Why You Are Always Broke

Is it easier to earn money or have money? Keep your answer to the side. We’ll be returning to it.

In the U.S. the median household income for 2022 was $74,580. That means over the working careers of the wage earners in a household, income will total around $3 million.

Of course, most people make less when they start a career and have their highest earning years closer to retirement age. Still, the median household income hovers around $75,000. Assuming household income only climbs with inflation, a household at the median will pull a cool $3 million over a lifetime.

We should also clarify some terminology. Notice I did not say “average” household income. Average income is skewed higher by a few people pulling mega-million dollar salaries. Think sports stars and CEOs of major corporations. “Median” is the point where half are above and half below the amount. The sports star getting a massive payout gets only one vote in the median calculation, instead of a vote with each dollar, as with averages. Therefore, median is more reflective of a typical household than average is.

So we are clear. Half of households will bring in more than $3 million over a lifetime and half will bring in less.

Well, with $3 million in income you would think most Americans would have a serious net worth. The median net worth of American households in $192,900. That is it.

$3 million in; $192,900 to show for it.

In all fairness, many households have not yet reached $3 million in income. But we did not include other forms of income people get, e.g. Social Security. So all household income received is actually much higher than $3 million over a lifetime. Just the earned wages are $3 million.

Still, the median net worth in the U.S in 2022 is a mere $192,900. And half have less!

Clearly, people are much better at earning it than keeping it. Now you have the answer to the question at the opening. It is easier to earn it and harder to keep it… for most people.

The bottom 50% control less than 3% of wealth in the U.S, with an average net worth around $51,000. (Statistics for the bottom 50% are calculated as an average because there are no huge upside outliers in the statistics.)

It is tempting to believe the financially wealthy inherited their money. However, just over one in five millionaires (21%) inherited a single cent! A mere 16% inherited more than $100,000 and 3% $1 million or more. It also needs noting that large inheritances do not all go to the rich. Many receive and spend it, hence, they are not millionaires for long.

Once again, it is clear people are much better at offence (bringing money in) than defense (keeping it).

And that is a sad reality because net worth invested in income producing assets replaces income from labor to income from investments. Since income from investments often face a lower tax rate it is hard to understand why more people do not focus on defense.

The Flaw in Capitalism

The top 10% will always have more than the bottom 10%. It is a matter of math. Those who earn more are likely to have more. But that is not always true.

Capitalism has a massive flaw built right into it and there is no way to fix the problem. Anyone can exploit the flaw to their advantage as long as you know what the flaw is.

The best way to understand the flaw in capitalism is to examine three high school buddies on graduation day.

In our example, three young men are graduating from the same high school. Rather than attend college they decide to work for the exact same employer for the exact same wage.

Each man will have a gross weekly wage of $1,000. None are married, dating, or have children. In all matters, the three men are identical, except for one thing.

A week into their employment each man gets his $1,000 wage, minus taxes.

The first man spends his entire paycheck. The second spends his entire paycheck and gets a credit card so he can buy more stuff. The third man spends only $800, including taxes.

The first man will always tread water. He spends what he earns. He is only as financially wealthy as his last paycheck. He gets it, he spends it.

The second man does much worse. Not only did he spend everything he earned, he also borrowed from his credit card for fancy furniture and a new TV. When a payment is due he will pay interest on his excess spending, which means at some point his spending will be curtailed to make room for the interest and principal payments on the credit card loan.

The third man has a choice to make. He has an extra $200 burning a hole in his pocket. He can leave the money in the bank and earn a very modest amount of interest or he can drop the money into an index fund.

After a year passes with each man carrying on with his same spending behaviors, we see man one with nothing to show for his work, and a growing debt load for man two.

Man three spent $10,400 less than he earned over the first year. If all he gets from his savings is 5%, he is over $500 ahead of man one and two.

But man three is wise. He invested his extra $200 weekly into an index fund. Every day the companies in the index are working hard to increase their value. Man three did nothing to achieve this advantage. The managers of each corporation did all the work.

Man three enjoys his pro-rata share of the profits, plus the increase in the value of his share of the businesses he owns in the index fund. Yes, the stock market does not always reflect the gains. The market goes up and down. Sometimes irrationally.

Warren Buffett, repeating the words of his mentor, Benjamin Graham, clarified the issue when he said the stock market is a voting machine in the short-term and a weighing machine in the long-term. In other words, as value rises, so does the price of the company’s stock over the long run, with short-term bumps along the way.

In 10 years, man one is still no better off than he was the day he graduated high school. Man two is headed for bankruptcy. Man three invested $100,400 over the past decade. That investment more than doubled. Since the long-term trend for the stock market is around a 10% annual gain, man three on average will see his net worth increase more than $20,000 per year, plus dividends of another $2,000 or so annually!

This is the flaw in capitalism. Those who have get more. They always get more because they get their share of the profits as a dividend, stock buy-back, or profits reinvested in the company by management.

Man three has reached average annual gains of close to half his annual salary earned by selling his time. In 20 years, he will have invested $200,800. But his investment account value will likely be over half a million dollars, depending on if the market is in an up or down phase at the 20 year mark. It is also important to note that man three after 20 years earns more income and increase in value in his investments on average every year than he does working his job.

No matter what man one or two do, they can never catch up to man three unless man three slows down his savings rate and starts squandering his new found financial wealth. As the Bible says, those who have will be given more and those who do not have will have what they do possess taken from them and given to the haves. This isn’t new information. It has been around at minimum 2,000 years.

The great news is you can start at any time. Man one can spend a bit less than he earns, investing the rest. Soon he too will enjoy income above wages earned. Man one can, in essence, give himself a pay raise.

Man two is in a bind. He first needs to spend less to pay off his debts. He could invest some of his reduced spending so he builds extra income, but the debt still needs to be addresses. Not impossible, but he needs to get serious fast.

The Big Lie

Unfortunately, not everyone can play our simple game, exploiting the flaw of capitalism. There are instances where wage income is so low that excess funds to invest are minimal, if they exist at all. The only recommendation I have is to take any free time you have to improve your wage earning potential. It may require moving to a place where income and basic costs of living allow for excess funds for investing.

I strongly caution you not to delude yourself! Often I see people saying there is no spending to cut or opportunity for more wage income. For most, the situation is not dire. You can improve your lot in life. I can’t tell you how to do it. You have to decide which path to live your life.

There are also people with disabilities or suffering illness. Others are dealing with family members in poor health. Your health, your family, come first. Money is NOT more important than family or your personal health.

For everyone else, you now know the flaw in capitalism and how you can exploit the flaw. No excuses! Get it done.

This post originally appeared at The Wealthy Accountant.

Category: Personal Finance