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How does wealth grow without work?

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Aug 21, 2010
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I don't really know what the age spread is among members of this forum, but I'm sure it skews to the older end of the spectrum. As a "younger middle aged" guy, I like to peek at my retirement savings now and then to see how I'm doing (and dream about an early retirement if I win the lottery!).

One thing that became immediately clear to me at a very early age is this: If you can sock away money early in your life and build up a little nest egg, the benefits of compound interest (and/or capital appreciation, if you invest in equities) will eventually dominate the growth of your bottom line, and the benefits of regular contributions (like 10% of your paycheck or whatever) will become a minor player.

If you don't follow what I'm saying, you can plug in some numbers into a calculator like this one (http://www.bankrate.com/calculators/savings/compound-savings-calculator-tool.aspx) and see for yourself. Here's an illustration:

Assume a 5% rate of return, compounded monthly. Then:
Example 1: Start with $1000 in the bank and save $500 per month vs. $100 per month for 20 years:
a) Total after 20 years at $500/mo and 5% interest: $206,373.
b) Total after 20 years at $100/mo and 5% interest: $41,275
Dump in five times as much money every month and you end up with about five times as much in the bank at the end.

But let's say you were pouring that money in early at $500/mo, and built up to $200,000 after 20 years, and let's run the numbers going forward from there:
Example 2: $200,000 in the bank, and save $500/mo vs. $100/mo for 20 years:
a) Total after 20 years at $500/mo and 5% interest: $748,901
b) Total after 20 years at $100/mo and 5% interest: $583,803

Dumping in five times as much money every month only gets you about 20% more after 20 years. At some point during your savings career, your monthly contributions stopped making much of the difference in the bottom line--it was all about how much you had already saved, and the power of compounding interest.

This is a simple calculator and it only models a simple savings account with fixed interest. But the same concept would apply if you were making regular contributions to a stock or mutual fund whose shares (we hope!) appreciate in value over time (eventually, after you accumulate enough, your contributions start to pale and most of the growth is due to capital appreciation).

Now, most of my middle class friends graduated from college pretty much broke, or even tens of thousands of dollars in the hole. At best, we started out in the case of Example 1, above, and hoped to get to Example 2 or better well before retirement.

But what if you are one of the wealthy elite in our country, and mommy and daddy give or leave you $100,000, $200,000 or $500,000 when you're young? (Or $10,000,000 when you're older?) Well, if you're not an idiot, and you live reasonably within your means and invest wisely, then through the beneficial powers of compound interest and capital appreciation, you will see your wealth grow, and grow, and grow, even if you don't contribute an additional penny to your savings.

Conversely, if you are at the bottom of the wealth ladder, and you never have two cents to rub together, you're never going to get off the zero mark and have any savings at all.

Now I know that we all like to believe the American Dream, and that if you work hard you can be Donald Trump regardless of what you started with.

But what I just described goes to show that if you happen to start off blessed, then you don't gotta do a gosh-darned thing, and you'll keep getting more and more blessed even if you sit on your butt all day playing video games and eating Cheetos.

If left unchecked, these natural tendencies for wealth to migrate towards wealth will inevitably have unhealthy consequences for society.

What happens when 1% of the population controls 25% of the wealth of a nation? What happens when 50% of the population control less than 3% of the wealth of a nation?

What happens when, for 50 years, that top 1% has been accruing more and more of the nation's wealth, and the bottom 50% have been accruing less and less? What will happen if that trend continues unchecked ad infinitum?

You get the United States of America. In the 1920s, a similar condition existed right before the Great Depression. In the flurry of economic reform following the GD, much wealth was redistributed and for several decades the gap remained somewhat stable, or even closed a little bit.

But since about 1970 or so, the gap between the rich and the poor has consistently grown, and as time goes by, the speed at which the gap widens has increased.

Is this desirable? Is it sustainable? I dunno, but it sure doesn't exactly give me a warm fuzzy.

One thing's for sure: Instituting a flat tax and/or a failure to increase the taxes on capital gains (as opposed to income) will only continue the same "wealth migration toward the already-wealthy" trend we've seen for 50 years, so if you're happy with that, then get behind those plans.

Good thing for you the 85% (or more) of the population who'll be screwed by those plans are too clueless to realize it and vote against it. (You *are* smart enough to know whether or not you're in that 85% getting screwed, right?)

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