External income vs interest on savings

8 Nov 2023

Blog External income vs interest on savings

In this post we will discuss 2 different financial situations. Both are wealthy but have different lifestyles and financial incentives due to the different source of their income.

New Money Ned gets his income from his successful business. He does not have large savings. Old Money Osborne gets his income from interest on his large savings. 

Why new money spends more than old money

People think new money spends more than old money because new money:

  • Is less financially literate.
  • Is over excited to be able to buy nice things for the first time in their lives.
  • Lacks long term planning and naively thinks their current success will last forever.
  • Wants to show off their success to others.

That’s not wrong but there is a practical mathematical force at play on the other side. The other side being why does old money spend so little?

If New Money Ned spends x% of his savings, then his income is not affected, the profit keeps coming in from the business. However if Old Money Osborne spends x% of his savings, then his income goes down by the same percentage, because his income is a percentage of his savings so his income amount is determined by his savings amount.

Spending more than you earn

Here is an example of 2 people who start with the same income but from different sources. They have the same yearly expenses paid from their savings. Note the effect that the spending has on their income going forward in the last line.

Table 1New Money NedOld Money Osborne
Income sourceProfitable business5% return on savings
Start of year savings$1,000,000$10,000,000
Start of year Income$500,000$500,000
Year expenses$600,000$600,000
End of year savings$900,000$9,900,000
End of year Income$500,000$495,000

New Money Ned spent 60% of his savings but his income is unaffected. On the other hand, by overspending 1% of his savings Old Money Osborne’s income has decreased by the same 1%. In fact Old Money Osborne is in danger of a wealth death spiral, his income has gone down and if he keeps spending the same it will keep going down even faster all the way to zero! This is why old money is frugal.

New Money Ned has also gotten closer to being broke in that his savings have depleted, but he does not rely on his savings for income. Still they would both be better off spending less than they earn.

New Money Ned only came out with a better income than Old Money Osborne because they both spent more than they made. If they both spent less than they made the opposite would be true.

Spending less than you earn

Table 2New Money NedOld Money Osborne
Income sourceProfitable business5% return on savings
Start of year savings$1,000,000$10,000,000
Start of year Income$500,000$500,000
Year expenses $400,000$400,000
End of year savings$1,100,000$10,100,000
End of year Income$500,000$505,000

Old Money Osborne can increase his savings and his income by simply living within his means! That’s why he drives a Subaru and wears a Casio watch. 

Income from a successful business and interest on savings!

You might say it’s better to have income from a successful business and interest on large savings; Old Money Osborne should start a successful business and New Money Ned should grow his savings and get meaningful interest on them. Good idea but hard to pull off, anyone who can do this over a sustained period has found financial El Dorado.

It is very difficult and risky for Old Money Osborne to attempt to start a successful business and there are no guarantees. He might work really hard for a long time, hate it, and lose money. Which would be stressful and reduce both his savings and income! Better to leave the money invested at 5% and just live within his means risk free without having to work, like in table 2. 

New Money Ned needs a lot more savings to make the interest meaningful. A few of the things which make that rare include:

  • New Money Ned keeps spending, or investing in his own businesses, so does not accumulate large savings to gain interest on.
  • The only way New Money Ned could get large savings quickly would be by selling his business. He would then be in the same position as Old Money Osborne; large savings but no income from business.
  • It’s a lot more common to be successful for a while than it is to stay successful for a long time. After an Entrepreneur has made his millions he might lose the passion and drive that allowed him to be successful. Or he might have had a head start due to good timing but then got outmatched when the competition arrived. Both happened to me.

Inflation punishes savers, crypto fixes this

It’s important to understand that if the interest on Old Money Osborne’s savings is less than real inflation, then he is screwed in the long run. He will have to deploy his capital with greater risk and reward rather than just let it sit in the bank and make interest. This deployment of capital could increase economic activity and create jobs, if he did something like start or invest in businesses. 

What he should do is go all in on cryptocurrency. If he chooses the right investments he can make the equivalent of interest on his savings with DeFi returns from things like staking, lending and liquidity providing. The price of the crypto he holds will go up over time defeating the inflation threat, and then some.

New Money Ned with his income from a business is less impacted by inflation. As his costs go up he can raise prices to match, and his profit will nominally rise in line with inflation (the number will rise, not the real value). Even so, the best way he can grow his savings and get meaningful interest from them is to invest in crypto and DeFi.

Gentleman James

Gentleman James: New money trash connoisseur

Gentleman James
New money trash connoisseur

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