Why do the rich get richer?
Wealth accumulation over 30 years
This question fascinates me. Not only because it is asked so often, but also because of some of the replies I have heard.
My favorite answer comes from talk radio, “The rich get richer because they keep doing what made them rich.” Thank you, that is very helpful.
What do rich people do become rich? If we agree with Fisher, he would say that the rich are the patient. The personal characteristics, listed in Fisher’s Impatience Theory of Interest, they posses lead them to be more patient.
The more important characteristics are foresight and expectation of life. According to Fisher, the patient looks towards the future to see what their future needs will be. The impatient person says, “Live in the moment” on the other hand the patient person would look forward to their retirement. This is the reason the “rich” always consume more in the future compared to the present.
What do rich people do to become rich?
They spend less money than they make. They do not live “pay check to pay check.” The “rich” lend other people money to earn interest. This could be putting money in a savings account, investing in stocks or bonds, buying real estate to rent out, etc.
Let’s look at the mathematics of how we can take one person with 3 different possible paths and see how difficult it is to make them “rich”.
Assumptions:
- Income received from work will be $24,000 a year and never change
- We are also going to ignore taxes to simplify the calculation.
- Investments will increase at 7% per year and the dividend will be a constant 3%
- P1 is our person that (spends all money they earn, saves nothing)
- P2 invest 25% of their earnings, but spend their dividends each year
- P3 invest 25% of their earnings, and reinvest their dividends
Something interesting happened to P2 and P3, they both added an extra income stream. P2 gained extra income, the dividends, that they chose to spend on whatever they wanted. P3 chose to reinvest their dividends, which resulted in nearly twice as much wealth accumulated over 30 years.
If P1, P2, and P3 where three different people. Would some people make the statement that P3 gets more “rich” over time? They all started equal and were all given equal amounts every year for 30 years to do with as they pleased, yet at the end of 30 years, there is a huge disparity in wealth accumulation. This is why Fisher spent half of his book on patience and impatience.
Conclusions
In the end, Fisher was saying many of the same things personal finance bloggers say. Do not borrow money if possible. Spend less than you make. Lend the rest to someone, a business or the government and earn interest. Think about the future and the things you will need in the future.
Do you agree with Fisher? Would you say he is wrong in any of his thoughts?
Interesting theory. I’m not sure what I believe with regards to this, but I do think it’s important to do all of the things you’ve mentioned. I think it’s also like a snowball effect – you keep making money on the money you have (interest) and the amount gets larger and larger each period (compounded), and you keep investing more, and it keeps growing – it’s hard not to get richer if you think of it in those terms.
Spend less that you make for sure. I think most people would have a hard time with the lending to others, but I get the concept. I am going to be carrying a loan for the balance of my business saleat the end of the year. While it does have some risk, it should be profitable for myself and the buyer.
Lending to others includes investing in the stock market, buying bonds, etc. Basically anything that earns you interest.
Since this was post was written from the perspective of Fisher. He says that rich people borrow money to protect their investment or because their is an extraordinary opportunity to make more money than the cost of borrowing money.
Hi there! This post could not be written any better!
Going through this post reminds me of my previous roommate!
He continually kept preaching about this.
I most certainly will send this information to
him. Fairly certain he’ll have a very good read. Thanks for sharing!