Why the Wealthy Get Wealthier
Learn why the rich get rich and the poor often stay poor
Wealth through generations creates a wealth cycle but how?
The top 1% of American earners own more wealth than the bottom 90%.
How did they get that way?
You may have heard of the "cycle of poverty." The cycle starts when a child is born into an impoverished family with limited means to improve their standard of living.
But there is an inverse to that - it is called the "wealth cycle," which includes wealth creation, preservation, and distribution. Scholars believe the cycle persists for at least three generations.
"Old Money" and Generational Wealth
Since the 1880s, the Social Register has published a directory of America's elite, including socialites, business tycoons, and "old-money" families, such as The Rockefellers and Vanderbilts.
Old money refers to affluent families that maintained their fortune for multiple generations.
There are many ways families can build and preserve generational wealth.
How did they get rich?
First, they generated significant income.
That income did not come from working for others. "Self-made" men (and in more recent times, thankfully, women) created "streams" of income.
In fact, approximately 65% of self-made millionaires have three streams of income.
These income streams include earned income (especially early on in wealth creation) and passive income.
Think of earned income as income a self-employed (using that term loosely) person generated as his or her company "profits." Passive income is the rich person's money making that rich person more money, often through investments.
Something as simple as putting money in the stock market can double the investment in 7 years (if it generates an average return on investment of ten percent per year) or 10 years (if it generates an average return on investment of seven percent per year).
So $5 million becomes $10 million in 10 years, that then becomes $20 million in 20 years at 7 percent on average per year. That same $5 million becomes much more if the return on investment is higher than 7 percent per year.
Now keep growing that wealth and taking it across generations many decades and eventually centuries.
During that process, the wealthy have the passive income we discussed, less debt and they create estate planning documents like wills, trusts, annuities, and more to ensure that money goes to who they want when they want and how they want.
And let's not forget the business or businesses they own or control continue to grow.
This exponential growth builds wealth, keeps wealth, and passes on wealth to children, who keep the "cycle" going.
What about taxes?
But the Federal and State governments take half of that income right? Wrong.
The Federal and State tax system takes a higher percentage of money from the working American who earns $100,000 per year than the multi-millionaire who earns the same $100,000 through his or her passive investments…and the millionaire may be able to mitigate or defer some or all of that tax payment through legal loopholes within the tax system.
In short, the Federal and State tax systems put a high tax burden on working Americans, not Americans who sit back and watch their money grow through investments.
Cue the, "what the heck, we need tax reform now!" claims.
Neither political party has cared in the past, although newly elected President Biden may propose taxing capital gains income at or around the same level as earned income. And yes, Wall Street is not happy. But will it actually happen?
Warren Buffet is a good example of this wealth cycle
Warren Buffet, worth an estimated $96 billion, exemplifies "working smarter not harder" but he also is a living example of exponential wealth growth.
He grew his wealth through strategic investments and exponentially increasing his investment company's share price over the years.
Additionally, Buffet opted to have an open marriage instead of divorcing his first wife, Susan Thompson. Was he smart enough to realize divorce can be expensive? Probably. He also apparently had an understanding wife and mistress.
Despite being the sixth richest man globally, Warren pays himself a salary of $100,000 annually for the last 25 years and paid a lower tax rate than his secretary. Why? Because nearly all of Buffet's income comes from his investments, which is taxed at a much lower rate than "income" from employment.
The wealth cycle does not work without inheritance
The descendants of William Cargill and John MacMillan have owned common equity in Cargill Inc. for over 140 years.
Today, about 90 family members allegedly own 88% of the company through inheritances, worth an estimated $115 billion.
Wealthy families rely on professional advice to mitigate or lower taxes and given the mammoth tax code, there are plenty of those only the rich can afford.
Loopholes are no help to the middle class or upper-middle-class working family. They cannot afford the expensive CPAs or tax lawyers, nor have enough money to make the tax avoidance worth the fees.
A word about marriage (and divorce) in wealth creation and preservation
Marriage leads to significant wealth creation if a person marries another person of significant wealth. File that under, "duh, common sense." However, that assumes the marriage lasts.
And if the marriage does not last?
Tabloids ruthlessly labeled 26-year-old Anna Nicole Smith as a "gold digger" when she married 89-year-old billionaire J. Howard Marshall in 1994.
Smith and her estate litigated unsuccessfully for a share of Marshall's estate for fifteen years.
You thought big tax breaks were just for the super-wealthy individual? No way.
The Federal and State government likes the give breaks to the rich of every kind, flesh, and blood or creatively formed entities.
After all, corporations are people too.
Hello billion-dollar company, how can we help you?
In 2013, the Washington State legislature gave Boeing an unprecedented $8.7 billion in tax breaks.
Many people criticized this decision because Boeing is a multibillion-dollar company.
Research, however, found that most states and local governments provide $30 billion annually to corporations in money grants, publicly-funded benefits, and tax breaks.
Lower Relative Cost of Lifestyle
NBA player Kawhi Leonard made headlines in 2016 for driving a '97 Chevy Tahoe despite earning $16 million annually.
When asked about this, Leonard explained that "It runs … and it's paid off."
Some rich people prefer not to live a life of riches. Other affluent people indulge in luxury and sometimes free of charge.
Many wealthy people leverage their celebrity, connections, and status to receive perks at no cost to them, including:
- Cosmetic surgeries
- Designer clothing
- Consumer electronics
Multi-millionaires like Kim Kardashian and Nicki Minaj receive roughly $100,000 in gifts annually.
Additionally, celebrities like Cristiano Ronaldo receive close to $50 million in free products and services in exchange for promotional Instagram posts.
These lavish gifts allow the wealthy to allocate more disposable income to investments and savings.
Money and elevated status allow the wealthy to wield greater socioeconomic power.
For instance, Donald Trump used his presidential power to pardon several wealthy, white male allies such as serial offender Charles Kushner.
The elite also enjoys capital beyond economic capital.
Social capital refers to mutually beneficial networks that provide someone resources to achieve desired outcomes, such as the following.
- Referrals for robust legal representation.
- Exclusive club memberships.
- Lobbying power through political action committees.
- Legacy admission into prestigious universities.
Many wealthy families maintain or grow their social capital by marrying people with similar means, such as actors Angelina Jolie and Brad Pitt.
Unfortunately, Jolie and Pitt's marriage did not last, but they were proactive enough to sign a prenuptial agreement.
Jolie and Pitt's divorce has gone on for four years.
Fortunately for them, they do not have trouble affording legal representation.