03/21/11 Baltimore, Maryland – We listen to CNN in Spanish, trying to improve our Spanish while driving to work. At first, we barely understood one word in 10. Now, we’re probably at one in 4.
This morning, we thought we heard the following story.
Researchers asked rich people how much money they needed to be rich. A million dollars didn’t get you very far in the eyes of these rich people. They said you needed $7.5 million, minimum.
Why so much? How much does it cost to live well?
Well, it depends. When we began our career, we worked for $100 a week. That became $100 a day after a few years. And then, it became $100 an hour. And so on. We don’t recall being any less happy at $100 a week than we were at $100 an hour. And today, we would readily trade: make us 25 years old again…and we’ll work for, well, $100 a day.
But as our income rose with our years; so did our expenses. At about $40,000 a year, we bought our first new automobile – a Datsun pickup truck. At $100,000 we had a Volvo and a Ford pickup. And a farm in the country. Every increase in earnings came with a price tag attached. Whenever we thought we were getting ahead, we found some new necessity…something we had to have.
That is why so many people with high incomes have no money. As soon as they get a raise, an entrepreneur offers them something they can’t live without.
In our experience, you can live “as though” you were rich on, say, $350,000 per year. That’s about what two good lawyers…or doctors…or small business people…might earn, together. They pool their earnings. They can enjoy “the good life.” Vacations. A nice house. Nice cars. All the gadgets.
But wait, if you could get a steady rate of return of 3% on your money, that would require $11.5 million in capital. And if you had $11.5 million in real capital, most people would agree – you would be among “the rich.” But you can’t BOTH live off $350,000…as though you were rich…and also accumulate enough money to really BE rich – not unless you’re earning a lot more.
If you only had $7.5 million, for example, at 3% yield, you could only expect income of $215,000. That may seem like a lot of money, but it is hardly the kind of money that would give you and your family a lavish lifestyle. After taxes, health insurance, tuition, autos, mortgage payments, and other real necessities, there wouldn’t be that much left. Wealthy? Yes. Rich, not quite.
But even putting together $7.5 million requires a bit of luck. We’ve been meaning to explain a concept we developed many years ago. It’s called “Financial Escape Velocity.” It describes what has to happen in order for you to build up any serious money.
The general problem is the one we mentioned above. Your cost of living tends to go up with your income. Wants and needs rise to meet the income available to them; that is a financial law as rigorously enforced as the Law of Diminishing Returns or the Law of Supply and Demand. That’s why it’s so hard to be rich and get rich at the same time.
The way to beat this phenomenon is either to exercise remarkable self-control…or to outrun your wants and needs with “escape velocity” wealth. That is, wealth that rockets up so fast, you can’t shop fast enough to keep up with it.
Typically, people reach “financial escape velocity” when their wealth surprises them. A family may own a farm or an apartment building. The asset is not very exciting, so they forget about it. And then, one day, they wake up to the fact that it is in the path of a major development, and they are being offered far more than they expected for it.
Another way to reach financial escape velocity is by using the miracle of compound interest. You make a small investment. You add to it. You keep at it.
Compounding works its magic. After a few years, you may notice that your wealth has raced ahead of your expenses. If you are lucky…you will be able to hide the fact from the rest of the family…allowing the compounding more time to reach escape velocity. Imagine, for example, that you have an account that has grown to $2 million, compounding at 10% per year (just to keep the math easy). You will earn $200,000 from the account this year. If you take it out and spend it…the compounding effect will stop. You’ll have $200,000 to spend. But your wealth will cease to grow. And your family will have a chance to bring its spending habits up to the level of your income. Better to say nothing and let it run. After another 5 years you’d have $3.2 million – giving you more than 50% more income.
Another place compounding works is in business. Often, businesses reflect the kind of compound growth you might otherwise get from an investment – only, it is less obvious. Accumulated effort compounds like dollars and cents. Work, capital investment, growing expertise and a little luck is a great combination. Earnings can creep up on you. One year, your business earns $100,000. Ten years later, it earns $1 million. And if you’ve been putting your earnings back into the business, you would not have gotten accustomed to spending more and more. Your spending wouldn’t have kept up.
If you had taken your earnings out, the business would have been unlikely to grow. Instead, your expenses would have grown, making it even harder to ever build up any real capital.
But let the business grow, and one day you could realize that you’ve reached the point where your earnings and capital can grow faster than your expenses – financial escape velocity.
And when that happens, best to keep it to yourself.
Regards,
Bill Bonner
for The Daily Reckoning
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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Excellent, Bill. You have described eloquently the way the rich get richer. They exercise self discipline! Most people make more and spend more, but the wise make more and save more.
I’d just like a chance to prove it for myself, please…
That money can’t buy happiness…
A good business with growing capital needs can be a great way to compound wealth. It refuses to release much spending money until after it is sold for example or grows very large.
Put your money in a taxable account in a good stock that pays no dividend, like Berkshire Hathaway. Refuse to sell any lest you pay tax on the gain. Wait 20 years. Voila, you have compounded your money.
These years will go by whether you do this or not. May as well arrive old and rich.
shaun,
i wood lik to pour over Birkshire finanshul reportz with U.
I believe it was Newton who made the observation about the law of inertia; -bodies at rest tend to stay at rest, bodies in motion tend to stay in motion. Wealth is pretty much the same. Look at the class mobility statistics for the United States; pretty much if your born rich you will die rich. If you’re born poor, you will probably die poor. Wasn’t always like that, and I think you can add that statistic to the enormous body of evidence suggesting the nation is in a state or decline.
No Bill, the quickest,surest way to get rich is to bribe politicians.
That’s exactly what as happened. Until you acknowledge that as the reality of what the U.S. has become, I’ll regard you as this semi-stooge of the system. You’re not quite that, some of your posts reflect it… but your propensity to lambaste “zombies” while sparing the whip for wall st and central banks gives you away.
Ultimately, I see you more as a supporter of the ‘system’ than not.
Shawn,
I would like to merge my newsletter business with you…
-BB
On a more serious (?) note, this article was published in Bloomberg a while back…
Not feeling wealthy? Would $7.5 million help?
Elizabeth Ody, Bloomberg News
March 15, 2011
How much does it take to feel wealthy these days? For many millionaires, it’s about $7.5 million, according to a survey by Fidelity Investments.
“Wealth is relative, and to some extent the more you have the more you realize how much more you need,” said Sanjiv Mirchandani, president of National Financial, a Fidelity subsidiary that provides clearing and custody services to broker-dealers, in an interview before the survey’s release Monday.
The more than 1,000 households surveyed had an average of $3.5 million in investable assets. About 42 percent said they don’t feel wealthy, saying they would need about $7.5 million to feel rich. The 58 percent of respondents who said they do feel wealthy were younger on average and have a greater number of remaining years in the workforce, said Mirchandani.
A 65-year-old millionaire is “looking at potentially the loss of a paycheck as they retire, and 30 years in retirement, with inflation on the horizon,” said Mirchandani. “So they kind of go ‘Well, $3.5 million, $4 million, isn’t what I thought it would be. I’d like to have more.’ ”
There are about 5.5 million U.S. households with at least $1 million in assets, or about 5 percent of the population. Millionaires control 56 percent of the country’s wealth, according to Fidelity, which is the second-largest U.S. mutual-fund company after Vanguard Group Inc. Household wealth was $56.8 trillion at the end of 2010, according to the Federal Reserve.
The survey found millionaires’ outlook for the future is the most positive it’s been in at least four years.
“They’re beginning to feel that perhaps we’re turning the corner on a more consistent basis,” said George Walper Jr., president of Spectrem Group, a consulting firm that tracks attitudes among millionaires.
About 56 percent of registered investment advisers, who manage or advise individual investors’ money, are bullish on the stock market’s prospects over the next six months, according to a January survey by San Francisco’s Charles Schwab Corp. Of the advisers surveyed, 23 percent said they’re providing reassurance to their clients about reaching their investment goals, down from 49 percent in January 2009.
About 83 percent of millionaires surveyed by Fidelity said the financial crisis didn’t shake their confidence in investing, and 43 percent said they plan to invest more money in stocks over the next 12 months. A majority said a goal is preservation of capital, rather than growth.
“They’re still fairly conservative in terms of what they’ll buy,” said Mirchandani.
Millionaires planned to give $38,000 on average to charity in 2010, up from $36,000 in 2009, the Fidelity survey said.
The asset-management firm hired Northstar Research Partners to survey 1,011 households with at least $1 million in investable assets via the Internet during October.
Market data provided by Bloomberg News
Maintaining velocity, let alone reaching escape velocity, is getting harder by the day as the Fed waters down the fuel.
I don’t know about the Velocity, but I invented the Concept of Financial Critical Mass!
“but the wise make more and save more.”
…and then their kids get to enjoy it!
Investors Friend said: “That money can’t buy happiness…”
Money can’t buy happiness but being destitute can sure make one miserable.