It doesn’t help that most of us – as first world humans anyway – tend to measure success in monetary terms, e.g. the size of your house, the fancy car you drive, etc.
So-called designer labels exacerbate this problem, serving to further illustrate achievement of wealth and/or success, regardless of the actual, underlying facts.
In a previous blog post I shared that my sales manager picked up the tab for an overnight hotel stay during a weekend sales trip, years ago. A reward for sales achievement. Writing that got me thinking… higher level… does it seem unfair that wealthier people end up paying less for stuff than poorer people?
The cost of a hotel room for one night was probably inexpensive back then, but it didn’t cost me anything.
Or - in other words - the sales rep with the highest earnings also enjoyed a paid-for-by-someone-else hotel room. Colleagues who hadn’t sold anything on that same trip would have had to pay their own accommodation (or sleep in the car and use my hotel room shower).
Think about the information shared above for a minute. If you were to buy something expensive - say, a fancy car - chances are that a rich person driving the same model/type of car, paid less for it than you did.
Their cost of borrowing is likely less than yours, for a loan, like a mortgage. Their FICO credit score may be better than yours. Greater wealth generally creates more/better opportunities to leverage (borrow) at lower rates. That’s regardless of the fact that they may not even have needed to borrow money in the first place.
You see, rich people usually only borrow money to make more money (i.e. return on investment achieved), or to offset/defer current tax expenses for a future period.
Poor people borrow money to buy stuff they shouldn’t buy and cannot afford; usually cars and a house. Hopefully poorer people aren’t using credit cards to buy stuff they cannot afford… because that’s just plain stupid! And a primary reason why the rich get richer and the poor get… well, poorer!
Having access to money, allows wealthy investors to make more money; sometimes without having to take too much risk at all.
Here’s an example:
Let’s assume that you want to invest in an “AA Rated” company bond that offers a semi-annual coupon rate of 6% annually. Available to anyone for investment.
A typical, average retiree would be required to make this investment using his/her personal, hard-earned savings. The return in my example above is predictable. The investment risk includes default as a possible worst-case scenario; resulting in lost capital, in addition to the lost, future return on investment (opportunity cost.)
That’s only one reason to diversify!
But what about the 1%ers?
Well… they play in a different sandbox, in case you hadn’t noticed.
A private banker may help them to assess investment risk; tap into substantial bank resources to determine the quality of the offering; viability and sustainability of the corporation making the bond offering; and more. Then - at the current interest rates - the banker may lend the client the entire amount required for investment to the client at e.g. 2% interest + a 1% management fee. Total cost 3%. The wealthy investor can therefore end up making 3% annually (pre-tax), using other people’s money.
Whose money is this other people’s money? Well, banks can currently borrow money from the Fed at 0%, but they don’t even really have to do that. The same bank may be offering small depositors (savings accounts) interest at a fractional rate, e.g. 0.1%. Meaning… the bank already has poor people’s cash in hand, ready, and awaiting investment!
The example above is likely not available to you as an investment option, because you may not be able to qualify for a multi-million dollar loan.
In my example then, what does a rich person do with his/her own cash available for investment? Well, in general, probably something like: (1) either viewing it as cash awaiting investment to buy assets cheap, like an investment property in the instance of 3D scenarios (death, divorce and/or debt); or (2) to buy toys, e.g. cars and/or yachts (because they are able to generate passive income using other people’s money.)
Of course, there are many more investment vehicles available to all investors, but the above is intended to demonstrate how the rules and opportunities don’t apply equally to all investors, small and large.
The real message in this blog post should not be lost on readers: Firstly, know that wealth is a relative concept. If you're happy and in good health, you're already wealthy! More importantly, live within your means, cut (or ensure that you’re able to manage) your debt, and save/invest as if your future depends on it… because it does.