Will Time Make Us All “Rich”?

The following is a guest post by MasterPo from The Po File.

In today’s social and political environment harping on “the rich” seems like a daily sport. Never mind that most of the pundits and commentators lambasting “the rich” are themselves among the highest rich in the country by anyone’s definition! But let us not digress…

As it stands, at the time of writing this the commonly accepted and PC way of definition “the rich” are those with incomes of $250,000 or more. (In some conversation that number is reduced to $200k, $150k, $125k, and even $85,000(!).) It is unclear to MasterPo how or why such a line in the proverbial sand is used (and certainly not clear how or why such persons are now considered public enemy #1!)  but that seems to be the standard of the day so let’s work with that figure.

The question is: As time marches on will $250,000 still be considered “rich” after applying years even decades of inflation erosion on purchasing power?

MasterPo normally doesn’t like to resort to number crunching models to make a point. But math is absolute and unquestionable. And a subject like this requires clear illustrations.

The time value of money should be SOP to all investors. As such the basic compound growth formula should also be so basic to all investor as to be able to do the math in yourself:

T = P(1+i)^t

Where “P” is the starting amount (principle), “I” is the rate of growth (annualized), “t” is the number of periods in years, and “T” is the final total after compounding. It’s just basic high school algebra.

Now let’s apply this to the thesis of “the rich”, time, and a real world example.

According to the National Association of Colleges and Employers (as reported by the U.S. Bureau of Labor Statistics) the average starting salary for a college graduate with a Bachelor’s degree in Computer Science is $61.407 as of July 2009 (latest statistics available as of writing this).

So if we presume a mere 3% annual inflation, applying the above formula, then someone born today and graduating college at age 20 would need a starting salary of $111,000 (rounded) to be equal to today’s starting salary.

Let us go further and presume someone graduating 20 years from now and starting with $111,000 salary works for 10 years and receives an annual raise of just 3%, also matching inflation only. At the end of 10 years that person will be making $150,000 (rounded).

That’s pretty darn close to the magical $200,000 mark knocking on the doors of “the rich”.

Take it one step further: Let us now presume this person meets someone else of similar career background, one thing leads to another, and it’s wedding bells time. Now you have a married couple each making $150,000, or now $300,000 combined income – well over the $250,000 “rich” mark!

And if we presume 4% annual inflation then the numbers become $135k, $199k, and $399k respectively in the scenario above.

Plus this does not take into consideration any massive jump in inflation or hyper inflation. Just one year of 10% inflation throws these figures even higher!

MasterPo knows some critics of scenario will try to make the argument that by that time government will have adjusted tax brackets and various other thresholds to account for inflation adjustments. Can you really count on that? History proves that thresholds for determining “the rich” are coming down and not going up! (MasterPo won’t even go into a discussion of misleading if not outright false inflation calculations.)

Too many people today, either by short sightedness or sheer class envy, just don’t think about policy ramifications on income levels higher than their own. Not really much of a surprise as people are constantly being hounded that anyone who makes more then they must have stolen it somehow. But as this illustration shows just the power of inflation, as low as it may be, can and will rise people will into levels of “the rich” without actually being “rich”.

It’s always amusing to blame your woes on someone who has more than you. But sit back, relax, have a beer and play some Xbox. You don’t have to worry. You will never be “rich” – or will you?

Comments

[Apex]

Another Po post without a point. Remind us how your posts are supposed to assist or inform us financially again?

(tip: grinding an axe against the monetary definition of rich is not helping or informing us)

[Alias]

While I agree that many like to blame those who make more money or are well off. I think your numbers are a bit off. Nobody I know holds a bachelors degree in Comp Sci at age 20. The average age of a college graduate with a bachelors is probably closer to 24. Inflation is also a skewed number. Govt CPI excludes some components that IMO that are directly correlated with inflation. And rich...well I guess we all have our own defintions and benchmarks. 250k in Des Moines goes a lot further than in NYC or SF.

[jim]

Ok, everyone with a Computer Science degree stop being mean to rich people!

[Pop]

"Let us go further and presume someone graduating 20 years from now and starting with $111,000 salary works for 10 years and receives an annual raise of just 3%, also matching inflation only. At the end of 10 years that person will be making $150,000 (rounded).

That’s pretty darn close to the magical $200,000 mark knocking on the doors of “the rich”."

Huh? That's a very "po" effort. I expect more from a master.

[Greg McFarlane]

The biggest fallacy in the class envy war on "the rich" is that they're a permanently definable class of people. As Thomas Sowell points out, wealth is a condition, and not always a permanent one. Pick a percentile, say 90: the richest 10% of Americans aren't the same as the richest 10% of Americans 5 years ago, nor 5 years from now.

The best advice I ever received: "The best way to help poor people? Don't add to their ranks."

[Don Current]

Something else to consider. If you make $250k/yr and you spend $270k/yr, are you rich? To copy a phrase from the master of all things rich, Thomas Stanley, is the person income statement wealthy or balance sheet wealthy? That's the true measure. Income has nothing to do with wealth. How about the parking lot attendent making $20k/yr who has over $500k in investments because he busted his butt, lived frugally and made EVERY penny count even putting his kids through private school? Is he not rich because he only makes $20k/yr?

The parking lot attendant's story - http://www.smartonmoney.com/retiring-wealthy-on-an-average-salary-the-story-of-the-persevering-parking-attendant/

[bb]

Yes, they're still "rich" because national median household income is low ($50K). 20 years later with annual 3% inflation, today's $50K will only become $90K. $250K will "still" be about 3x median.

[Ed]

No point to this.... It doesn't even warrant a philosophical discussion.

Worry about the things in life you have control over and you will prosper on all fronts. People waste too much time thinking and talking about what they cannot control.... Work hard. Do what you have to do to make yourself more valuable in the market place. Spend less than you make.... And you are going to be rich. Who cares how others define it.... Inflation is what it is...

[MBTN]

I will say that defining rich in terms of annual salary has always bothered me. It doesn't take into account net worth. It doesn't take into account cost of living where you work.

Consider two examples...

First is the person who works in a factory in some developing country who is making "only" $5 a day. We here in the US will say that paying somebody $5 a day is a crime and the worker is being taken advantage of. However, $5 may be a huge sum of money in the terms of the local economy. In terms of the country's standards, that person might be considered rich.

Second is the person who might only make $10K a year in income but has a large net worth, say $10 million. By making $10K a year, that person is technically below the poverty line, but nobody would consider that person poor with a nest egg of $10 million. So is the person really poor?

[MasterPo]

As always, MasterPo appreciates the comments.

The point of this article was to raise awareness of the power of compound inflation, the 'damage' just a short period of higher or hyper inflation can due, and to make you stop and really think about how we as a nation are defining "rich" now and in the future.

It is true the individual American can't do much to prevent inflation. But inflation - high or low - happens.

As investors the accumulation of wealth is the goal, be that as growth or cash flow (income). Anyone who is investing and isn't seeking wealth is investing for the wrong reasons.

Therefore, as investors - or simply as successful people - it is crucial to recognize the impact that compound inflation will have on the very artificial definition of "rich" and the 'penalties' that come from meeting that definition. You may not consider yourself "rich" today but your children and children's childern will certainly have to be "rich" by today's definition in the future just to have the same life style you enjoy today.

When that happens "rich" is no longer rich.

Thanks for reading it.

[Mike Hunt]

In 2005 there were about 10,000 government employees making more than $150k a year. Today that number is around 130k people... now that is wage inflation!

I don't think it's safe to assume that wages will go up 3% a year, there is still more global wage arbitrage to play out.

And the bigger issue when looking ahead is the size of the US debt- growing at over 1 Trillion a year (that's 4 billion dollars a day or $200 million per hour).

In the time I took to type this post the US debt has gone up by $9 million. In the time you take to read this the debt will have gone up another $2-3 million. No way we can continue like this for the next 20 years.

So, in conclusion- you cannot think of income growth in a vacuum looking out 20 years - way too many other factors at play.

-Mike

[Mike Hunt]

Hi Masterpo,

In the last 10 years has the average income gone up?

I had thought that earning power has gone backwards (or is this only after adjusting for inflation)?

-Mike

[StL Pastor]

Mike, its only after adjusting for inflation that earning power has gone backwards (though, inflation's been pretty tame the last 10 years).

On Master Po's point-obviously, inflation matters, that's why putting money in a mattress is a bad idea. Yeah compound interest.

But why on earth am I vilifying the rich to say that the top 2% of Americans have received the vast majority of income growth over the last 10 years while middle class families have had static income, and thus it is a wise decision for the US Federal government to increase taxes on those people who have a larger share of the national wealth pie to help deal with the Federal deficit? I'm not saying they got the wealth unjustly, I think its largely a function of globalization rewarding the highest performers more, but I still think they can pay more in taxes.

And also, almost everyone living in America is rich, globally speaking, and $85,000 per year is about 70% more than the median family income in the US, which while not super rich, is certainly doing quite well for yourself.

Finally, while 'the rich' is not a static class, American social mobility is rather limited-much worse than in Europe or Canada.
http://www.huffingtonpost.com/2010/03/17/social-immobility-climbin_n_501788.html

[Harm]

I'm surprised no one has pointed out that that's
exactly what has happened with the alternative minimum tax (AMT).
It was supposed to affect all those rich sneaky bastards who
paid 'less than their fair share'. Now it is at large in the upper
middle class, creating havoc, affecting more of us every year....

[aaktx]

I am kinda rich but my income gains started later in life(late 30's), so I've missed the wealth compounding effects of time. Most people do not earn 250K off the bat. I think this type of discussion should include WHEN you make that kinda of income.

[Old Limey]

In 1992 when I retired my annual salary was $72,500 as a senior staff engineer for a major aerospace company, my wife earned $13,500 as a part time kindergarten teacher.
In 2010 neither my wife or I have any earned income whatsoever but we receive 2 pensions & 2 SS checks amounting to $55,000 annually after all deductions.

Excluding State and Federal taxes we could manage quite well on that if we had to but, being a very frugal couple, over our lifetime we amassed quite a large investment portfolio that is invested in fixed income investments that generate close to $300,000 annually that is either tax deferred or tax exempt. Isn't this the very reason why we try very hard to get out of debt and build up as large a nest egg as possible by the time we retire, but sometimes we overdo the saving or we hit a great period in the market and it keeps on growing faster than we anticipated, just like the proverbial snowball rolling down the hill.

The only issue I face these days is that since 2008 interest rates have dropped so much that CDs are too low to bother with, money market funds pay practically nothing, and new issues of municipal bonds also have very low coupons and very long maturities. Thus I have to take greater risks when I replace bonds that mature or CDs that get redeemed by the FDIC because of bank failures. Thank goodness we once had a great & caring president by the name of FDR that introduced FDIC insurance and other reforms or the current recession could have easily turned into another depression. Actually though it took WWII as well as FDR to bring America completely out of the great depression.

Our largest expense these days now that we are both well over 70 1/2 is paying the taxes on the mandatory transfers out of our IRAs into our Trust account. Unfortunately the "Free" ride on IRAs doesn't last for ever.

[Apex]

@Old Limey,

Would you be willing to give some insight into how you make the decisions you currently make about finding investments to replace your bonds and CDs. As you already said, rates across the board are horrible right now. Are there some particular instruments that get better returns at acceptible risk levels and how do you identify those.

Thanks.

[jim]

"In 2005 there were about 10,000 government employees making more than $150k a year. Today that number is around 130k people... now that is wage inflation!"

Its not like 120k people got big fat $40k raises all the sudden.

The top pay grade GS15 got annual raises averaging 2% from 2005 to 2010. The key reason so many more people are making over $150k is that the top GS15 salary rate just got over the $150k threshold.

Also pay rates are limited by the head of an agency so when the head of the FAA got a raise, 1700 people under him also got a raise. That right there accounts for 1700 of the people now making over $150k.

[jim]

"exactly what has happened with the alternative minimum tax (AMT). It was supposed to affect all those rich sneaky bastards who paid 'less than their fair share'. Now it is at large in the upper middle class, creating havoc, affecting more of us every year."

ONly around 3% of the population pays AMT. AMT tax rate is never more than the normal tax with standard deduction and the rate is 29% with a large exemption.
They do need to index it to inflation, rather than raising the limits periodically as they have been.

[Old Limey]

Apex:
I bought some muni bonds today in the secondary market that have a 4% coupon. I paid $955 for each $1,000 bond so as well as paying annual interest of $40/bond there will also be a $45/bond capital gain when they mature on 12/1/2023. The issuer was a major convention center in the state of Washington. Thus I am getting 4.19% tax exempt interest on money locked up for 13 years.
For taxable bonds at this time I also bought some shares in both a low duration and an ultra short term duration mutual fund. They have a very low volatility, yield around 3.5% interest and can be sold any time you like. The fund company I selected was Metropolitan West - they have a family of funds and a highly respected and well known fund manager. They hold a mixture of US treasury bonds, Federal Home Loan Mortgage Corporation (FHLMC), and Federal National Mortgage Association (FNMA) notes. They also use options to lower the duration. Fortunately I also own a lot of CDs and muni bonds yielding 5.5% that I bought in 2008, they are of course valued much greater than my purchase price but I'm holding them until they mature between now and 2023.
The average return on my portfolio right now is about 4.87%. Currently there are no CDs anwhere near that high and even the highest I see are 3.5%, 15 years, and not call protected. For new issues of muni bonds you would have to either pay a high price premium, accept a very low interest rate, or go out to 2040 and beyond. These are difficult times for old people that used to be able to get 5% interest just by going to their local bank.

With a municipal bond or a CD held to maturity the daily market fluctuations are not an issue. With the taxable bond funds I selected them, using proprietary software and data, out of 105 short term bonds available to me on Fidelity's funds network, based upon their volatility, worst drawdown, and risk adjusted rate of return over several periods such as the last month, the current year, and the last 2 and 3 years.

During these volatile times my goals are 1) Not to lose money, and 2) To get the best risk adjusted return I can.
There has been an advertisment running in our local newspaper seeking investors and offering "in their words" a guaranteed interest rate of 10%, but not insured by the government. This has to be a blatant scam because only someone like Bernard Madoff could make that kind of offer and he's in jail for the rest of his life.

[Apex]

@Old Limey,

Thanks for posting that. It's valuable to see the types of products, durations, and rates someone as versed in the topic as you is getting. It confirms that for new money you have to lock it up for a long time to get even mediocre returns unfortunately.

[jason]

I think this post might benefit from giving us a marker as to what was considered to be rich say in the 30's, 40's, 50's up until today. Of course inflation has occured and rich in the past is much different from rich now and will be much different than the rich in the future.

[Debt Free Daniel]

With inflation at the sides, we will never be rich as time flies. We can be rich if we go back in time. If we are making such huge amounts today, that same amount is worth less for some five years from now. That is why a lot of people just don’t leave their money on a savings account that gives small annual interest on their balances. Better off invest that money where we can get a higher interest.

Daniel

[RB Boren]

When the inflation comes, we will all be RINOs.

Rich In Name Only.