createwealth8888 said...

Any practical suggestions for other passive income besides stock dividends and rental income for an average person e.g can't write books to collect loyalties

Royston said...

I think the definition of wealth depends on whether you want to take it literally as in monetary sense or figuratively as in personal well-being.

If we take it in the literal sense, then i think it can be measured in terms of total asset worth, be it cold hard cash or real estate assets.

In the more subjective form, i think wealth can be measured by personal satisfaction in his/her own well-being. One who is greedy and yearns for the world, would never feel wealthy irregardless of his material assets. Yet one who lives simply may not need much to feel wealthy.

Musicwhiz said...

Hi Createwealth8888,

Thanks for your contributions. Appreciate them.

I can't think of many other passive income sources besides dividends and rental. Perhaps other readers have suggestions on this?

Cheers,
Musicwhiz

Musicwhiz said...

Hi Ricky,

Yes, though it takes time, effort and a lot of discipline. It's like sowing the seeds now and waiting to bask in the shade of the tree which will be there 20 years later!

And yes, I do agree insurance is a very important aspect of wealth building because it is a form of protection. Good point!

Regards,
Musicwhiz

Musicwhiz said...

Hi Royston,

Yes, it really pays to be easily satisfied, so you will not always end up COVETING, which will make one perpetually unhappy because it's never enough!

For me, I'd rather focus on personal well-being as it can be very tiring to always "chase" after money. I heard a line once from a dying tycoon who regretted not spending enough time with family (he focused too much on making money). He said: "I am a rich man who has lived a very poor life". How true!

Cheers,
Musicwhiz

Ricky said...

You can try writing a very popular blog like this and monetize it :)
Put some ads let readers click...money rolls in :P
Gotta ask MW if it works haha

la papillion said...

Hi mw,

Wow, I didn't know there are so many ways to measure wealth. Actually I never thought much about how society measures wealth. I just need to know that I've got to hit this target and that target :)

I'm thankful that I dun have to be in the environment of people who will judge me based on the clothes and car that I have. AND THAT IS GOOD! haha :)

TGPlan said...

Hi MW,

Yes how true. There are those who are so preoccupied with earning money that they forget to live their lives with it.

Royston

Musicwhiz said...

Hi Ricky,

Haha well apparently it does not work as well as I would want it! The ads don't generate quite enough to even cover a meal every month, and that's the truth. I am blogging more for passion and personal interest and also to share my journey and thoughts, rather than to make a business from this and earn "passive income". Hehe.

Thanks!

Musicwhiz

Musicwhiz said...

Hi La Papillion,

Haha well there are so many ways you can measure anything I guess.

It's good you don't subject yourself to peer pressure. It can be very "fake" and makes one feel stress one shouldn't even be feeling. Good for you!

Regards,
Musicwhiz

Musicwhiz said...

Hi Royston,

Yep that's the sad reality of life. That's why we must have balance in everything we do. It's not easy to achieve this balance though, we must constantly ensure we do not tip the scales either way.

Cheers,
Musicwhiz

JW said...

Wealth can be self-created too.

I hereby declare my water bottle to be worth $1 mil

There you have it, my networth is a million dollars!

Investment of the Decade is coming soon... said...

The society measures wealth in a strange way. I am earning more than most of my peers. Just because I am not owning a car, many of my peers perceive me an unsuccessful. Never judge a person by their appearance.

Musicwhiz said...

Hi JW,

As part of conservative and prudent accounting practice, one is NOT supposed to recognize internally generated goodwill!

Haha.

Cheers,
Musicwhiz

Musicwhiz said...

Hi Investment Of The Decade,

I am somewhat of the opposite! I don't own a car but I know for a fact that I earn LESS than my peers. Perhaps that's why I don't own a car! haha.....

Regards,
Musicwhiz

Ricky said...

Hm, how do you know how much your peers are earning? I think going by the GDP or something like that, i'm earning less than average...

Royston said...

Hi MusicWhiz,

I'm compiling a list of Singapore Investment Bloggers...

http://sginvestbloggers.blogspot.com/

Have added your site in the list, appreciate if you can also create a link to the site.

Cheers,
Royston

Singapore Stock Picker said...

hey.. MW... can drop me an email? just want to bounce ideas off you ...
sgxstockpicker@gmail.com

cheers

Musicwhiz said...

Hi Ricky,

I have a rough idea of what my peers are earning, not an exact figure but a range. I know I am below the average, so I cannot surpass them in this aspect. What I can hope to do, though, is to SAVE more than them in terms of % of my income. That would be the way to go to build wealth.

Regards,
Musicwhiz

Musicwhiz said...

Hi Royston,

OK, thanks. Added.

Cheers,
Musicwhiz

Musicwhiz said...

Hi Singapore Stock Picker,

Already sent you an email.

Cheers,
Musicwhiz

CK said...

Interesting blog as always sir.

I think this quote should summaries the many lively posts here:
"Acquire worldly wisdom and adjust your behaviour accordingly. If your new behaviour gives you a little temporary unpopularity with your peer group…. then to hell with them." --Charles T. Munger

Oh, and something even better from the same man:
"I think when you're buying jewelry for the woman you love, financial considerations shouldn't enter into it."

Musicwhiz said...

Hi CK!

Haha thanks good quotes as always by Mr. Munger.

Regards,
Musicwhiz