One could argue endlessly about what it means to be rich in financial terms. But most definitions would indicate that being rich means the ability to spend a large amount of money annually and to sustain that for many years, ideally for life. I would argue that while all rich people do not necessarily actually spend a lot each year, having the ability to do so, for many years or indefinitely, if desired is a necessary prerequisite to being rich. What constitutes a large amount of spending per year depends on your perspective and frame of reference and is not a set amount. Most people might agree that those who make say five times more than they do are rich. So a minimum wage earner might consider everyone making $100,000 per year to be rich, while those making $100,000 per year consider that it takes $500,000 per year to be rich.
Whatever your definition of what it means to be rich, this article discusses how it might
be achieved.
In our economy there are basically two sources of income available to individuals. There is income from employment and there is income from assets owned. In this case we might define assets as anything of value that produces a current income, is expected to produce a future income, or can be sold now or in the future for cash.
We could perhaps also include income from government social programs. But if we are focusing on how to get rich we can pretty much ignore that source of income.
The following are three main categories of how to get rich. There would be some overlap between them and many rich people have probably achieved their success from more than one category.
Getting rich from working
A relatively few people in society are basically rich through employment income. There are certainly executives making $300,000 per year and there a few making over one million per year. And in some cases (but probably not most) they will make these incomes for decades and then receive very lavish pensions for life.
Those on the lower end of the income scale would likely include many of the higher paid government workers in this category as well. A couple with two well-paying government jobs and the associated pensions might well be viewed as rich by those who must get by on jobs that pay less than half and which include no pensions or other benefits.
Specialist doctors, dentists and many senior lawyers might qualify as rich through employment income. However in some or many of these cases there is no pension and so the income cannot be relied on for life.
Some top entertainers and sports stars certainly earn incomes that would qualify them as being rich in most people’s eyes. But some of these careers are short-lived.
Getting rich from owning and controlling a business
Some business owners would qualify as being rich. These people don’t make up a large percentage of the population. Still, there are many thousands of people who own businesses that produce large incomes for the owners and that will continue to do so, perhaps indefinitely. These would include some of the owners of the more successful franchise businesses, especially those who own multiple locations.
Also included might be owners of large car dealerships and industrial dealerships. At the very top end are the controlling owners of the largest businesses in the country.
Getting rich (slowly) through saving and investing
It may be that very few of the world’s ultra rich got that way through saving and investing. But certainly many moderately rich people got that way through saving and investing.
For most people this is likely the best way to get rich. Most people are simply never going to earn employment income sufficient to be considered rich from that income alone. And there are many barriers to getting into business and most people are never going to own their own business and also the vast majority of business owners remain small business owners and do not become rich (although that depends on your definition of rich).
I contend that over a lifetime it is quite feasible to become rich through saving and investing.
Over periods of 30 years the U.S. stock market has never failed to return an annual return of at least 4% over inflation and very seldom has it been under 5% and it has been above 6% (as a compounded average over the full 30 years) about 75% of the possible 30 calendar year periods since 1926.
So let’s assume that you can make 5% on investments over and above inflation.
How does money then grow?
A $10,000 one-time investment would grow as follows:
Start – $10,000
Year 5 – $12,763
Year 10 – $16,289
Year 15 – $20,789 (doubled in 15 years)
Year 20 – $26,533
Year 25 – $33,864
Year 30 – $43,219 (more than quadrupled in 30 years)
Year 35 – $55,160
Year 40 – $70,400
Year 45 – $89, 850
Year 50 – $114,674 (more than a 1000% gain in 50 years, and this is after inflation)
In reality we can’t know what return we will get from investing. But the above illustrates that the rewards of investing eventually become very large over the decades.
I believe that a realistic goal for a young person would be to eventually build up financial assets that will produce an income similar to his or her wages from working. This would allow the person to eventually retire. To be free of the need to work. This could be defined as financial independence. It’s not an easy task. But it is a goal that the data suggests is achievable.
END
Shawn Allen, CFA, CMA. MBA, P.Eng.
President, InvestorsFriend Inc.
April 6, 2014