In the past few years I have perceived a particular habit of many high income earners over and over again. They work hard like clockwork, burden themselves with more and more responsibilities, get promoted in turn, and so the figure on their monthly paycheck grows from 4 to 5 digits quickly. And yet, they struggle to make ends meet.

Especially those who practice professions with a reputation for a high occupational status - like entrepreneurs, film stars or even in my own industry of Berlin real estate - are likely to experience the discomfort of crippling dept, up to the point bankruptcy in the most severe cases.

To understand the issue here, it is crucial to distinguish between high income and high net worth. The common misconception is that a high income correlates with high net worth, but shockingly studies reveal that the opposite is the case. Don’t misunderstand: It’s not that low income guarantees high net worth, and of course individuals with a higher income have the bigger potential to amass wealth, but people working in an industry with a high occupational status (who in turn have a high income) tend to fall into what I like to call the “social recognition trap”. The inevitable result is living from paycheck to paycheck.

The keyword here is financial literacy. Or simply put: It’s not about how much money you make, it’s about how much money you keep.

In “Stop Acting Rich: ...And Start Living Like A Real Millionaire” business theorist Thomas J. Stanley highlights how 1 in 4 physicians in the US has an annual income of $200,000 or more, while “only about 1 in 10 is a millionaire.” The reason many people with high income struggle to actually build wealth is because of an unnecessarily extravagant lifestyle. They purchase luxury goods like expensive watches and jewellery, they wear designer clothes, they live in palace-like houses, they drive the newest cars and host their dinners in fancy restaurants. This is what I mean with the “social recognition trap”: This particular group of people I’m referring to is more focussed on creating an image of being wealthy, rather than actually becoming wealthy.

The exact opposite of this lifestyle is the practice of frugalism. Frugalists aim to cut their expenses by a resourceful use of the goods they already own and self-restraint when it comes to acquiring new goods. They avoid extravagance and suppress the instant gratification of consumption. As a result they manage to maintain high savings-rates, which enable them to build such wealth, that many of them can retire for good in their late-forties. Now, I’m not saying that you should not enjoy life at all and just hoard all your money. All my close friends know that I enjoy wearing a well-tailored suit, or that I will buy a bottle of good wine for a special occasion. The difference is not made by forbidding yourself all simple pleasures in life, but by deciding what you can do without.

To help you review your lifestyle, it’s good to always question your KPI (key performing indicator) when considering a new purchase. Always ask yourself what the motive behind your consumption is. For instance, when you buy a car: Do you need it for work or to run errands for the family, or do you want to show off in front of your friends because you “worked so hard that you just earned it?” Or when purchasing property: Do you view the new apartment you intend to buy as an asset to invest into, maybe even rent it out for a long-term revenue, or do you want your neighbours to be lawyers and brokers and to have the country club next door? Up to this day Warren Buffett, one of the wealthiest men in history, lives in the 610 square meter house he bought for $31,500 in 1958 (about $250,000 by today’s standard). If you walk by it without the knowledge of whose home it is, you would not even take great notice of it.

Another critical aspect hinted at earlier is your savings rate. If you make it your habit to put aside every bit of money not needed to pay for your fixed expenses, your net worth will increase substantially. My personal advice is automating all your fixed payments, and reviewing the automated processes frequently - this way you to never lose the overview over what you can afford to put aside. And if you invest your savings into assets that make money for you, you can actually become rich in the classic sense eventually (for more detailed information on how to build wealth by acquiring assets read my article “Build Your Wealth”).

So all in all it’s a simple equation: Low living costs combined with high savings rates build net worth, not high income. Learn to detect the social recognition trap, and start avoiding it.