What is Wealth?

The idea of wealth can be tough to understand - it's not the same as the paycheck you earn.  You can earn a huge sums every month and still have little to no wealth. Confusing?  Maybe this analogy will help:  

Picture yourself standing in the wilderness alongside a running stream and looking out across the stream at the water flowing.  As you watch the water, imagine you're watching your cash 'flow'.  As the water - or money - flows from upstream toward you, you are seeing your income flowing into your bank account. As that water passes you by and fades away downstream, the passing water represents the income you've spent - your expenses, dinners out, car payments, etc.  If you spend every cent you earn, all the water (money) remains in the stream and flows away out of sight, never to return.  It came to you and you spent it. 

However, if you were to begin dipping a bucket in that stream to remove some of the water as it flowed by, then the downstream flow of the stream is slightly reduced. The water remaining in the stream - representing your money spent - is less than before, reduced by the volume of water in the bucket you pulled from the stream to keep.  The water in your bucket is savings.  In equation form, it's:

Income = Savings (buckets) + Expenses

A more familiar expression is:

Savings = Income - Expenses

This version of the equation shows that each dollar of income that exceeds your expenses is a dollar saved.  

So, after years pulling buckets of water out of this income stream and storing it, you will have accumulated enough water to partially fill a swimming pool. The water in the swimming pool represents money at rest - or wealth. 'Wealth management' is the business of answering the question "What should I do with the water in my pool?" You can choose keep the pool as it is (by simply retaining the bucket contents in cash form) or you can try to grow it (by investing that cash in something). While you're making that decision, hopefully you're continuing to regularly pull buckets from stream (the habit of saving) and pouring them into the growing pool of wealth.  

At the end of your working life (also known as 'retirement'), you'll step away from the income stream. There is no longer money flowing in that stream from your job since you're not employed, and the income stream was flowing as a result of your employer paying you for your labor. Post-employment, in order to cover your expenses, you'll need to begin slowly draining the pool by making retirement withdrawals. These withdrawals establish a new stream - your 'retirement income' stream. This new stream may include a military pension, social security, disability payments and other wealth sources - but a significant portion comes from your personal wealth pool. The 'big idea' is to fill and grow the volume of water in the pool during your working years so, when you start draining it in retirement, it won't run dry.

Keeping the pool full.

Think of the size of the bucket you use each month as your 'savings rate' (discussed elsewhere). The bigger the bucket, the quicker the pool will fill. The number opportunities you have to dip the bucket in the stream is your 'time horizon' (also discussed elsewhere).  So, if you're 30, plan to retire at 60, and you're saving monthly - that's 12 mos/yr x 30 years, or 360 bucket dips in the income stream.

The most mysterious part of this analogy is this: when you invest the money in that in the swimming pool, the quantity of water in the pool can quietly grow in volume, often far eclipsing the total volume of water buckets pulled from the stream.  For example, you can save a hundred buckets over eight years yet clearly see double that water volume sitting in the pool. The water in the pool grows (and sometimes shrinks) almost like someone stuck a garden hose in the pool and is twisting back and forth on the water spigot. The gains and losses of water in the pool represents the volatility of your chosen investment. This volatility means the amount of water that comes out of the garden hose varies over the short-term, but - and this is important - over the long-term the pool gets more full since the spigot is on (positive growth) more than it's off (negative growth). This long-term trend of reflects the historical long-term return rates of the US equity market. 

Pool Care

So, after you've plucked hundreds of buckets from the stream over the years to fill the pool, you want to keep all the water you can - but every pool loses some water. The pool’s water loss (evaporation, leaks, etc) is similar to the wealth lost due to the costs of your investment product. Some of the loss could be due to mutual fund expense ratios, other wealth is lost to advisor fees. If those expense ratios and fees seem high*, patch your ‘wealth pool leaks’ by finding investments with a low expense ratios or an advisor with lower fees (or eliminate the advisor altogether). Managing these wealth leaks is important because these costs reoccur every single year! Minimizing costs is crucial to keeping your pool as full as possible.

*Expense ratios above one percent (1%) are very high. A half percent (0.5%) is better, but below a quarter percent (0.25%) is best.  Many low cost index funds are below one tenth percent (0.1%).  The US government's TSP funds average about that one twenty-fifth of one percent (0.042% for 2019).