Becoming wealthy: it's up to you

USA Today (Society for the Advancement of Education), Sept, 1998 by Richard B. McKenzie, Dwight R. Lee

The path to fortune is possible IF you live modestly; save consistently; take advantage of compound interest; avoid "irresistible" temptations; get an education; marry someone with an equivalent education and stay married; take some risks; and are willing to work diligently.

Critics often speak of "the rich" with none-too-subtle disdain, as if those at the very top of the income ladder all are crooks or as if becoming rich is difficult and means others must become poorer. While we would be the first to admit that some rich people are crooks, we hasten to add that achieving the status of "the rich" (defined, say, by having a net worth of $1,000,000) is not particularly difficult, contrary to popular wisdom. The rules for acquiring substantial wealth are few, simple, and well-worn. This fact suggests that becoming rich for most Americans is largely a matter of choice.

Unquestionably, some people are rich because their parents were rich. Sen. Ted Kennedy (D.-Mass.) never would have lived his lifestyle or most likely have achieved his high office if he had parents of modest means. Of course, Kennedy is not alone in the good fortune of his birth. By world standards, most Americans are "rich" precisely because they were born in this country. They typically have far more wealth than people in other countries and, as a consequence, can generate more income each year with greater ease. Americans produce nearly 60% more per person than Europeans. They produce each year close to 300 times the output of the typical person in Ethiopia, a notably poor country. The relatively high production levels in the U.S. mean that most people can earn a lot and save some of what they earn.

The first rule for becoming rich is have a reasonable income base, which is what most Americans have virtually by the fact of their birth. Few people who have subsistence income levels can expect ever to be rich. They must devote themselves entirely to survival, meaning they can't save and their wealth can't grow. This doesn't mean that all Americans live in luxury or have high incomes. Some do live in squalor and are incapable of saving. Nevertheless, the fact remains that even poor Americans have more than the subsistence-income levels of people in Ethiopia and many other countries. By world standards, most Americans start with a reasonable income base from which they can save, invest, and build their net worth.

Without question, some individuals have become inordinately rich because they have been lucky. They won a lottery or had the right talents at the right time. If Chicago Bulls' star Michael Jordan had been born 30 years earlier, he might have done well in basketball, but he certainly would not have earned the substantial fortune that he has. Contrary to conventional wisdom, the overwhelming majority of millionaires in the country do not have anywhere close to Jordan's tens of millions of annual earnings. Indeed, half of all millionaires have an annual income of less than $131,000.

How can an ordinary person (with a modest annual income) become rich? One surefire method is to live modestly (if not close to poverty)--that is, to save a substantial portion of earned income, until the savings pile up. This is precisely the route a majority of rich people have taken to their good fortunes. For most people of modest or above-modest means, the savings, through the power of compounding, eventually will make for a substantial net worth--and an income level that will be the envy of those who have chosen to fritter away their incomes on compact discs, cigarettes, and new cars. Indeed, a modest and continuous saving plan started early in life can ensure wealth later in life--say, at retirement.

As a simple illustration, suppose that a newly minted 22-year-old college graduate with a starting salary of $30,000 a year salts away a mere $2,000 the first year (and only the first year) on his or her first job (or a saving rate of 6.6% of income). Assume as well that the new graduate is able to secure an annual rate of return (above the inflation rate) on the accumulated investment of 15% until retirement. The one-time investment will be worth more than $800,000 at age 65 and more than $1,600,000 at age 70. This individual clearly would be considered "rich," given that, in 1993 (the latest year of available data), the median U.S. household net worth was $37,587, including the value of the equity in their houses. However, median net worth varied from under $6,000 for young adults to a high of $91,481 for people in their prime earning years, 54-64 years of age. Households headed by those 75 and older had a median net worth of $77,654.

Granted, 15% might be an unreasonably high expected rate of return for such a long period of time, but notice that the calculations are based on a one-time saving of a mere $2,000. If the person could achieve just a 10% compounded rate of return (approximately equal to the appreciation of the stock market over the last half century), then his or her one-time, $2,000 investment would reach $120,000 at age 65 and $194,000 at 70, a not inconsequential wealth level compared to what most retirees have. If he or she could achieve a compounded return of only six percent (which assumes the average rate of increase in the stock market for the past 70 years, minus an inflation rate of three-four percent), the investment would reach $24,500 at age 65 and just under $33,000 at age 70. The person would not then be rich at age 65 or 70, but neither would he or she have sacrificed much in consumer goods along the way. Indeed, the sacrifice would have been zero during every year of his or her career, other than that very first year.