There are two ways of measuring wealth.
This post was originally posted here. The writer, Kyith is a veteran community member and blogger on InvestingNote, with username known as Kyith and 700+ followers.
I didn’t realize this explicitly. I did note this implicitly.
The American Method of Measuring Wealth
The first way is the American method. In United States, when they refer to wealth, you tend to hear someone say, “He has a net worth of $1,500,000.”
What she means is that if this person in question sold her assets, settled all her debts and deposited the remainder of her money into a checking account in a particular bank.
This method of measuring wealth grew in popularity during the rise of Rockefeller and Carnegie.
We can call this net worth or net wealth (because people find the link of wealth to worth to be uncomfortable)
And you can compute this using the personal net worth here.
The British Method of Measuring Wealth
The second way is the concept very prevalent in Great Britain a century ago. In London, the financial capital of the world back then, you tend to hear someone say, “He has a private income of $100,000 per annul.”
This is referring to the household income generated by her portfolio of investments.
This income represents the money the owner could spend without touching her principal. According to the experts, this is not similar to the sustainable maximum withdrawal rate, which is the constant inflation adjusting method of withdrawing money.
Household Income Accentuates the Functional Utility of the Wealth Compared to the American Method of Determining Wealth
One draw back of the American method of measuring wealth is that some of the assets can be rather unproductive.
Here are some examples:
1.Richer people can own a piece of land that is valued at a very high price but cannot be easily sold. They might not be willing to sell it as it is a family heirloom, many family members vested interest determining what they should do with the piece of land
2.A landed property in land scarce Singapore is very valuable so the landed property, if liquidated can fetch a lot of money. However, in terms of how much it could rent for, it might not perform as well, in terms of per square foot net rent, compare to other forms of property. Against other form of investments it might not provide the same level of efficiency as well
3.You could own many different assets such as an expensive motorcycle, and cars. You should be able to liquidate them. However, if you lose your high tier job, a person might be caught in a frame of mind that cannot readily liquidate these assets and turn them into cash flow. They might be unwilling as well
The British method focus on the functional utility of your wealth. It allows you to see how the wealth can change your life.
The first thing is how much of your expenses, that you pay with your work income, can this stream of cash flow replace. This stream of cash flow increases your current overall purchasing power.
It allows you to:
1.wear nicer clothes
2.donate more to charity
3.expand your investment holdings
4.send your grand children to university
5.have better food
The savvy people would know what to do with a lump sum of wealth. Unfortunately, not many are that savvy. But if you have an inexhaustible stream of cash flow, it is easier to think how you could spend this money to help the people around you and yourself.
Most importantly, it limits you from making poor decisions with your money.
Based on sunk cost theory, if you wake up, you could always say “I do not care about what I do with the cash flow in the past, let me plan what I would do with the cash flow going forward”. If you have a lump sum and you erroneously spend it in an inappropriate way, it is not going to come back.
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