What is Wealth?

A few days ago I heard on the news that because home prices were starting to rebound, people were feeling wealthier and therefore were spending more.  While I’m glad to see home prices rebounding a bit (although now more people can actually afford a home), the fact that people were “feeling wealthier” shows that there is a misconception of what wealth is.  Your home going up in value does not necessarily make you wealthier, and it certainly is a bad reason to start spending more money.

Wealth is the ability to create income without personal labor.  A large stock portfolio is wealth.  A successful business is wealth.  Even a large amount of cash, because you can invest it and create income, is wealth.

Home prices are a bit different.  In general, home prices increase with inflation and replacement cost.  This means that if your home goes up in value, so do home prices everywhere.  Just because your home is now worth more therefore does not make you wealthier because you need a place to live and therefore cannot really use the value of your home.  It is locked away and while the value may be interesting, it really doesn’t affect the amount of money you have available to spend.

There are times that increases in the value of your home can make you wealthier.  For example, if you live in an area where prices increase more than elsewhere and you are willing to sell and move to a lower cost area, increases in hme values can increase your wealth.  Another example is if you are in a large house which goes up in value and are willing to sell and buy a much smaller house and invest the difference.  You can then free up some of the equity you have and use that money to generate income.  Most people will not do this, however, so increases in home values do not cause their ability to generate income to increase.

My main point is that just because your home increases from $250,000 to $300,000 doesn’t mean you should go out and spend more.  Your income did not increase just because your home’s value increased, and because of this the amount you will have for investing to build wealth will decrease if you do so.  For “normal people” who spend all they take in normally, doing so will cause then to go further into debt and actually make them less wealthy.  (Taking on debt makes you less wealthy because you need to generate more income before you have any money to spend.)

It is good to own a home since it allows you to reduce your monthly obligations (the amount of money that is already allocated before the month begins), which is particularly important as you enter retirement and see your income from work disappear.  Spending levels, however, should be guided by how much income you have from different investments and not by the value of your home.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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