income-and-wealth-share

The Relationship Between Income and Wealth

Let’s say that your neighbor is a surgeon that makes $250,000 a year. Does that mean he or she is rich?

The answer is “no” – and it turns out that the actual statistical relationship between income and wealth is surprisingly low.

Graphing Income and Wealth

The folks at Don’t Quit Your Day Job did an analysis of federal data on income and net worth, and the results can be summarized with this visualization:

Relationship Between Income and Wealth

The X axis shows annual income, and the Y axis shows net worth. It’s also worth noting that both scales are logarithmic, so they the intervals increase by a factor of 10x.

The above data has some correlation, but it’s not as much as you’d likely think.

The R-squared value, a measure used to express the relationship between two sets of data, is only 33%. In other words, one variable only helps to “explain” the other about a third of the time, which suggests just a partial relationship between income and net worth.

Although this minimal relationship may seem counterintuitive to some people, it all makes more sense when you consider that income is just one factor that could contribute to overall net worth. Income is important, but spending habits, savings, and investments are also important to building wealth over time.

The Age and Experience Factor

Now, here’s the really interesting part: income is a better predictor for the wealth of people in certain age groups, and a worse predictor for others.

Here’s another chart from DQYDJ:

Correlation for income and wealth for different age groups

For younger people, there seems to be hardly any relationship between income and wealth. Later on, in the late-30s, the relationship seems to peak. During this age period, income is actually a very good predictor of someone’s net worth.

Finally, from there, the relationship seems to decrease over time. The older you get, the less likely income is a useful predictor of actual wealth.

This makes sense for a variety of reasons, but perhaps one of the more important one is how that money is spent. People that are disciplined savers and smart investors will increase their net worth over time, regardless of their income.

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