The Wealth Formula: Income x Savings Rate = Wealth

One of the most overlooked questions in finance is the question of savings. How much of your income are you actually able to save? 

One of the things that people most often ask me is “what’s the best investment right now?”. It is like someone asking a chef what the best ingredient right now is. It totally depends on your appetite.

Investment has been glorified: the markets, the live prices, the multiple screens with complicated charts, the allure of big gains. In my experience, all of this attracts folks who are not actually able to save that much and want to make the little that they are able to save work really hard. They want 10x returns and they are willing to put everything on the line for it.

I have had people literally scoff at me when I tell them that getting a 6% yield on a safe asset where you don’t have to do anything is actually an extremely compelling proposition. But looking back, it was not the people who have plenty of savings to invest that scoffed; it is usually the folks with lower savings who are in search of huge, unrealistic gains.

The income question is something I have not really seen the finance industry address. But for us at IFG from a pure mission perspective of us wanting to see the Muslim community in particular level up, it is absolutely central. 

It’s why we as an organization have done talks up and down the country on career planning for years now, much of it unfilmed, and before you could even call us an “organization” (!). Although I did find one video of Ibrahim in the archives from around four years ago.

Your income level is critical before you even start thinking about investments. In this article, I’m going to dive into the data and spell out why your income level needs to be your first point of attention. Then I’m going to give some practical advice on how you can increase your income level. We’ll finish on a target savings percentage and how to then actually get it to work.

So, how much can you save then?

If the answer to that is “barely anything” there are usually one of two (possibly both) problem areas at play:

1. you are spending too much; and/or
2. you are not earning enough.

The older generation like to make us think that the problem is just that we spend too much. If you remember the viral, infamous article that said that actually we CAN all save for house deposits if only we could give up our penchant for avocado and expensive coffees. 

The reality is that it just isn’t true. Costs are incredibly high nowadays relative to where salaries are and, even if the older generation cannot quite recognize it, it is objectively the case that it is very difficult to save very much on a monthly basis for most households.

Buying value brand beans instead of branded ones is only going to help so much. The biggest potential is much more likely to lie in (2) – increasing your income. 

And the data backs this up.

There is a really interesting paper from 2000 entitled “Do the rich save more?”. One of the big conclusions there is that people with higher incomes save more money. 

It sounds like an obvious statement, but when wealthy people fill the airwaves with trite ideas around being frugal, investing well and then becoming rich, they often forget their own story. Wealth may well derive from great investments, but the money for investing can only come from high levels of income.

Life’s cheat code

The cheat code of life is that things only cost so much. 

Nobody stops you at the door of the supermarket to check your bank balance. So whether you’re a multi-millionaire or whether you are living month-to-month without any savings, you are going to be doing similar grocery shopping, you both still have to fill your car with fuel, pay your bills, and so on.

Sure, the rich person will afford themselves some luxuries. If they see something they want on the shelf, they don’t have to think twice. And they probably go into a nicer car (though not necessarily) and a nicer house. And the kids probably go to a private school and more expensive holidays.

But how much extra does that really all cost in the grand scheme of things? Unless you’re absolutely wasteful and you’re spending like crazy on a daily basis, your expenses as a rich person are not by default hugely higher than someone living month-to-month.

What does that result in? More excess cash at the end of every month for the rich person whilst the other person is completely spent out at the end of every month.

OECD data puts the average household saving rate of a UK household at 6.9%. The data for higher income households will show a higher percentage of savings rate. And since you are dealing with larger numbers for high-income households, that means that the numbers involved are larger too.

How to increase income?

Now that we’ve established that higher income households save more and can therefore invest more and become wealthy with the right moves, the question is how do we increase our income?

If you’re young and yet to enter the workplace, my key advice here is three-fold:

1. Look into areas of work that have high earning potential and double down on them. These might be areas that are somewhat “new-age” e.g. AI, software engineering, data science, etc or they could be very well-trodden paths like Law and Medicine. But have mind to the future as well – some career paths pay well initially, but cap out quite early too. You want to have a path to be earning at least $500k+ if you are good enough to rise to the top of that field. Obviously this will not come overnight but $100k should come fairly quickly and then you are well on the right path.
2. Be very purposeful about what you do outside of work. There’s two big areas of leverage that everyone should consider in my view. The first is some kind of business. Whether that’s starting something whilst you’re young with a view to growing it and then making that your entire purpose, or even if it’s something you can build and then make passive for yourself and get income from, business is a great way of getting to high income levels. Secondly, consider your personal brand and get yourself out there with content. It makes you a much more desirable asset.
3. Invest in yourself. Use your early money to upskill yourself. Do not worry about investing small amounts of money in the stock market or other investments. That will not change your life even if it does well. I know that doing 1000x return on a small investment can indeed change your life, but let’s work off probabilities and not rely on essentially a gambling mentality to dictate your future.

If you’re older and already more established, perhaps in a career with not much progression prospects:

1. Consider the fields out there like I outlined above that you could switch to. Or consider upskilling hard in one area that is in-demand that you can create a one-person agency around e.g. SEO, digital marketing, web development, etc. This is very realistic, puts you in the realm of doing business (albeit as a self-employed person) but it means you’ve now got something where you can increase your income over time (e.g. by charging more) or indeed actually build a business by growing the agency by hiring people.
2. If your industry is a good one but your firm is not, play the field. Look out there for other opportunities and don’t be afraid to let your employer know that your current salary will not work for you if you have other viable options to go to. 

What to do with higher savings?

If you are in the position of saving a good proportion of your income (which I’d define as 20% or more), then you are in the realm of now having to decide what to actually do with your money.

There’s 3 ways that I think about this:

1. My family’s quality of life. Money is a tool and I have a God-given duty as a Muslim man to provide and to protect for my family.
   
   Abu Mas’ud reported: The Prophet, peace and blessings be upon him, said, “If a Muslim spends on his family seeking reward from Allah, it is charity for him.”
   
   We shouldn’t be miserly when it comes to our family and if there is an opportunity to do something the kids or your partner wants to do that will make them happy, I make the above intention and (within reason) we do it. I also try to be proactive about this and spend money to, for example, make my wife’s life easier where it can achieve that. For instance, ordering food in if she is tired to cook (or cooking myself).
2. Investments in active things. When you invest, you can either invest in something that you have to put work into, or something that someone else handles. Ibrahim and I recently invested into a business as part of our Muslim Mogul video. Given the active involvement that we have with the owner there, this is very much an active investment. Active investments generally give you better returns but there’s a limit to how many you can do. Another example of this would be buying a business yourself, running your own property portfolio, or constructing something yourself.
3. Investments in passive things. Most of my spare capital goes into this bucket. I try to make sure I’ve got a good spread of things and I make sure I know why I’m investing in something. I have my goals written down, I know what money I can afford to lock up and what money needs to be more liquid. Naturally I invest in some of our own products at Cur8 Capital and I also manage my own stocks portfolio.

Conclusion

If there’s just one thing to take away from this, let it be this: if you are saving less than 20% of your income right now, focus on increasing your income before considering any investments. 

Your big wealth jumps will come when you can increase your income. Not just in terms of your bank balance, but also in terms of your mindset. More excess capital means you can do more varied investments with differing risk profiles. And the more higher risk investments you can make safely, the more chance you have of that real compounding effect.