The Fundamental Role of Income

I have a question I ask all my clients: “What is the engine that drives your lifestyle?”

Most of them eventually land on income. Of course health, family, faith, and many other things are important to our existence, but the income we earn, in my estimate, is the thing that is the lynchpin for our lifestyle. Whether you are 2, 20, 65, or 90 years old, it is about income. Working or retired, it is about
income. You may say, well there is that one person. Perhaps you have taken a vow of poverty and it is about someone else’s income. Or perhaps you are a YouTube sensation, forging hatchets from iron ore, completely self-sufficient, living off the land. Either way, for most of us, income is paramount to the lives we live.

THE ILLUSION OF ASSETS OVER INCOME

An interesting thing I have observed is that society tends to be more enchanted by assets. To allow you to think for yourself about what is most important.

Imagine this… Imagine that you won the lottery, and I told you your ticket was worth 100-million dollars! What feelings would you have? How would your life change in the blink of an eye? How would you physically change before our eyes? And then, just as quickly as I said you won $100-million dollars, I followed up with the fine print of your massive win: “You, my friend will receive your $100-million in the form of $1,000 annual payments for the next 100,000 years, and upon your death, whatever you have not enjoyed, you will leave for the next lucky winner!”

I am not saying any of us would turn down an extra $1,000 a year, but hopefully I am proving to you that it is not about assets, but rather the income that can be generated from those assets. We have a tremendous amount of clients in the Capital Region who have, or will have, NYS Pensions. For years now, I have smiled at how little these clients have appreciated the money that is required behind these pensions to guarantee payments for a lifetime. Ironically, I have also smiled at how much our clients overestimate the amount of income that their 401(k)s can generate based on the lump sum they have.

UNDERSTANDING COMPOUNDING INTEREST & MORTALITY CREDITS

Two simple but profound distinctions every human should understand are the idea of compounding interest, and the law of large numbers; or in the context of income, mortality credits.

Investopedia defines compound interest as the interest on savings calculated on both the initial principal, and the accumulated interest from previous periods. As I often say, over many, many years of diligent saving, you have the opportunity to take a little bit of money and create a lot of money. In the context of compounding interest, the years you have and the interest you earn each year will determine the success of this strategy. The law of large numbers, and in this case mortality credits, can have a significant impact on income.

Simply put, across a very large group of people, actuarially, you can determine an average age of death. Some people will live beyond this average age, and some people unfortunately will die before this average age. Mortality credit is the idea that when you pool a percentage of your money together with thousands of other people, the ones who pass earlier than expected can benefit the ones who live longer than expected. This can increase the amount of income available for each individual while they are living. Pensions, such as the ones provided to employees of NY State and other municipalities, leverage this actuarial science and mortality credit in providing these employees with a guaranteed income for life.

TOOLS AND CONTEXT IN FINANCIAL PLANNING

In my opinion, the financial industry is divided into two camps. Of course, there are firms like Thoroughbred Advisors who enjoy and see the value of each camp. The financial tools available in our industry primarily fall under two major umbrellas: investments and insurance. Those in the investment camp leverage the distinction of compounding interest, and work to solve the income challenge through building greater assets. The insurance camp often leverages the law of large numbers and mortality credits when solving the income challenge. In my opinion both are valuable, they are simply different tools.

We believe that tools are neither good nor bad, until you put context around them. To give a simple example, in the context of a nail, hammers are amazing tools. In the context of a screw, hammers are not so amazing. With that said, I can definitely get a screw in with a hammer! At the end, however, what does the screw look like and what does the material surrounding it look like?

THE CONTINUOUS IMPORTANCE OF INCOME

The context of our lives. The resources we have. These and other factors will impact the tools you will need to implement. And as a reminder, your lives are driven by income today, and so it will be for the years to come.

If you do not have a clear view of how you will maximize income now, and in the future, we would welcome a conversation.

The information provided herein is for general informational purposes only and should not be considered investment advice. Any strategies described may not be suitable for everyone. Readers are encouraged to evaluate all information in light of their own situation and seek the advice of an appropriate professional advisor.

Thoroughbred Advisors is a leading financial firm dedicated to providing tailored, transparent, and authentic financial solutions for their clients. Established in 2014, the firm focuses on empowering individuals, families, and businesses in the Capital Region to achieve lasting financial success. Visit our office at 421 Troy Schenectady Rd, Latham NY 12110, or our website at www.thoroughbredadvisors.com