Is being rich and being wealthy the same thing? If not, then what is the difference between rich and wealthy?
Contrary to popular belief, being rich and being wealthy is not the same thing. Being wealthy means you have a lot of money in the bank while being rich means you have a high income. But, just because you have a high income does not mean that you use your money wisely—money can disappear as fast as it appears if you aren’t responsible.
Here is why making a lot of money doesn’t mean you’re wealthy.
We Confuse Being Wealthy With Being Rich
What is the difference between rich and wealthy?
According to behavioral expert Morgan Housel, if you’re wealthy, you have a lot of money in the bank. In other words, wealth is money you’re not using—it’s money you could use if you wanted to. In contrast, if you’re rich, your current income is high: You have money you’re able to spend on expensive items.
Crucially, Housel contends, you can tell whether someone is rich, but you can’t tell if they’re wealthy. This is because you can see how much someone spends on items, but you can’t see inside of their bank account to see the money they’re not using—in other words, their wealth. Of course, as Housel notes, someone can be both rich and wealthy, but you can only see how rich they are. For example, if you see both Steve and David buy a $100,000 watch, you know both are rich. But you can’t see that Steve, who has 50 times that in his bank account, is wealthy and David, who’s paying for the watch in installments and has hardly any savings, is not.
|The Origins of Wealthy vs Rich|
In The Millionaire Next Door, Thomas J. Stanley and William D. Danko popularized the difference between being wealthy—having money accumulated—and being rich. Like Housel, they point out that people with high income can lack wealth and that it’s hard to identify wealthy people because they save their money. However, the authors go a step further than Housel: They define your wealth as your net worth, which is your current assets minus your liabilities, and share a formula for discovering how much net worth you should have based on your income and age: Multiply your age by your realized (taxable) annual income, divide it by 10, and subtract any inherited wealth.
Housel argues that when you imagine having a lot of money, you’re usually imagining being rich: You imagine how much more you could spend. But—as obvious as it seems—when you spend money, you lose it. If you had a million dollars and bought everything you wanted, you wouldn’t have a million dollars anymore. The more money you spend, the less wealthy you become.
(Shortform note: You may assume that anybody who actually had lots of money wouldn’t spend it all as they would instinctively know that when you spend your money, you no longer own it. However, several millionaire celebrities have bankrupted themselves due to lavish spending, proving otherwise.)
Housel contends that most people would rather be wealthy than rich. Being wealthy—having money in the bank—gives us freedom to take advantage of more opportunities when they arise, which is ultimately what people really want out of money. (Shortform note: Housel elaborates further on the flexibility that people want from wealth, and why it’s so essential, in Lesson #5.)
So why does knowing the difference between being wealthy and being rich matter? Housel argues that it’s because we learn by imitation, and knowing who to imitate—and who to not imitate—can help us protect our money.
In an ideal world, you could learn how to be wealthy by seeing the self-control that wealthy people exercise. But since wealth is obtained by not spending your money, you can’t see the process. Therefore, it’s hard to learn wealth by imitation—you don’t know who to imitate. (Shortform note: Even if you don’t know who to imitate, you can still discover and imitate the habits that lead to wealth by consuming the right knowledge—like by reading The Millionaire Next Door, which describes the habits of wealthy people.)
But it’s easy to see and imitate people who are rich—and if you don’t understand they might not also be wealthy, you may assume that being wealthy means you can spend money as you wish. But this is the exact opposite of wealth; this will impoverish you. When you understand the difference between being rich and being wealthy, you avoid this trap and prevent yourself from draining your money away.
(Shortform note: Stanley and Danko don’t argue that people who are rich but not wealthy become so by imitating other rich people and overspending; rather, they argue that they’re unknowingly imitating their lower-income parents. Stanley and Danko suggest these rich people mainly want to be “better off than their parents.” But they learned from their parents that the purpose of money is to “spend it when you have it”—and so they spend to appear better off than their parents now, instead of realizing that the purpose of money is to save or invest it so that you can grow wealthy.)
———End of Preview———
Like what you just read? Read the rest of the world's best book summary and analysis of Morgan Housel's "The Psychology of Money" at Shortform .
Here's what you'll find in our full The Psychology of Money summary :
- Why the key to financial success lies in understanding human behavior
- How to make better financial decisions
- How chance plays a bigger role in our financial lives than we think