We all know, innately, how the rich get richer. Money begets money. But how does that actually happen, aside from compounding interest and purely financial factors?
You could take the cynic’s view that the game is rigged. But the more accurate answer, backed by research, is that the rich get richer because of great parenting. How rich you become over your lifetime is directly related to how early you capture the basic truths of finance and investing.
You have seen the exception that proves the rule, the rich kid who blows his family’s wealth in a generation through poor decisions. Chalk that up to absentee parents. Truly, teaching is the missing link.
According to a report in Time magazine:
In a paper unveiled a few months ago, researchers led by Annamaria Lusardi, professor of economics at George Washington University, found that an early understanding of financial concepts accounts for as much as half of the wealth gap between the affluent and those with low incomes. Lusardi also found an exponential effect: Those who acquire financial understanding early tend to accumulate assets faster and those with more assets tend to keep learning about personal finance because they have more at stake. (Emphasis added)
There are two powerful forces at work here, in terms of how the rich get richer. Let’s tease them out so that you can benefit from the knowledge.
First and foremost, how the rich get richer has a lot to do with picking the right parents. Kidding aside, being born into a developed-country household, availing yourself of a quality education at a low relative cost, enjoying the benefits of a healthy diet and a safe childhood, all of these things give a person automatic advantages.
Yet there are people born into good circumstances who nevertheless seem to just “get by.” They see the rich get richer and, quite rightly, question their own choices.
Instead, they should question, or at least examine, their parents’ choices. Kids do not listen to what their parents say. They do what their parents do. A parent who saves diligently and consumes moderately is setting a very good, lifelong example for his or her children. A parent who constantly overspends and lives in debt does not.
But the kicker here is learning by doing: Teaching by example is great, but a child learns the power of saving and investing not only by seeing it done by others but by doing it themselves. Practice is how the rich get richer.
Once a young person gets a little bit of capital set aside, they begin to think more conservatively about money: How can I protect and grow that wealth? What are the risks to my plan?
How the rich get richer is by passing on these simple lessons — about compound interest, about risk and reward, and about the role of money in a healthy, happy life. Rich parents do not fear money; they consider it a useful tool. Those attitudes pass on, compounding in value with each succeeding generation.
Working hard at getting an education is a great base. The simple act of periodic, automatic saving is another excellent lesson. Prudent, effective investing is yet another.
Great fortunes are often built not on chance events but on steady, risk-controlled investment plans that take into account the best practices of generations.