The Three Zones of Wealth

In my last post I talked about wealth, and how you could define being wealthy. Being wealthy is not defined by your earned income, and is certainly not defined by your lifestyle. With the collapse of the housing bubble, we are seeing plenty of people who are not only losing their jobs, but whose lifestyles were supercharged by pulling equity out of their homes and spending it. The lifestyle was never sustainable over the long term, and the job loss just accelerated the crash.

For me, wealth means passive income. Loosely defined, passive income is money that comes to you with little or no work on your part. Another way of putting it is with the old saying “Have your money work for you, instead of you working for your money.”

Just because you have passive income doesn’t mean you’re wealthy, however. You have to have enough of it. I’ve got both interest and dividend income that I list on my tax return, but I’m a long way short of being able to retire.

And that brings me to what I really want to write about today. I view wealth as happening in three zones, each of which defines a different way of looking at what it means to be wealthy.

The first of these zones is what I call retirement wealthy. Sometimes I hear this being described as financial independence. You enter this zone when you have enough passive income to pay for your current lifestyle. Once your dividends (or royalties, or rent, or bond interest) are enough to cover your expenses, you’ve got a choice: keep working for income, or retire and do what you want to do. I think this is what most people would define as being rich.

To achieve this state, you have to work both offense and defense. Offense, in terms of increasing your passive income (maxing out your 401K, e.g.) and defense, in terms of decreasing your living expenses (drive used cars, clip coupons).

The next zone of wealth starts where considerations of defense can fade away. You want to go to Tahiti for a week? Charter the jet! Seventy-two inch TV catch your eye? Buy it! This is the level of wealth where you have people to handle the mundane details of daily life. You don’t sit around the house all day waiting for the cable guy. That’s what the housekeeper is for.

Once you have entered the first zone of wealth, the longer you keep working, the closer you get to the second zone. After all, if you are not spending all of your passive income, then it will continue to compound on you. Money is the only animal that will only breed in captivity.

The third zone of wealth is what I call Future Old Money. I saw an interview with the country singer Garth Brooks once. One of the things he said was “I have more money than my children’s children will be able to spend.” Future old money. Fifty years from now, Garth’s grandkids will be toasting him at their dinner parties for making their lives of leisure possible.
Most personal finance writers concentrate on the first zone of wealth. After all, that is the zone that all of us can reach. It only takes time, discipline, and a modicum of knowledge. And most of the focus is on what I call defense, reducing expenses, if only to free up capital to invest.

To get into the second and third zones, however, you’ve got to win big. Even if we saw a way to do that, most of us don’t have enough appetite for risk to get there. I certainly don't.