The Rich Get Richer
#getrich #stayrich The richer you are, the more volatility you can afford. After all, if you have to go a few years taking lower end vacations but you get massive returns in the long run, great!
Note: this post is a statement about how things are. This post is not a statement about how things should be. If you think you are reading a subtext within this post about how human society or governmental policy should be changed, you are inserting that opinion yourself. This post takes no position on what, if anything, should be done at the societal level in response to these facts about the of the math of investing. Here at Solving Wealth, we are allergic to politics. This is a post about what you should do in your own financial journey.
The universe is biased towards the rich. Setting aside any sort of policy environment,1 rational wealthy folks will, over time, tend to accumulate wealth faster than equally rational poor or middle class folks. Why? In a word, risk.
If you’ve ever set up an investment account in the USA, you had to fill out some form of questionnaire in which your bankers were required to ask you how much risk you were willing to take on. This survey is pretty silly, if you think about it. It’s like asking what mph2 you drive. An experienced driver would respond, “Uh, are you asking for an average? Am I driving a dirt track through the woods, or on a straight and level track in a high end car trying to set a personal speed record?”
But no, we’re expected to rate ourselves from “conservative” to “speculative” as if risk was a one-dimensional scale with an extremely limited number of choices. To a real investor, risk is a nuanced and rich topic. If you ask me about my risk appetite, I’m going to respond, “Uh, what kind of risk? Volatility? Wipeout risk? Over what time horizon? Measured against what benchmark? What are the goals we are trying to achieve? How attached are we to hitting them, vs. settling for the backup goals? What are the backup goals?” It’s hard to fit all of that thinking into a silly little survey, so I always just answer “speculative.”34
Kind of by definition, a rich person5 has all their needs met and then some, while a poor person lives on the edge. Therefore, a rich person should always be ready to cut back on their spending,6 while a poor person will suffer some nasty real world consequence if they do so. If an investment offers wild fluctuations over the short run, but a ton of growth over the long run, the rational rich person can choose it, and the rational poor person should not.
This would all be academic, except that there are people who sit around all day and figure out ways to make money by arbitraging risk vs. long term growth.7 Therefore, unless you notice something before everyone else, an investment is either going to be highly volatile and high growth, or low volatility and low growth. A checking account won’t pay much interest, but the dollars you put into it today will be the same number of dollars you can pull out tomorrow, barring some extremely unusual edge cases.
The stock market will randomly lose 25% in less than a month, or 80% in under a decade, but it has always come back. On the other hand, a low cost, whole world stock market index fund is also close to the least risky thing you can buy for any money you don’t need for 30 years, because while it might bounce around along the way as the talking heads on various media whip people into panic buying or panic selling, it’s going to get you growth that beats inflation consistently by a large margin in the long run.
The richer you are, the more volatility you can afford. After all, if you have to go a few years taking slightly lower end vacations but it sets you up for massive returns in the long run, great! But if you have to go a month without eating, well…
So the poor hold cash, food, and other predictable assets. The middle class start buying some precious metals, bonds, and real estate, and then stock market index funds as they get richer. The rich have all of those, but can also afford to buy or build a business, take a flyer on a single stock, invest in startups, cryptocurrencies, on top of whatever the latest thing is that might 1000x your money, or might lose it all.
As an example, an angel investor probably needs to put a minimum of $50K into each company, on average. However, at the earliest stages, only 1% of startups might go up 1000x.8 So the rich person who carefully invests $15M using talent and judgment across hundreds of startups might see returns of $150M or more over the next couple decades, while that poor person can’t even scrape together enough to make a single investment, and if a middle class investor is foolish enough to put $50K into a few startups, they are overwhelmingly likely to just lose it all.
Because rich folk can afford risk, rich folk reap rewards. This is why it’s vital to have a high savings rate. Unless you power through the earliest phases of your financial journey by paying off debt, building an emergency fund,9 you will never make it to being able to afford the stock market, any significant amount of cryptocurrency, or businesses.
Similarly, that’s why, if you aspire to become richer than you are, you must also educate yourself about investing at the next level. The poor can't afford volatility or wipeout risk in their investments, because they live with the personal wipeout risk of life every single day. The middle class start to be able to afford volatility, and the rich can afford to take on some limited wipeout risk as well, if the investment is carefully fit into a portfolio constructed around long term goals, and the wipeout risk is constrained to a particular asset. Invest in your own education, so that you can take the fastest path through the first part of your financial journey!
Remember, this post is not about politics! This post is talking about the nature of investment, not policy! If you are reading this post and getting some sort of left or right or libertarian or progressive or conservative or any other form of political slant out of it, you are pulling something out that we assiduously attempted to avoid putting in! Of course all humans have political leanings, but let’s set those aside for one blog post so we can have a much more interesting discussion about investing, agreed?
km/h for those of you who don’t measure things in hogshead per acre-foot.
If you answer anything other than “speculative,” your banker might give you a hard time when you are trying to take advantage of a nice investment opportunity. Of course if you answer anything other than “speculative,” the banker might prevent you from investing in something stupid, but I wouldn’t count on it!
The problem I have with this survey is that it primarily revolves around how the investor feels about their investment. Investors shouldn’t feel about their investments. They should feel about their goals, and then invest to hit those goals. Rationality is a poor tool for deciding what’s important in life, while emotionality is a poor tool for figuring out how to get there.
rich = high net worth and high income for the purposes of this discussion. poor = low net worth and low income. HENRY (high earning not rich yet) is a temporary state.
If you had to cut your spending by 45% tomorrow, you have a pretty good idea where you’d start. Right? Right?
If I had an investment that was super predictable with high growth, I’d buy the crap out of it! If enough of my friends do that also, the price will go up faster than it would have otherwise. Because of a group of investors called “momentum traders,” it might keep going up until the asset actually was set up to lose value! Then it would crash. The “smart money” sells at the top, the process repeats over time, and the asset is left with precisely the amount of crashes necessary to scare off just enough investors such that the volatility and long term growth even out. In modern portfolio theory, this is called the “efficient frontier,” and it’s why most assets that are traded widely and get enough attention from the markets have a precise mathematical relationship between growth and volatility. It holds true for total market bond funds, total stock market funds, and even Bitcoin and Ethereum!
These numbers are illustrative, and while they are probably true for some subset of startup investing, are also probably not exactly right.
The rich don’t even need an emergency fund, because what’s the worst thing that could happen, a $25K roof repair? That’s less than a month of normal spending for a decamillionaire.