How Rich People Think

Daddy Warbucks - Bad Guys.jpg

I’ve written about this before, but given how much ‘the rich’ are in the political news, perhaps a review is in order.

Disclaimer: for about a decade, I was in the 2%. That was also the decade I put 4 kids through private school and Catholic colleges, so, net, I’m not exactly ready to retire in style. Prior, I made below or near average household income for our area; I’ve been jobless for almost the last 2 years. So I have fairly broad personal experience here.

One thing we have to get through our heads: income does not equal wealth. Let’s repeat that:

Income does not equal wealth.

Say I make half a million dollars a year, well into ‘the 1%’ range. Am I rich? Maybe. Am I an older person who owns my home and have been banking/investing a good piece of my income for a couple decades? If so, most people would call me rich, and for good reason: if I never worked another day in my life, I’d be almost assuredly set anyway. If I were prudent, I’d have an investment portfolio I’d never have to draw down – I could live in style on the investment income alone.

Having plenty of money, never having to work again – that’s a pretty good functional definition of ‘rich’.

But what if I’m a 7th round draft pick in my second season as an NFL running back? If I last a typical 3 seasons, I make a bit over a million dollars by the time I’m 25 – less my agent’s fees, and before taxes. After year 3, banged up and having lost my job to a younger, cheaper guy, I might have a couple hundred grand invested, if I were extraordinarily prudent, or I might be broke. Owner of a Maybach, maybe, but broke. So: I made a ton of money – had a very high income – but I am not wealthy. I am not rich.

It gets more complicated: we all hear those stories, I presume, where some guy with a mundane job as a postman or a janitor dies and leaves a million bucks to a hospital or library or something. They were never ‘rich’ in the sense of making tons of money. Instead, they merely lived within their means and socked away a little something every paycheck for decades. Rich? They never bought the Maybach, never had a big house or fancy clothes – but then again, they never wanted those things. Yet, they were somewhat secure – maybe not enough to retire early, but a nice personal safety net if things went bad.

Meanwhile – and I’ve known these folks – you have your high-end sales types pulling down seven figures – and spending it all, and then some. They have all the trappings of ‘rich’ without any wealth. They live enormous paycheck to enormous paycheck, and, if they lost that job, they’d be broke. (And they often know this, and like it that way: they see themselves as supermen, and always think they can get more – and they’re usually right. High-end sales skills are very, very valuable.)

Back to politics. So: which ones of these ‘rich’ are we going to soak? In practice, we soak the young running back for three years and the prudent dude with the investment portfolio over his lifetime. Today, the postman can give his million to the hospital without too much soaking; he paid comparatively little in taxes on his comparatively low income, and bequeaths don’t get hammered too hard – yet.

The salesman gets soaked the most. He’s at the top of the income scale, and pays all the consumption (sales) taxes on the money he fritters away. Over his working life, he will pay the most in taxes of any of these examples, and, if he has his way, die broke. His estate will consist of cars and airplanes and houses – and debt. His ex-wives will fight over anything left. Uncle Sam ain’t getting any windfalls here.

The difference here has as much to do with how we think about money as with how much money we make. Books have of course been written – the Millionaire Next Door is a representative one. To sum up: rich people think primarily in terms of assets, not in terms of income. You use income to build assets, up until the assets yield enough so that you don’t need any other income. Then, outside income is just a nice to have, but is not the source of your wealth.

Let’s take an extreme example: Bill Gates is worth roughly $100B. Even if all he did was plop that money in savings accounts yielding 2% (he’d get the *good* rates) that’s $2B *a year*. In *income*. For letting his money rot in a bank.

Suffice it to say, he doesn’t need a job, nor does he need to dip into his savings. Gates doesn’t need to think about income, nor drawing down his vast fortune for anything other than some gigantic gesture or huge self-indulgence. His day-to-day needs are funded by the equivalent of loose change from under the couch cushions.

One common strategy for the very wealthy is to stick a few tens of millions into tax exempt bonds, just for spending cash. A AAA-rate muni will historically get you maybe 2%. Throw $50M at that, get a million a year tax-free. Then let the other hundred million or billions ride, not worrying about income but about asset growth. But such moves are the Trivia. They leave spending cash strategies to their financial managers. They worry about the assets – the companies and physical and intellectual properties they own.

Now scale all this way down. Say I live comfortably on $50K/yr. If I’m willing to accept a little risk, a basket of assets including stocks and cash in a money market account worth about a million dollars could yield me $50k/yr. To be safe, I’d need that million and a buffer of, say, $100K, so that I can ride out the down years and take care of smaller emergencies. If I need $100k/yr to live, I’ll need a $2M portfolio and a $200K emergency account. And so on.

This is how people who aspire to be rich think. The actual numbers will differ, inflation needs to be considered, needs will change, but this is the general idea. What we think of as the very rich got to this minimal point fairly early – or had income that dwarfed their needs fairly early – and started worrying about legacy or just seeing how far they could take it. Think about it: you get lucky or work a particularly profitable angle, and bank that $2M or $4M or whatever – now what? You might shoot for $8M, just to feel more secure, or you might decide you have a taste for charity (or trophy wives) and so just keep pushing to see how far you can go.

This mindset is distinct from seeing how much income you can make, which is the mindset of the super salesman described above.

This, by the way, is why incomes are taxed, but assets are usually not. It isn’t just because rich people tend to take more interest in (and a more active part in writing) tax laws. It’s because asset ownership fuels economic growth. Gates, to return to the example above, is very interested in growing his company. Growing the company means (in almost every case) hiring more people, building more office space, investing in plant and equipment – and paying more salaries and, both directly and indirectly, paying more taxes. So we don’t tax the assets until they are sold (if then), but in most cases, the assets’ owners are very interested in growing them, and thus in generating more revenue for their employees and venders, and incidentally paying more tax.

So: “Soaking the rich” means…? Looking at history, the rich have generally been defined as ‘those with anything more than I have’. You and I are unlikely to know any billionaires, but we certainly know some people doing better than we are financially. People with assets spring to mind.

Going after people’s assets, figuring only the ‘rich’ have assets in the first place, is trickier than it might sound. What happens to stock prices if, all the sudden, it is understood that the government will require people with large stock holdings to sell a significant portion of those stocks to pay taxes? Classic economics, and thus sadly out of reach to many: the supply of stocks for sale rises, the price goes down. This will be especially true if the ‘soaking’ is intended to raise significant money. If you intend this soaking to fund huge social programs, you’d need to close ‘loopholes’ to make sure the tax on assets penetrates any number of layers of mutual funds and holding companies and the like.

And it doesn’t stop there: dropping stock prices over any length of time tend to cause a series of cascading effects. When its stock price falls, a company will have a harder time getting financing and will pay a higher rate to borrow money. Since more of their income is devoted to paying for debt (that’s what higher rates mean), the company won’t be able to do as much business as it would like – e.g., they will be able to afford to pursue fewer new project, open fewer new store or plants or offices. Ultimately, they will not hire as many people or pay as good wages.

On an individual level, when people’s IRAs and 401(k)s take a hit, even if it’s not affecting their individual income at the moment, they tend to rein in their spending. Consumer spending is 2/3 of the economy.

And this isn’t even defining ‘rich’ down very far. History seems to show that, once you’ve soaked the more obvious and convenient rich, and find that not only does this not solve any problems but rather makes things worse, the temptation is to keep defining ‘rich’ down and down. When the Soviets had reduced most people to poverty, the relatively prosperous Kulaks started looking like the rich people, what with their having a cow and maybe hiring help for the harvest. So they had to be soaked. And murdered. That seems to generally come next.

Back when I was making good money, I didn’t mind paying taxes. Once the rules are known and – critical – the situation looks stable, people tend to cope and get on with it. Thus, for most any survivable level of taxation, a stable level will reached in which life goes on. And, maybe, there is some good way to raise taxes on the most wealthy with the net result being relatively more revenue. People are stubborn; entrepreneurial types are generally very optimistic, so if there’s a way to succeed around new tax burdens, people are likely to find it.

Unfortunately, there is no evidence the people pushing for socialism, even socialism by a thousand cuts, understand any of this.

Author: Joseph Moore

Enough with the smarty-pants Dante quote. Just some opinionated blogger dude.

One thought on “How Rich People Think”

  1. One day the dictionary will give me the credit I deserve for coining the term “middle class poor”.

    Dad has a great job, nice house, cars, lawn, neighborhood…and we’re in tons of debt, all three of us kids paid our own way through college with loans (2 years community college and commuting), and if my dad lost his job we’d have some very short months to figure something out before things became disastrous.

    The truly wealthy really have no idea what the middle class is like.

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