THE EFFECT OF COMPOUNDING ON WEALTH AND INCOME
JUST REALITY NOT ANYTHING ELSE
Someone with very little money will have more in interest bearing, lower return accounts than someone who doesn't need to keep as much safe. And the returns would accordingly multiply quicker.
It is the compounding of natural effects that produces the increased wealth and income discrepancy over time, even if we do not count the greater earnings people can make in their actual work by being more productive than others. (Contrary to some beliefs, there are very few crooks and unfair people involved in all of this - naturally the information we get is exclusively about the "bad" people so we think there are more of those than there are, by far.)
Basically, two things occur:
1. A person with more money to start will grow in wealth much more. (Duh!)
2. A person who is earning more and/or is older will be able to save more and invest more, so that will have an
additional difference in wealth accumulation.
The explanations for these distributions of income and wealth are not complete and are not rational. You decide what is rational and protect yourself from bad information and poorly thought-out conclusions.
INVEST A LUMP SUM, STARTING HIGHER
If someone starts with $10,000 compounding at 5% and someone else starts at $100,000 invested differently with higher risk and reward 8% over 28 years.
Initial Compounded Income from Income
wealth wealth investments 1979
$10,000 $39,201 1,960 500
$100,000 $862,710 68,960 8,000
Ratio 10 to 1 22 to 1! 35.2 to 1 16 to 1
Was this unfair or was it appropriate? Did the high wealth investor steal from the lower wealth investor or just compound more?
The higher wealth person increased his wealth and income 8.6 times while the other person increased his at 3.9 times.
Clearly, the effect is strictly due to mathematics, but people will lose their perspective if no one explains and presents the facts in a realistic way.
INVESTING SAVINGS PER YEAR
Additionally, if the $100,000 wealth person earned $100,000 per year (say he was older and able to earn more and had a lower mortgage) and saved $10,000 and the other person earned $60,000/year and saved and invested per year 500, invested each year for 28 years would result in:
Saved From investing Total wealth Investment income
$100,000 $10,000 953,339 1,816,000 145,280
$60,000 500 29,201 68,402 3,420
Ratio 10 to 1 32.6 to 1 26.5 to 1 33.5 to 1
UNFAIR OR JUST MATH?
Was this unfair? Or was it just compounding?
One version some might come up with, looking at just the ratios, would imply that there was chicanery and unfairness and that one person had a smaller portion of the pie due to improper manipulation. But simple math proves that this was not a well-thought-out fact-based calculation.
It was just mathematics.
Does that make sense?
Would you buy into the other argument anymore about the unfairness of distribution of wealth and income or was that simply what was earned fair and square?
Per the charts, the income of the top 1% grew about 10 times that of the middle 60% of the people, who probably actually were more likely to overspendi, with only a few of them being good savers. Almost all the increased income of the top percentiles are invested. Investments of course create capital for growing companies, requiring them to hire people, who would then be better off.
