I am sure you would have heard the above saying: “why rich get richer ?”. And I totally agree with the statement. It is true, rich do get richer. Income inequality is growing considerably. Top 1% in the world keep on becoming richer. And there are plenty of reasons for that. Yes, you can blame the politics (I will too below) or you can argue that rich have a higher starting point (I will too). But there are some reasons that are our own mistake. We shall look at both types of reasons. Let us look at the top reasons why rich get richer.
Reason 1 – Politicians love the rich
Disclaimer : Before someone wants to put me in jail for inflammatory content I want to clarify something. The intent is not to disrespect politicians or political party. Neither am I pointing towards any wrong-doing from anyone.
I hate to discuss politics on this blog but I can’t avoid, as most people think it to be the number one reason why rich get richer. Everyone blames the political party they hate, for being hand in glove with the uber rich. I would rather say politicians, of any party, do make most decisions pivoted to benefit the uber rich and business houses. And there is incentive for them to do that. In the US, lobbying is legal. That is businesses legally pay money to political parties to lobby for a legislation that favours their business. In India, businesses give donations to political parties. Also, these businesses do impact the economy in a substantial way. Is it correct to do this? I don’t know. But whenever government tries to help a business it doesn’t necessarily mean that government is doing something wrong. Yes, the decision might favor someone, but that doesn’t mean that there is always a wrong doing or something fishy about it.
Now when decisions are made that favor the rich, what do you think happens? That is right, rich get richer. This has happened since long and will continue to happen. Of course, if it goes out of control then a system overhaul takes place. But it is something not under an individual’s control.
Reason 2 – Rich don’t spend much on crap, middle class does
Think about an average upper middle class person. This person doesn’t want to retire early, earns handsome salary and lavishly spends. This person has ambitions and wants to look rich. Hence, he/she spends on expensive clothes, luxury goods, a car bigger than what he/she should buy (read my post on the car you own tells a lot about you) etc.
Every credit card swipe, leaves this person with more debt. Additionally, there is less money available to build his/her net worth. All because, this person wants to impress.
Why rich get richer is because they don’t want to impress others. Warren Buffett still lives in the same house he bought for $31,500 in 1958 (or $260,000 in today’s dollars). He still drives a $45,000 car. Instead of accumulating debt by swiping the credit cards, rich put their money in buying appreciating assets (like stock market).
Reason 3 – Rich realize power of compounding
Have you heard the saying, money attracts money? Nothing can be a better example of that than compounding. The money you save will only take you so far, it is the compound interest that adds real value. Let me take a very simplistic example. Following are the two scenarios:
Person 1, thinks that let me enjoy whatever money I get and I will save later when I get a high interest. Suppose the person invests Rs. 5 crore 20 years from now for 1 year. What is more, this person manages to pull off the unbelievable and gets 30% interest on his savings.
Person 2, wants to get rich. And he keeps on investing Rs. 25 lakhs each year for 20 years. Suppose the annual interest rate comes out to be 7% for him (which is less than one fourth of person 1’s interest in 21st year).
Who do you think ends up with more money at the end of year 21? You might have guessed that it is person 2 and you are right. Person 1 will end up with Rs. 6.5 crore with a 30% interest but only 1 year of investment, while person 2 will end up with Rs. 11 crores with just 7% annual interest but a disciplined investing routine each year. This is the power of compounding.
There are three things in building up money via investment: principal amount, rate of interest and time. Rich have a lead in principal. May be also in rate of interest because there are certain high interest avenues only available to people who have a minimum amount of money to invest. That minimum amount is something not everyone can afford. But time is one thing that is common for everyone.
Reason 4 – Power of compounding leads to a snowball effect as well
Well this is with reference to the point around if you have more principal, you earn more money. If one person invests Rs 10 lakh @ 10% and other invests Rs. 10,000 @ 10% then after year 1, first person will have Rs. 11 lakh while second person will have Rs. 11,000. Hence the initial gap which was Rs. 9 lakh 90 thousand now widens to Rs. 10 lakh 89 thousand. And it will keep on widening each year. That is the snowball effect that is a factor to explain why rich get richer.
You may say, well that is a dead end for me. I would say that is an opportunity for you to jump to the next league. If you don’t start today, you or your next generations will never reach a point when their investments will also be in a position to take advantage of snowball effect.
Reason 5 – The risk becomes less
That is the single biggest advantage rich have. To make any reasonable gains, one has to invest a minimal amount of money. A common man wouldn’t have Rs. 10 crore to invest in diversified assets, so that they can invest Rs. 1 crore in each. A common man may be would have Rs. 5 lakh to invest. If he/she diversifies in the same ratio, then different assets would have only Rs. 50,000. This might not even be possible, as some type of high return assets require a minimum amount of at least Rs. 25 lakhs.
What ends up happening is, for a common person his/her risk is not diversified. Hence, in a lot of cases people end up losing money as the single investment avenue they chose did not perform well. Also, for a common person this was probably the only saving he/she had which gets wiped off and is never recovered. The rich on the other hand have multiple investment avenues. Even if one avenue is in loss, it is not the end of story for them. With time, they can afford to recover the loss from money invested in other investment avenue.
All in all, rich have more initial money to save, more avenues available and comparatively less risk. Hence, more control over the game and that’s why rich get richer. But that should not dissuade you from investing. After all, investing is the only tool that can help take you to a position where you also have more initial money and hence more avenues available to reduce the risk. Keep investing.