Question: What's The Correlation Between Income and Net Worth?

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Dec 12, 2016

Stats teachers teaching correlations will love this graphic…and you should too!

2013scf_income_v_wealth_united_states

I love the folks at Visual Capitalist (ongoing hat tip to Big Picture Blog) and their creativity at using graphical representations to help elucidate (been dying to use that word) complex topics.

First, let’s orient what you’re looking at (from Visual Capitalist):

On the x-axis, you’ve got household incomes, as defined in the SCF (think ‘taxpayer units’).  On the left axis, you’ve got a measure of wealth (see the SCF methodology for details).  The color of the dot represents the age of the ‘head of household’, where darker dots represent households headed by younger folks.  The ‘size’ of the dots is the number of households which are supposed to be represented by the sample, so even though there appears to be a large number of dots in the upper right… they don’t mean as much as the lower left dots do.

So we probably need to define income and net worth which can be confusing to students. I like to think of income as the money that individuals earn annually from items like the salary at their job, interest on savings account (not much these days), dividends from stock investments, etc. On the other hand, net worth represents the difference between the assets you accumulate (checking and savings accounts, stock investments, autos, home equity) minus money  you owe (or liabilities like car loans, mortgages, money you borrowed from your friend).

Here is the analogy that Visual Capitalist makes to explain the two terms:

Income is better analogized to acceleration and wealth to speed – just as a car accelerating quickly from start means something completely different than a powerful car accelerating quickly on the highway, the two quantities are related in a way… but are not the same.

Stats geeks, I leave it to you to unpack the R squared and correlations that the author includes in the article. How to make this accessible to all? Here’s a simple way to get the point across that income doesn’t equal net worth a.k.a. wealth:

  • Trace the vertical line at $100,000 in income.
  • Do most households earning $100,000 a year have the same net worth?
  • What is the range of net worths from lowest to highest for households whose annual income is $100,000?
  • Why would a household earning an annual income of $100,000 have a net worth of only $1,000?
  • Why would a household earning an annual income of $100,000 have a net worth of over $10,000,000?
  • Are you surprised by the wide variance in net worth for a given income level?
  • You hear a friend say: If I could earn $100,000 per year, I would have an incredible net worth. Is he right? Use evidence from the graph to support your answer.

What I hope that students take away (which they can also get from watching this ESPN Broke vide0), is a deeper understanding of that old adage “It’s not how much you make, it’s how much you save.”

 

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.