Decide to Be Rich

Here's a guest post from Marotta Asset Management. My two cents: it's easy to become rich if you really want to.

It used to be that becoming a millionaire was regarded as a huge achievement. In today's dollars, however, it is fairly trivial. According to the Department of Labor's inflation calculator, $1 million today was worth only $183,285 in 1970. But $1 million in 1970 had the same buying power as $5,456,005 today.

That's the new rich: over $5 million.

Depending on your lifestyle, if you have amassed $1 million at age 65, you may not even have enough to retire. At age 65, you can withdraw only 4.36% of your assets each year to ensure you don't deplete your savings before you die. So if you are just a millionaire, you must be able to live on an annual income of $43,600. And if your lifestyle demands twice that amount, you don't have enough money to retire yet.

Many of our parents and grandparents were fortunate enough to have pension plans that continued to pay their salary in retirement. Even though they never had a large investment account, those guaranteed benefit plans were extremely valuable. A pension paying $43,600 a year starting at age 65 is worth $1 million in the bank. Our parents and grandparents were truly millionaires, although they didn't know it!

But the days of defined benefit plans are over. Most employers today provide defined contribution plans. They define the amount they contribute to your retirement, usually in the form of matching dollars, and you are responsible for saving a sufficient amount and investing it wisely. Thus employees must amass $1 million for every $43,600 they'll need when they retire.

Want a higher lifestyle? Save $1.5 million and you can spend $65,400 each year. Save $2 million and you can spend $87,200. At $2.5 million you can spend $109,000. So don't think people with a big income don't have to worry about money. Those accustomed to a high lifestyle can find it very difficult to save enough to retire.

All this information leads us to the most important lesson about wealth. You can live rich or you can be rich. Many people live as though saving and investing wealth is wrong. Yet consider the alternative: Is spending every dime you earn virtuous? Isn't it better to produce more than you consume? Isn't it preferable to consume less and therefore have more wealth that you can invest and put to work creating jobs and producing goods? After all, the economic definition of capital is deferred consumption. Can you put off spending or decline to consume long enough to create investment capital that creates factories, businesses and jobs so others can benefit?

Consider two families with identical incomes. Family A lives rich, buying high-definition TVs, indulging in luxurious vacations, dining out frequently, and so on. Family B chooses to save and invest instead. Which family is wasteful and addicted to wealth, the family that is living rich or the one that is growing rich?

Family B may live simply and modestly below their means during their entire working careers. Amazingly, for every $100 a month they save and invest at 10%, they will have $1 million more when they retire. The two families may have the same income, but Family A spends $250 each month on a richer lifestyle and Family B retires with $2.5 million in assets. Interestingly, one of them we encourage, help and support and one we envy, tax and ridicule.

The members of Family A who have lived rich will have no assets at retirement and will further strain the Social Security and Medicare systems. We perceive them as the truly needy when in fact they have lived life as the truly greedy. They could have taken care of themselves, but instead they burdened society simply by ignoring their retirement.

To add insult to real societal injury, these same people often claim they just don't care about money. They are above amassing wealth and instead just live to enjoy themselves. If they truly were indifferent about money, however, they would be able to live on 15% less than their take-home pay and save and invest the difference.

A couple we know just retired with $2.5 million after working and earning quite modest salaries. They lived simply and practiced frugality. Nothing was wasted. They waited a few years before purchasing the latest technological gadgets and then bid for them on eBay. They made do or did without. They grew rich by shopping at sales and avoiding impulse buying on credit.

Now that they have managed to save $2.5 million, however, some of the presidential candidates have suggested increasing the tax on investment gains to 28%, rather than taxing the consumption of those living rich. That will mean if your investment assets earn an 8% return, you will be unable to make any progress toward your goals. Five percent of your return will just keep up with inflation, and you will owe 2.24% for a 28% capital gains tax. You would only be left with a 0.76% real return after taxes and inflation.

We won't be able to help the truly needy until a majority of Americans realize they are part of the problem. People's failure to save for their retirement stresses our governmental programs with those who ought to be multimillionaires. Saving just a few hundred dollars a month over your working career makes the difference.

No matter what your income, a similar family is living off half of your salary and still saving more than 15% of their take-home pay. Another family is earning twice what you earn and struggling to make ends meet. Nearly every family we work with wishes they had an extra $10,000 a year to make life easier.

Because of inflation, the gap between the rich and the poor is growing. If $5 million today is less than $1 million in 1970, the absolute dollar difference between the rich and the poor has to be at least five times greater. The poor always have zero.

Greg Mankiw, a professor of economics at Harvard, offers an interesting analysis: "If we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. Let's take the adjustments one step further. Richer households are larger--an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1."

That's the difference. The richest 20% in America live 2.1 times more extravagantly per person than the poorest 20%.

Another study by Steven Landsburg shows that leisure used to be evenly divided among the classes, but it isn't any longer. Although Americans as a whole have an extra four to eight hours of leisure per week (or about seven extra weeks of leisure per year), this extra leisure has not been gained evenly. About 10% have no more leisure than they did in 1965. These hard workers, it turns out, are highly educated and have had the largest gains in income. At the other extreme, about 10% have gained 14 hours a week or more (over 18 extra weeks of leisure per year). These excessive gains in leisure have gone, oddly enough, to those who are the least skilled, least educated and have the most stagnant incomes.

It used to be the leisure rich or the idle rich. Now it is the working rich and the idle poor.

Many believe it is OK to redistribute income but would consider it absurd to redistribute leisure. It turns out there really is little difference.

Decide to be rich. Your retirement, and the country's welfare, depends on it.

Comments

[Ryan S.]

This is very true. I personally have made it my quest to get ride of idle time this year as much as possible from my schedule. Although, I don't consider vacations, trips, and actually doing something as idle time. Work hard and play hard. What I consider idle time is plopping myself in front of the TV (and the internet to some extent).

[tracy ho]

Your facts amaze me , great inspiring post ,

Thank you ,

tracy ho
wisdomgettingloaded

[savvy]

The problem with articles such as this is that they appear to make the assumption that it's an all or none proposition. Either you live 'the high life' or you save a lot. It's not always that cut and dried.

It is possible both lead a very comfortable lifestyle and save lots money. I plan to retire before age 50 but I'm having fun along the way too. Why lead a spartan lifestyle in the hopes that one day you'll be around to enjoy the savings you sacrificed so much for?

[Duncan]

Deceptive would be a kind description of this article. Family B would pay no taxes on their investment gains under the current system. If they used a Roth IRA account they could save $10,000 a year as a couple and all of their returns would be untaxed.

[Matt]

4.36% safe withdrawal rate? Even though that's probably *around* the right amount, that seems awfully specific. Where are those 3 significant figures coming from?

[sow]

Savvy,
Well said. We are doing the same. People too often wait to "enjoy" life until they retire. I call this "half living". You live modestly during the work years and then you plan on being in a lower tax bracket when you retire. Accumulation doesn't lead to wealth. Utilization can.

This post only touches on "inflation" as being a problem with money. What most people don't realize is that inflation is only one of the eroding factors of money. There are other big factors like taxes, planned obsolescence, technology change, health care costs, market changes, interest-rate changes, etc. Take note of what banks do. They velocitize money and put it to work.

[Mixer]

Sow - inflation *is* a tax, and a tax with no return to boot. Estimates right now place monetary inflation at about 16%, with most taxpayers paying about 18-19% in income taxes. Granted, the income tax is higher, but at least you are getting a standing army and some other pleasantries for it. Monetary inflation only helps the government spend more and does nothing for the citizen, who tends to only see price inflation as a result.

Also, bank velocitize currency, not money, and they have to do it to keep up with inflation to maintain a wealth base; banks are one of the few businesses out there that understand money, currency and wealth. Kiyosaki still hasn't learned the difference between the three.

[sow]

Actually, currency is a paper medium of exchange. It is a form of money, which is really just an idea. And the banks velocitize and utilize it not only to maintain, but to create wealth. You're right, they are one of the few out there that understand how money works. Whether you like Kiyosaki or not, we can really learn from the bank!

[Todd]

While I agree the article oversimplifies things a bit, I do agree with the main thrust of the article, which I take to be that our government punishes those who are financially responsible and rewards those who are not. Moreover, another point in the article, that two different people with the same income can have dramatically different retirement outcomes, is well taken.

[Kyle]

Interesting post. It never occured to me to view the rich and poor in terms of consumption, but the numbers are striking and make perfect sense in retrospect.

[Mixer]

Sow - this is a hard concept to describe in the space of the comments section. No offense intended, but you're like most people out there in that you mistake money for currency and both for wealth, and understandably so - that's the way almost everyone, including the wealthy, think of wealth; it's the way wealth has been described to us in books, the media and by the culture at large. But, the three are not the same. Ask a Zimbabwean today if currency equals money. Ask an Argentinian 8 years ago if money equals wealth. Ask any of our forebears from the 1800's if currency equals wealth, and ask any French citizen from the late 1700's if wealth equals money. The US and most of the developed world are once again trying the ages-old experiment of creating wealth from nothing. Maybe they'll succeed and maybe they won't. Yes, you can get wealthy playing the game they are running, but be careful of the endgame.

[sow]

Mixer,
No offense taken. I think we're talking about the same thing. I totally agree with you. Like Kiyosaki says, "You can be a millionaire by being cheap. But guess what, you're still cheap." Thus, the broke millionaire.

Wealth is a state of being, not having. And the more you can exchange value, the wealthier you will be.

[earle]

that's a good article, makes sense to me. fmf, but, what about the rest of the main streeters who make a ton of bad choices, i.e. tremendous over consumption or no retirement savings, and then eventually are bailed out? the cities of america are littered with these types. what's the incentive to save? or keep from sapping ss when you can just consume? curious to know.

[rwh]

The only way family B can have an additional 1 million from saving an extra $100/month at 10% (compounded daily) is if they do so for 44.5 years in an account that is not taxed. Under current rules that has to be in a Roth IRA, individual stocks that are held and never sold during this time, or I guess, tax exempt municipal bonds, which probably won't yield 10%. Once they reach the 1 millon figure they will pay no tax if the money is in a Roth IRA, and will pay a 15% tax at the federal level only on the assets they choose to liquidate if they are not in a Roth IRA. In either case they will have enjoyed untaxed growth for 44.5 years.

I hardly think this is punishment for becoming rich.

Also, the average CPI increase over the last 17 years is 2.69%. So where does he come up with the figure that inflation is going to take 5% of your return? Or does he measure average inflation over a longer period?

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

[jg]

Spot on. The mortgage bailout is a prime example of individuals taking risks while others don't. If you can't handle the downside then it is a stupid risk and they should be responsible for their actions, yet it seems if things don't go well for them we bail them out. Taxes on consumption would revolutionize the way americans think and live for the better.