By Aaron Cirksena
High earnings provide the potential for high net worth, but they don’t guarantee it. Hence the existence of HENRYs, the embodiment of the wealth paradox.
HENRY stands for “High Earners, Not Rich Yet.” Essentially, a HENRY is someone who is earning a high amount of discretionary income but is not managing it in a way that is focused on accumulating wealth, meaning they tend to spend more than they invest or save.
HENRYs stand as an excellent illustration of the wealth paradox that exists in the US today. High-earning households earn as much as 15 times the income of low-income households. They would appear to have everything they need to build a high net worth. However, recent reports show that an alarmingly high number of high earners are putting very little away for their future.
One recent study reveals that high-earning households, which are described as those making between $150,000 and $283,000 annually, are the least likely to give retirement planning the attention it needs. The study says that 32 percent of high-earners are not taking retirement planning seriously. Meanwhile, only 26 percent of middle-income households — those making between $59,000 and $95,000 — are falling short in retirement prep.
The findings on retirement planning show that a large number of high earners have not adopted the type of long-term thinking needed to inspire financial practices that grow net worth. Turning the trend around requires a deeper understanding of what drives the wealth paradox and a commitment to establish a new approach to money management.
What Causes the Wealth Paradox?
A high-consumption lifestyle is the first major driving force at the root of the wealth paradox. Discretionary income is the term used to describe the financial resources that remain after basic living expenses such as food, shelter, and taxes have been met. Using discretionary income to finance a high-consumption lifestyle leaves high earners without the resources required to increase their net worth.
Financial advisors often use “50/30/20” to describe the formula for not overspending discretionary income. It’s a rule of thumb that recommends allocating 50 percent of one’s income to necessities like housing and food, 30 percent toward discretionary spending, and 20 percent to savings.
However, a recent report shares that very few Americans apply the 50/30/20 rule, and only the upper echelon of earners seem to have prioritized wealth building. Among the top 1 percent, the average savings rate is 38 percent. For the remainder of the top 10 percent, who would be considered high-earners, 12 percent is the average savings rate. And among the bottom 90 percent, the rate is 4 percent.
The Problem With Misplaced Priorities
Misplaced priorities are a second characteristic that supports the wealth paradox. The 50/30/20 rule is designed to help earners establish a healthy mix of priorities. Further, it encourages, for example, limiting lifestyle essentials such as housing to selections that do not exceed 50 percent of one’s income.
By encouraging 20 percent savings, the 50/30/20 rule prioritizes future needs over immediate wants. However, those caught in the wealth paradox align their priorities differently by often starting their spending with immediate needs and wants. If anything is left over, it goes to future wants and, finally, future needs. The general attitude is that there will be enough time to figure out how the future will be financed.
When future needs are not prioritized, however, high earners tend to turn an increase in pay into an increase in expenses. A bonus becomes a family vacation, or a raise becomes a higher lease payment on a newer car. After all, the extra $700 a month spent on the car payment doesn’t seem like much when one is bringing home $12,000 a month or more.
Focus on Tangible Wealth
Nevertheless, that type of spending prioritizes depreciating assets over tangible wealth. Tangible wealth describes things like a home or a retirement account that have the potential to appreciate over time. These are wealth-building assets that increase one’s net worth. Depreciating assets, on the other hand, are things like cars, clothes, and electronics that are used up over time. They ultimately have little or no financial value.
In the past, the tendency to spend beyond one’s earnings was referred to as “keeping up with the Joneses.” Today, it could be described as “keeping up with Instagram.” And it can quickly inspire misguided decisions that result in unnecessary expenses.
The 50/30/20 rule also encourages building net worth at a rate of 20 percent of one’s income per year as a means of preparing for retirement. The concept advocates for long-term thinking as part of a sound financial strategy. The wealth paradox occurs when high earners make financial decisions focused on the here and now. As a result, they ignore the future.
The Problem With Overdependence on Earnings
Overdependence on earnings is another factor that fuels the wealth paradox. When 100 percent of one’s earnings are needed to support their lifestyle, retirement will never be an option. This is the case regardless of how much money one makes.
When one limits their spending to build net worth, they are essentially sending money ahead to finance their future. Committing to a season of paying into savings and investments provides for a season in which one can draw out to finance the lifestyle they want.
Overdependence on earnings is also problematic when unexpected expenses arise. After all, if all of someone’s financial means are committed to their current lifestyle, they’ll have nothing to cover emergencies other than credit cards or other high-interest debt.
Taking Steps to Escape the Wealth Paradox
Escaping the wealth paradox requires making a shift in the way one’s money is spent. The current lifestyle must take a back seat to the future lifestyle. Otherwise, the potential for building a higher net worth will never be realized.
To break free, budgeting must become paramount, with savings being a non-negotiable element of the budget. Saving must be prioritized on the same level as food and gas if one is to increase their net worth. Once that point is reached, there is finally a chance to break free of the wealth paradox and create a more secure financial future by improving spending habits and increasing net worth.
For more news, information, and analysis, visit the Financial Literacy Channel.
Aaron Cirksena is the CEO and founder of MDRN Capital.