What makes the rich rich and the poor poor? If we took a poll to find the answer, I'm sure the responses would go something like this;
- The rich have jobs with better salaries like doctors and lawyers
- The rich have bigger bank accounts
- The poor never got an inheritance
What if we then asked people the one thing we can all do to make ourselves wealthier? I'm guessing we'd hear the following;
- Go back to school and change careers
- Buy real estate
- Play the lotto
So what really is the difference between rich and poor? And is there really something we can do to change where we are on the wealth spectrum? We can. Wealthy people invest as much as they can in the stock market and they do so for a really long time. They don't necessarily have a big salary or a large amount of savings, they just follow those two steps. And for most of them, they weren't wealthy when they started. It's the discipline of investing and especially the power of compounding, that got them to where they are now.
Why doesn't everyone know this?
First of all, there a lot of people who do know this. They're usually people in professions that require an understanding of how numbers work and the vast difference between linear and exponential growth. Many of them are engineers, financial analysts and computer programmers. When these people get paid, the brokerage account, 401(k) or IRA take preference over purchases at the apple store.
Unfortunately for everyone else. we don't teach basic financial concepts in school or anywhere else. Because it's not taught, people can either educate themselves by reading books (though I understand personal finance books would bore most people out of their minds), or follow the herd. Unfortunately the herd, which includes family and friends, usually doesn't have any financial education either. The danger arises when the herd THINKS they understand how money works, and family and friends trust their judgement. But the herd's advice usually goes something like this;
"Need more money? Get a higher paying job"
"Need a car? I know someone who can get you a good deal"
The financially intelligent advice would be:
"Need more money? Invest your earnings and let your investments provide more income for you"
"Need a car? Invest your money so you can buy one with cash"
Does it really work?
Can investing in the stock market, even if you don't have a high income, really make you wealthy? The answer is absolutely yes and it's very simple, but it will take time and discipline. Let's look at an example to prove this out.
Let's assume someone earns $30,000 per year and is 22 years old. This person like most people doesn't invest and doesn't understand the power of doing so, and lives paycheck to paycheck until they're 72. At 72 they start collecting social security but never generated any real wealth.
Now let's assume instead that this person knows that wealth isn't derived from income, and decides to invest 20% of their income into the market in a simple S&P 500 index fund. This is understandably not an easy feat on $30k of income, but it's not easy at $40k, or $50k either. This is where the discipline aspect of investing comes in. It's simple, but it takes discipline. We will assume that over time, this person's investments will earn the historical market average return of 9%.
So what kind of wealth does this lower income person actually build? Here is their investment balance starting at age 22 and every 10 years thereafter;
A quick look at the numbers is eye opening but think about what this actually means. By age 40, the investment balance is generating more interest in a year than this person earns by getting up and going to work every day. By age 52, the investment balance is generating six figures in interest, or more than three years of work.
How long this person allows their investments to grow will determine how much wealth they have because time is everything. Time allows exponential growth to occur - a type of snowballing effect with your money. And while this example is very powerful, it uses a relatively low income. The investment balances would be even larger for higher income earners and those that choose to invest a greater % of their salary. For all of us, rich or poor, the message is the same. Armed with this knowledge, we'd be fools not invest as much as we can for as long as possible. Any if we were able to share this information with the less fortunate, perhaps we can significantly decrease the number of people that struggle financially. Please pass this post along to anyone that is tired of struggling and ready to change their financial life.