Wednesday, December 05, 2007

Here’s Why The Rich Get Richer And The Poor Get Poorer

The rich get richer and the poor get poorer’ is a saying that gets trotted out all the time but this is because it’s essentially true. If you look at society in general this is exactly what happens, but why exactly is this?

Well the major reason is quite simply that the rich have the capacity to invest their money into assets and investments that will make their money grow over time, whereas the poorer people in society don’t have this option.

The wealthier members of society can invest their hard earned cash into the stock market, property, or even into starting up or buying their own business. They can essentially make their money work for them and increase their wealth all the time. They don’t need to worry about finding a high-paying job or climbing up the career ladder, they can simply use their money to make more money.

To demonstrate this let’s take as an example a man who owns a $500,000 house outright and has $1,000,000 in a bank account.

Historically we know that house prices on average double every 7 years, so just by doing absolutely nothing he could probably increase his wealth by $500,000 just by doing nothing for 7-10 years.

In addition he would probably want to invest his $1,000,000 in order to make it grow, so let’s say he invested it in a very conservative mutual fund that generated a modest return of 10% a year on average. In this case he would be increasing his net worth by a cool $100,000 a year and if he compounded his returns he would have made far more than this each year. All this was achieved with absolutely no effort needed from himself.

Even if he’d invested all his money into a standard 5% savings account he still could have earned $50,000 a year and after ten years with compounding his $1,000,000 would now be worth $1,628,894, a return of nearly 63% over 10 years.

Of course he could have achieved much more than this by investing in businesses, or actively buying shares or property, for example, but as you can see if you have a decent sum of money you can quite easily build a large income for yourself and make your money grow without actually having to work for a living.

Contrast this with a man who earns say $15,000 a year in a job and rents his own property. In this case he is probably spending all his income on rent and living expenses and will have no disposable income to save or invest, and even if he does he’s unlikely to be able to get rich from doing so.

He doesn’t have the capacity to make his money work for him because he needs most of it to just get by, and of course over a number of years he won’t benefit from any long-term increases in property prices because he is renting his own place, so he won’t increase his wealth this way either.

His best hope is to work his way up the career ladder or raise enough money to be able to start his own business and hope it becomes successful, but this is not easy and definitely not something everyone can achieve.

For most poor people who are living from paycheck to paycheck, it is really hard just to survive let alone get richer, and although they may not necessarily get poorer in real terms, ie their income doesn’t go down, with the effects of inflation over a number of years they are essentially becoming poorer because the cost of living is going up.

Is this fair? No of course not, but it’s part of the western society and unfortunately a sad fact of life. The only consolation is that there are lots of opportunities out there for people from all backgrounds but in most cases it’s essentially true that the rich get richer and the poor get poorer.


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