I was reading this wholly nonsensical article from 2014 and figured it would be useful to revisit this forever-hot-button phrase: the rich get richer.
Most of what we hear from talking heads has to do with access to inside deals and special tax breaks. Simply put, the rich have the clout to make profitable agreements and the wealth to (legally) avoid paying substantial amounts of taxes. Regarding deals, consider the epitomical arrangement that Warren Buffett has with Bank of America. As with bank fees, currency exchange rates, and financial management, having more money makes things cost less.
And in terms of avoiding taxes, everyone does it. But the rich can pay better accountants and lawyers to spend far more time finding loopholes and technicalities that lead to drastically lower tax bills. Whether the costs justify the gains is another matter.
What these fun-to-debate topics exclude, however, is the simple mathematical power of compound interest. Consider this: If you invest $1,000 today and earn 10% annually, you’ll have $1,100 next year. If a wealthier person invests $100,000, she’ll end up with a profit of $10,000. A principal investment of $1MM would yield a $100,000 profit, or enough to live in luxury for a year without touching the original funds. Enough. It’s not complicated.
What “compounds” the already wonderful power of compound interest is that, if the money is left untouched, it grows increasingly faster. The $1MM grows by $100,000, then $110,000, then $121,000, etc. Now imagine that the million bucks comprises the accumulated wealth of a middle-class family. As long as they earn enough salary to live, it will continue to grow in the background, turning into $2MM in 7 years and $10MM in 23.5 years. And that assumes that the family saved nothing extra. Meanwhile, a family with no accumulated wealth who diligently invests $5,500 each year would end up with $56,000 after 7 years or $520,000 after 23.5 years. It’s not pennies, but it sure ain’t millions.
I truly wish this article led to some meta-lesson that led to decreased wealth inequality and increased social justice. But alas, magic is not real. This is simply a reminder that one of the simplest pieces of math can explain why “the rich get richer” far more than complicated or far-fetched theories of tax-evasion and other rhetorical flourishes. If money isn’t squandered or diluted, any wealthy estate can remain in the top 1% forever, outpacing any newcomers through its snowballing growth.
What you, dear regular person, can take away from this is that yes, the rich get richer. But you can harness their wealth-building powers for free! Just understand that compound interest is valuable and doesn’t require any wealth to start with. No, you won’t end up with the above $10MM after 23.5 years, but $520,000 is nothing to scoff at! And no, you won’t be earning 10%/year. But neither will virtually anyone else for more than a few years at a time.
Finally, do know that compound interest isn’t only positively powerful. If you lose 50% of your $50,000 portfolio, you’ll have $25,000. To get back to where you started, you need a 100% return. A portfolio, like trust, is harder to build up when it has suffered a loss. But over the long-run, the stock market moves up, not down, and compound interest works in investors’ favor. Don’t know how to start investing? Click Investing 101: It’s why we created this site.
So embrace the powerful, eternal, and immutable property of Compound Interest and build wealth rich-guy-style. If you manage to leave the money alone, it can be passed to your descendants (in a Roth IRA, among other ways) and become a verifiable family fortune. Furthermore, remember that most money is usually squandered and diluted across generations: the rich don’t actually stay rich, you know, like, um, forever. Stay smart, stay safe, and stay in it for the long haul.