Becoming wealthy: it's up to you - building personal wealth - Cover Story

The path to fortune is possible IF you live modestly; save consistently; take advantage of compound interest; avoid "irresistible" temptations; get an education; marry someone with an equivalent education and stay married; take some risks; and are willing to work diligently.

Critics often speak of "the rich" with none-too-subtle disdain, as if those at the very top of the income ladder all are crooks or as if becoming rich is difficult and means others must become poorer. While we would be the first to admit that some rich people are crooks, we hasten to add that achieving the status of "the rich" (defined, say, by having a net worth of $1,000,000) is not particularly difficult, contrary to popular wisdom. The rules for acquiring substantial wealth are few, simple, and well-worn. This fact suggests that becoming rich for most Americans is largely a matter of choice.

Unquestionably, some people are rich because their parents were rich. Sen. Ted Kennedy (D.-Mass.) never would have lived his lifestyle or most likely have achieved his high office if he had parents of modest means. Of course, Kennedy is not alone in the good fortune of his birth. By world standards, most Americans are "rich" precisely because they were born in this country. They typically have far more wealth than people in other countries and, as a consequence, can generate more income each year with greater ease. Americans produce nearly 60% more per person than Europeans. They produce each year close to 300 times the output of the typical person in Ethiopia, a notably poor country. The relatively high production levels in the U.S. mean that most people can earn a lot and save some of what they earn.

The first rule for becoming rich is have a reasonable income base, which is what most Americans have virtually by the fact of their birth. Few people who have subsistence income levels can expect ever to be rich. They must devote themselves entirely to survival, meaning they can't save and their wealth can't grow. This doesn't mean that all Americans live in luxury or have high incomes. Some do live in squalor and are incapable of saving. Nevertheless, the fact remains that even poor Americans have more than the subsistence-income levels of people in Ethiopia and many other countries. By world standards, most Americans start with a reasonable income base from which they can save, invest, and build their net worth.

Without question, some individuals have become inordinately rich because they have been lucky. They won a lottery or had the right talents at the right time. If Chicago Bulls' star Michael Jordan had been born 30 years earlier, he might have done well in basketball, but he certainly would not have earned the substantial fortune that he has. Contrary to conventional wisdom, the overwhelming majority of millionaires in the country do not have anywhere close to Jordan's tens of millions of annual earnings. Indeed, half of all millionaires have an annual income of less than $131,000.

How can an ordinary person (with a modest annual income) become rich? One surefire method is to live modestly (if not close to poverty)--that is, to save a substantial portion of earned income, until the savings pile up. This is precisely the route a majority of rich people have taken to their good fortunes. For most people of modest or above-modest means, the savings, through the power of compounding, eventually will make for a substantial net worth--and an income level that will be the envy of those who have chosen to fritter away their incomes on compact discs, cigarettes, and new cars. Indeed, a modest and continuous saving plan started early in life can ensure wealth later in life--say, at retirement.

As a simple illustration, suppose that a newly minted 22-year-old college graduate with a starting salary of $30,000 a year salts away a mere $2,000 the first year (and only the first year) on his or her first job (or a saving rate of 6.6% of income). Assume as well that the new graduate is able to secure an annual rate of return (above the inflation rate) on the accumulated investment of 15% until retirement. The one-time investment will be worth more than $800,000 at age 65 and more than $1,600,000 at age 70. This individual clearly would be considered "rich," given that, in 1993 (the latest year of available data), the median U.S. household net worth was $37,587, including the value of the equity in their houses. However, median net worth varied from under $6,000 for young adults to a high of $91,481 for people in their prime earning years, 54-64 years of age. Households headed by those 75 and older had a median net worth of $77,654.

Granted, 15% might be an unreasonably high expected rate of return for such a long period of time, but notice that the calculations are based on a one-time saving of a mere $2,000. If the person could achieve just a 10% compounded rate of return (approximately equal to the appreciation of the stock market over the last half century), then his or her one-time, $2,000 investment would reach $120,000 at age 65 and $194,000 at 70, a not inconsequential wealth level compared to what most retirees have. If he or she could achieve a compounded return of only six percent (which assumes the average rate of increase in the stock market for the past 70 years, minus an inflation rate of three-four percent), the investment would reach $24,500 at age 65 and just under $33,000 at age 70. The person would not then be rich at age 65 or 70, but neither would he or she have sacrificed much in consumer goods along the way. Indeed, the sacrifice would have been zero during every year of his or her career, other than that very first year.

The second rule for becoming rich is to take the power of compound interest seriously and do so very early in life. The sooner the saving, the greater the opportunity for the power of compound interest to work. The higher the return on the investment, the greater the growth. An obvious reason many people are not rich is that they save little or wait until late in life to take saving seriously, and by then they are not able to achieve a reasonable rate of return on their investments. Most have no one other than themselves to blame for their modest means late in life. They end up their careers with modest means often because they resisted the opportunities to live modestly along the way.

If a person were to resist the temptation to spend all earnings and were to save more aggressively (but still modestly)--say, $2,000 a year from age 22 until retirement--the investment would mount more rapidly, of course. If the investor were able to earn a 15% annual return, the nest egg would swell to more than $6,000,000 at age 65 and to $12-13,000,000 at 70. If he or she were able to get 10%, the nest egg still would exceed $1,300,000 at 65 and $2,100,000 at 70. If the return were six percent, the retirement fund would be almost $400,000 at age 65 and well over $500,000 upon retirement at 70--many times the net worth of the typical retiree today.

An even more reasonable career saving plan would run the wealth to extraordinary levels at retirement. Suppose that the college graduate's first job paid $30,000 a year and that, over the course of his or her career, he or she gets raises that, for purposes of simplifying the calculations, are two percent a year (after adjusting for inflation). The annual income would be just under $70,300 at age 65 and $77,600 at 70. That individual would not be "rich" based on salary alone, but could be very rich, assuming he or she saved 10% of each year's salary. Even at a rate of return of six percent on investments, that person's wealth would be nearly $800,000 at age 65 and $1,100,000 at 70. At a 10% compounded rate of return, his or her wealth would be $2,400,000 at age 65 and $3,900,000 at 70. With a 15% rate of return, the wealth would be $10,800,000 at 65 and $21,700,000 at 70. The person would be "rich" by any standard.

The third rule for being rich is to save a lot and do it consistently and, again, from an early age. We submit that most of the elderly are not rich now largely by choice. By world standards (and by past standards in the U.S.), many elderly Americans had reasonable income levels during the course of their careers. They could have saved far more than they did. In effect, they chose their standard of living today. Our point is that, if they had chosen during their careers to settle for the living standard of, say, the British, and had saved the rest of their income, they would have been quite well off today.

Many simply have been unwilling to forego the good life along the way. They were unwilling to resist expensive cars and "had" to trade them in for a new one every year or so. Some were sucked in by cigarette ads, and they now are "paying" for their habits both in terms of health problems and the unrealized income they don't have because of the expense of supporting their habits.

A retired person who smoked two packs of cigarettes a day since college graduation may have averaged spending, say, $547 a year on cigarettes (assuming an average cost of $1.50 a pack). If the money that literally went up in smoke had been invested, the person's retirement fund obviously would have been much greater, and surprisingly so. At age 70, the retirement fund would have been almost $150,000 larger with a rate of return of six percent and an eye-popping $3,400,000 greater at 15%. As investment adviser Scott Bums concluded after calculating his own wealth loss from his past smoking, "It comes down to this: If you want to be in the upper reaches of wealth in the U.S., you don't have to do anything complicated or heroic. All you need to do is dump the dumb habit. Is this a great country or what?"

Resisting temptation

The fourth rule for being rich is to avoid "irresistible" (meaning frivolous)temptations. That is easier said than done, and we do not necessarily recommend that all people should lead a pure and joyless life. We mean only to point out that the great majority of those four percent of Americans who have $1,000,000 in net worth get to where they are because they control their pleasures. For example, rich Americans buy cars that are on average only slightly more expensive than those less wealthy Americans buy.

Another way of stressing the same point is to note that habits and fun living have costs in terms of the build-up in wealth. They also have benefits that, presumably, are greater than the value of the foregone wealth. This explains in part why many rich people are not much happier than their counterparts of more modest means. This means as well that richness is not always to be envied or pursued, but neither should it be denigrated by those who chose not to be rich, as becomes apparent by their consumption decisions throughout their working lives.

Being able to save and accumulate considerable wealth is not automatic. People must have a reasonable income in order to save amounts that will make for wealth, which requires several auxiliary roles for achieving an income level that will allow for a minimum saving level. For most--those without the requisite luck, inheritance, special talents, or good ideas--becoming rich means getting an education. Few people who drop out of high school will be rich. The income of high school dropouts is about two-thirds that of Americans with a high school diploma.

To have a good chance at being rich, though, most individuals (aside for the lucky ones) will need at least a college education, which just about will double their incomes over what they would have earned with only a high school diploma. A professional degree will result in an average annual income of about twice that of college graduates (or six times the income of a high school dropout). This means that those who invest in education do not have to save as high a percentage of income (or to achieve as high a rate of return on savings) to be rich at retirement. However, in all probability, educated Americans will be richer at retirement simply because they will be able to save more along the way and because they are likely to be smarter and can achieve a higher rate of return on their savings.

The first auxiliary rule for becoming rich is to stay in school or, if out of school, go back to it. Of course, this presumes that students will do more than "tread water" while in school; it presumes they will learn something worth the time and effort. Contrary to all the talk about rising costs, it never has been easier to get an education. Public schools are free for the taking. College costs have been rising steadily in real terms and relative to family income levels for more than a decade. However, the rate of return on a college education has been rising as well, making the investment a good deal (which explains why more and more Americans are availing themselves of higher education opportunities and remain willing to pay greater prices). Meanwhile, the cost of self-education has fallen with the multitude of sources of knowledge and information available on CD-ROMs and the Internet.

The second auxiliary rule for becoming rich is to pick your education carefully. Teachers will find getting rich tougher than engineers, given that the former can expect to earn half as much over their careers. History and music professors can expect to earn less than accounting professors. For that matter, history and music professors can expect to earn a lot less than their students who major in business. That means that, to become rich, some people with lots of degrees will have to be more frugal than other people with few degrees.

The third auxiliary rule for becoming rich is to marry someone with an equal or higher education, and then stay married. By itself, marriage seems to provide a stable institutional setting that promotes greater earnings, which affords greater savings. Married couples not only earn more than non-married people, they tend to economize on the costs of running their households, allowing them to save and invest at higher rates. Moreover, the binding legal contracts at the foundation of marriages, which reflect their personal commitments to each other, give the couple an added economic incentive to invest in the joint assets of the union.

Two people simply living together without a binding contract between them must worry if they agree to invest in assets for their mutual benefit (a house, farm, business, car, or other durable goods). If one person walks away, the other has limited claims on that partner's income stream to cover the debt on the assets. Breaking up is harder to do for married couples, a fact that gives each spouse additional claims on the other. Hence, married couples should be expected, as a rule, to build up more assets than two single people or couples simply living together, and this is precisely what researchers have found and survey data show.

About 95% of millionaires are married. Even when marriage, in and of itself, doesn't make people millionaires, it appears to make it harder for the couple to fall into poverty. Nearly 14% of all Americans lived in poverty in 1996; less than six percent of married couples did. One-third of families headed by a single woman lived in poverty in 1996, while one in seven families headed by a single man did. However, less than one in 50 intact families with at least one full-time worker (no matter how menial the job) lived in poverty.

The reason for the higher poverty rate in 1996, in contrast to what it was in the last half of the 1970s, seems to be the growth in family breakups. The poverty rate for married couples has held steady for the past two decades. Married African-American couples have made significant progress in catching up to the incomes of their white counterparts over the past 30 years. In 1967, they earned 68% of married white couples' incomes; today, it is 84%. At the same time, the incomes of all blacks has remained unchanged at 59% that of whites.

In 1993 (the latest year of available data), the median value of married couples' assets was $61,905, two-thirds higher than the median assets for all households. The median value of assets of male- and female-headed households was one-fifth as much.

Given that more highly educated people earn more, it stands to reason that most educated individuals can assure they achieve the ranks of the rich by marrying someone who is similarly educated, thus guaranteeing a family income level that will allow for substantial annual savings. Staying married ensures that past savings will not be used to finance the legal costs of divorce or to support two households. Divorce is a gateway to poverty for many Americans, especially women with children.

Making divorce easier is a surefire way of reducing the accumulation of wealth in this country. The logic is straightforward: when divorces are less costly, more of them should be expected. Because of the greater ease and speed of getting a divorce, more incompatible couples will get married, knowing that they can make a break later at lower cost. The increase in divorce will make many of the divorcing parties poorer. Many couples will waste some of their assets squabbling over the split of the assets. Some married couples will be more resistant to investing in family assets, given that the marriage can be broken with greater ease.

Diligence pays

The fourth auxiliary rule for becoming rich is simple: be willing and able to work for a living. Obviously, diligence still counts in this country, given that welfare pays little and that household incomes rise markedly with the number of workers in them. Households with one breadwinner take home on average nearly 70% more than households with none, and those with two earners have incomes that are 80% higher than households with one earner (and three times the incomes of those with no earners). In addition, more of the added income from hard work can be saved with greater ease and with the power of compound interest in mind. One of the most fundamental justifications for hard work is that it makes frugality and denial less consequential in the wealth-accumulation process.

Most people at the top of the income ladder are there not for mysterious reasons, but because they live in families with more than one full-time income earner. It is a little-known fact that there are seven times as many full-time workers in the 20% of households with the highest incomes than the 20% of those with the lowest, and most of those high-income households are unified families. Of course, having high incomes doesn't assure richness, but it certainly makes saving easier and more likely.

The fifth auxiliary rule for becoming rich is to be able to work and save for a long time. Alcoholics and drug addicts who are not yet rich are unlikely candidates for becoming so. They will be unable to work long and hard enough to earn the requisite incomes, and their careers will be fraught with instability, if they can even have careers. Most will drink, inject, or smoke up whatever incomes they earn; their suppliers undoubtedly will get rich at the expense of their customers--the addicts.

Furthermore, don't expect to become rich early in life. It is understandable why most people are in their 50s before they become rich--it takes time to save the requisite amount and for the power of compound interest to work.

The sixth auxiliary rule for becoming rich is to do something of value for a large number of people. Wal-Mart founder Sam Walton and Microsoft founder and chairman Bill Gates often are cited for having amassed vast fortunes, sometimes with a derisive tone, as if they took their wealth from others. What should be noted is that Walton and Gates achieved their fortunes in a well-worn way--by providing their customers with value for the dollars collected. They accumulated a lot of wealth by adding to the well-being of large numbers of other Americans. Very likely, the collective increase in the wealth of Wal-Mart and Microsoft customers has been far greater over the years than the increase in Walton's and Gates' personal wealth.

The final auxiliary rule for becoming rich is to take some risks. No doubt, some readers will object to our use of 15, 10, and six percent rates of return on the grounds that hidden in them are "risk premiums," or returns for accepting the prospect that the investments will go sour and, in the end, the frugality will be for naught. Those critics are right. Moreover, the higher the expected rate of return, generally speaking, the greater the assumed risks. However, let's be frank about matters--not many people will get rich by playing it safe. Indeed, richness comes to those who do the country the social service of accepting the pain from risk.

Nevertheless, we hasten to add that, for young people, the risk of their investments is moderated by the long period over which their investments will be in place. Young people can ride out the temporary and expected ups and downs in the market. The fact that people are living longer has reduced the risk of investment. Moreover, there never has been a time in which the problems of risk could be more minimized. This is because there never has been a time when people more easily could build a portfolio of varied assets that neutralize the question of not knowing exactly which investments will pay off.

Not too many decades ago, Americans could invest in a few important assets: their own human capital, their houses, and a few stocks and bonds. They still have the old investment outlets, but they can invest in a wide range of stocks and bonds through mutual funds. Indeed, they can buy the entire stock market by way of index mutual funds (which buy shares of all companies in, say, the Standard & Poor's stock index). They can diversify their portfolios by buying shares in a host of different mutual funds (close to 8,000 at last count), many of which are focused on foreign investments.

We acknowledge the limitations of our rules for being rich, not the least of which is that the process of becoming so necessarily is far more complex than those rules suggest. Becoming rich normally takes decades and a lot of hard work. Above all, it takes denial, dedication, and perseverance. We understand that many readers will object to our theme on any number of grounds, most likely some combination of the following:

* Most people don't have the incomes to save what is required to become rich.

* Our estimates of wealth growth are much too unrealistic.

* The world is filled with too many temptations carefully cultivated by a plethora of mean-spirited multinational corporations.

* A lot of people are unlucky, with lives full of problems that range from business failures to expensive spells of poor health to unemployment.

The list of retorts easily could be extended, and we accept them at face value. Taken together, they help explain why more Americans aren't rich. Far too many want to believe some combination of the above reasons. These reasons (or excuses) are beside our central point--that devising a strategy for becoming rich is not as complicated or unattainable as many seem to believe.

From our perspective, becoming rich (or richer) is really a matter of choice. Opportunities to do so abound. The hundreds of thousands, if not millions, of rich Americans-those who have "made it" with only modest means to start with--validate our point. At the same time, they have eased the lives of others because they have invested and contributed to the wealth of the country while they have done well for themselves.

Inheriting money, being a star in the National Basketball Association, or winning the lottery are great ways of getting rich. Yet, these are not the ways most people get rich in America, and it is a costly mistake to believe they are. Most rich people did not come from rich families, are not great athletes, and never have won the lottery. They got rich because they chose to do so, and pursued a path to wealth open to most of the rest of us.

Of course, recognizing that you can choose to become rich does not mean that you should. As we have noted, choosing to become rich requires sacrifices that many people quite rationally have chosen not to make. One can lead a life rich in satisfaction and accomplishment without becoming rich financially, and nothing we have written here is meant to suggest otherwise.

The distinction we wish to stress is more fundamental: it is one thing to make a conscious choice not to pursue great wealth and another not to know the choice exists. Even if you decide that becoming rich is not the right choice for you, understanding how to do so can help you determine, and realize, the best financial goal for yourself. You also will have a more informed perspective on important public issues, such as the growing controversy over the politics of imposing special taxes on the rich.

The authors are, respectively, Walter B. Gerken Professor of Enterprise and Society, University of California, Irvine, and Ramsey Professor of Private Enterprise, University of Georgia, Athens. This article is based on a Contemporary Issues paper, Center for the Study of American Business, Washington University in St. Louis (Mo.).

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