If they both got the same interest rate, then their wealth would grow at the same rate. Add in progressive taxation and the gap might narrow.
If they’re getting different rates and taxation is regressive, then those seem like better explanations.
Edit: also spending patterns.
Edit again: note that this wasn’t meant to be a complete explanation. I just wanted to point out a few reasons why compound interest is not sufficient to explain a widening wealth gap (the claim in the comment I responded to).
High income save & invest a higher % of their income - therefore inflation is good (their stocks go up).
This isn't some sort of moral or judgmental statement. It's simple math. The more your income goes up over time, the less of a % is needed to cover the basics of food/shelter/energy.
Point being, through the same exact investment vehicle and with the same exact rate, a rich person of course will built more wealth than a poor person. It's just the nature of a percentage-based growth.
Owning something that earns while you sleep does tend to increase you ability to focus on what is important.
Sadly, I'm not sure anyone who is wealthy has what I would call a focus on what is important. Terrible situations, failed marriages, relationships with kids, etc..
(Eg where I live, there's no capital gains tax, so someone like Elon Musk could just sell their shares without any extra taxes, instead of having to borrow against them.)
Yet in that same year, the net worth of the top 5 wealthiest individuals in the USA (carefully watched on Bloomberg terminal and elsewhere) increased a LOT. Famously Elon Musk in particular.
How does "compound interest" explain that?
Edit: for those that doubt [0]
[0] https://www.sciencedirect.com/science/article/abs/pii/S01602...
> Regression results suggest no statistically distinguishable relationship between IQ scores and wealth
Stop spreading dangerous myths.
First, the rich don't reliably get richer faster than the poor get richer. (Despite what the linked article or other texts might claim.)
Second, interest rates are mostly an abstraction. Yes, if two people are both putting money in a bank account in the same currency, the one with the higher interest rate will get richer faster.
In the real world, many investments yield a variable nominal rate of return (eg real estate, stocks, art, etc). And you also have to worry about factors like inflation or counter party risk.
yes they do, as money printing benefits those who are leveraged into assets more than other types of debt holders.
The rich (by proxy, through investing in the stock market) actually hold more debt in aggregate. And per capita, they hold WAY more debt, hence benefit from money printing even more.
Money printing is indirect wealth transfer from everyone else to the rich.
Given same rate of return, the one who puts in the most money gets richer faster, in absolute dollars.
The article says that on top of this, those with more capital get better relative returns too. You don't refute this by just saying it's not so. The increasing wealth disparity we observe would seem to support this idea.
Doubling 100M in 10 years to 200M is, IMO, getting richer faster than double 25K to 50K in 10 years.
I may be mistaken but I think investing in VTI (total stock market index) and reinvesting dividends from 2004 to 2015 would yield you close to that 140 percent. Maybe 120 to 130? No need to be a top 0.1 percent to invest in that.
The "rich are getting richer" is a natural consequence of compound interest (which works for those with assets, and against those with debts) and the stagnation of some wages.
Then there's things like inheritance, foundations, access to better financial advisors and portfolio managers, access to social networks of other wealthy people, etc.
>access to better financial advisors and portfolio managers
If anything, active wealth management usually ends up yielding less than a broad market index fund.
Risk adversity is a big driver of that, since losing your emergency fund or savings is catastrophic for someone with no other assets, whereas losing some of your large stock portfolio is something rich folks shrug off.
“Conventional wisdom suggests that richer individuals put more of their assets toward high risk investments, which can result in higher returns. But our research finds that wealthy people often earn a higher return even on more conservative investments.”
I won't go into details, because they're country specific, but earing a wage here, especially an above-average (think engineer not richy rich) means you pay around 50% of your money in taxes. The percentage the government gets from the customer to your bank account (including the employers responsibilities and VAT) is even higher.
What you can do to optimize taxes is to drive 5, 6 hours to a different country, open a company there, and start charging the customers via that company... since the company profits are taxed a lot less, you pay only ~10% taxes. Because you want health insurance in your home country you also become an "inependent contractor" there, pay minimum taxes and get medical, kindergarden for your kids etc.
Now, if you're an engineer, with 1.5x-2x average paycheck it is possible but just not worth it... two accountants, driving there every now and then, two different taxes, fixed startup fees, fixed fees for yearly reports etc., plus the added risk of something going wrong, dealing with foreign tax inspectors etc.
If you're earing 20x the average paycheck, the fixed yearly costs are the same, but the 50%->10% tax reduction is a huge saving.
Same with companies... facebook can register a company in ireland and syphon their money over there, but for a mom and pop restaurant it just isn't worth it.
The rich get richer because they have access to more choices than the plebes do. There are lots of non-publicly traded investments out there. They have a minimum investment amount that many people cannot afford. A friend sets up and manages RE investment syndication deals - these are where a bunch of people pool their funds and buy RE properties (commercial offices, or large apartment complexes).
He used to require $50K as a minimum investment. He now asks $75K. He is on the low end. I've encountered many that require $100K and require you to be an "accredited investor" - you need either $1M in assets (excluding your home) or earn over $300K if married to qualify.
These investments are potentially higher risk (e.g. if they use your funds for 80% downpayment on a mortgage, and the value of the property drops 10%, you've lost half your investment). But their returns are quite high. For a deal that exits well, the investors typically get over 20% return (annualized). I used to be all about index funds, and then I saw these. You have to find an operator with a good track record, understand the factors at play well enough to evaluate their offering, and if you do your due diligence, then you pretty much always get at least 15% annualized. Most investors wouldn't even consider the investment if they felt it is less than that.
But you need a lot of money to get in.
Sounds like the bet Warren Buffett made and won.
https://www.investopedia.com/articles/investing/030916/buffe...
The trope of finding an operator with a good track record is regularly debunked by both the rich and poor.
Your link is about comparing index funds with people who manage other funds. None of these people are involved in the business operations. So yes, they suck and index funds do better. The investments I am talking about are where you invest directly in a business. You are not buying stocks in the business, the value of which depends on a fickle market (hence why I explicitly said "non-publicly traded investments"). You are buying equity of the actual business, with a contracted amount of returns (i.e. preferred investor). The operators I spoke of are the people who are actually running the business. In the case of an apartment complex, they are involved in the operations of running the complex.[1]
Don't think in terms of the stock market and index funds. Think in terms of "Hey, I'm starting a business and I'll give you 3% of equity if you give me $50K." The difference is that here they typically aren't starting a business, but buying an existing business (that already has clients, and a revenue history), so it's easy to analyze whether the business will be successful, and get a good forecast of revenue in the first 5 years.
For the record, most of my investments are in index funds so I know where you're coming from.
[1] OK, not really. Most will hand off to a property management company, but they've vetted the PMC before offering the investment to you.
Due to IRS rules on how to do it, it's not profitable for ordinary folks who may own an extra house they rent out, because one has to do a formal study, which has a fixed fee. But if you own an apartment complex with 10+ units, the depreciation gains significantly overcome that fixed fee.
That second point, the monetization of non money assets due to debasement of our currency and how that creates a pressure imbalance that moves real wealth from dollar holders to asset holders, I'd say most people discussing this topic don't get. I get it, but before reading this I wouldn't have been able to articulate it so clearly. The mental model you have to have about finance and economics in order to even formulate that understanding is almost too big for one person's head.
Doubtful. More likely they can simply afford to have people who ARE better with money management manage their money.
The poor, they don't have any money to manage. Stop assuming they're shit at it. If anything they have to be a damn sight more clever about it.
Rich people invest in stocks. Richer people also invest in private equity etc.
The results should surprise no one.
Poor people experience the downsides of inflation (risings costs of everyday goods) without the upsides (assets they own also going up increasing their wealth).
That is - if you are barely making ends meet and spend 80% of your income on housing/food/transport/energy, then 10% inflation is a huge problem for you. If you spend 20% on the same, and have 2x your income in the stock market, inflation might be awesome for you.
> This suggests that while money is perfectly inheritable, exceptional talent is not.
Unless I'm missing something, it also suggests that the rich get richer because they are more talented in the first place.
Which kind of makes the point of the entire article rather moot.
It's such a disgrace. I loathe the US for this. I dislike Putin and the chinese CCP too, but the war of economic ideology is such a blatant pain, it's really frustrating how people debate about those things.
I'm dumbfounded everytime I read people trying to defend american capitalism. I quit that debate so many times, it's really bad for my mental health.
Not a massive surprise that someone who goes from 10% to 90% has something going for them that means they reach 99% more frequently than the base rate but that appears to then only by 2.1%, or twice what you would achieve by chance alone.
I must be missing something.
> Controlling for age, parental background and earnings, moving from the 10th percentile to 90th percentile of wealth distribution increases the probability of making it to the top 1 percent by 1.2 percentage points compared to an average probability of 0.89 percent.
https://en.wikipedia.org/wiki/Capital_in_the_Twenty-First_Ce...
A great read if you haven't already.
It's pretty funny that they assume these original generation returns being higher are due to "exceptional talent", no one even bothers to consider the possiblity that the original wealth accuulating generation were just more mercilessly exploitive assholes...
