Hold those guillotines! I’d like to say a few words to provoke your sympathy for the well-off, particularly those who “have money” and don’t work for a living.
Legend has it that such people have it made. They don’t suffer the indignity of work. They clearly chose their parents or grandparents well. They’ve never had to worry about money. They tend to be taller and have straighter teeth. Their investments seem to work a lot better for them than working for a paycheck works for the rest of us.
Or so it seems.
Well, it turns out that keeping up isn’t that easy. In fact, most of the people who “have money” are likely to need to get a job if they aren’t very careful. For all the problems Johnny Paycheck has been having in recent years, keeping up with him is harder than keeping up with the Joneses, and you know how difficult that is.
How can this be? Easy. If you depend on income from investments, it is very likely that, over time, your income will fall behind what people who work for a living are paid. You also have to be a really long-term investor. While retirees may need to consider periods of 25 or 30 years, the young rich have to think about entire lifetimes. Being independently wealthy, it turns out, can be, well, difficult.
Surprised? So was I. But here is what I learned in a not entirely scientific exercise.
Let’s start by going back 50 years and trying to figure out how much money we would have needed to be pretty well-off. Back then the Social Security employment tax stopped coming out of paychecks at $4,800 a year. It seems puny now, but it didn’t seem so small in 1963. And then, as now, more than 90 percent of all workers earned less than the wage-base maximum.
Having a private income of $4,800 a year in 1963 seems like a good starting place. Being well-off begins with having more money than most people.
You could get nearly that much income by investing $100,000 in Fidelity Puritan fund, one of the oldest surviving balanced funds. In that first year it would have provided $4,650, according to Morningstar data. Of course, having $100,000 to invest in 1963 wasn’t easy. Back then, the IRS identified you as a “top wealth holder” if you had a net worth of $60,000.
But let’s assume you had that $100,000 and you invested it. Where would you be now?
Well, your investment would have grown to $1,480,758. Your income for 2012 would have been $26,535. That’s down from a peak of $40,561 in 2007. It’s more than five times your income in 1963. Unfortunately, inflation for the period in question was higher. You’ll have lost ground if your income isn’t about $36,000.
What’s to blame? We can point one finger, but just one, at Federal Reserve boss Ben Bernanke. If he weren’t so intent on keeping interest rates near zero, bond yields would be higher. Ditto stock yields.
And this is just the beginning of the problem. To keep your position as a pretty-well-off person, your income would need to rise faster than inflation. To match the growth of the wage-base maximum, which hit $113,700 this year, it would have to grow at a 6.57 percent annual rate. For our young investor to keep up, there would need to be some judicious withdrawals of principal.
As a person of independent wealth, you need to have a total return on your investments that is equal to the increase in the wage index plus your annual withdrawal rate. This suggests an annualized total return of 10 or 11 percent, if you can live with a withdrawal rate around 3 or 4 percent.
Can it be done in real life? Yes, but it’s no slam-dunk. Here is a list of five well-known mutual funds that Morningstar Principia data show provided at least 10 percent annualized over that 50-year period:
Templeton Growth A shares, 13.06 percent
T. Rowe Price New Horizons, 11.71
Vanguard Windsor, 11.49
American Funds American Mutual A shares, 10.82
Fidelity Puritan, 10.74
It turns out that having money is a bit like having cake: It’s difficult to have it and eat it too.
SCOTT BURNS is a principal of the Plano-based investment firm AssetBuilder Inc.