MasterPo says: This blog is about topics and issues that are of importance to me. I am not one of the countless blogging lemmings that are tripping over each other scurrying down the hill and off the cliff of blogging oblivion trying to write the greatest blog on the latest topic de'jour. Your comments are welcome.

January 3, 2011

Will Time Make Us All “Rich”?

In today’s social and political environment harping on “the rich” seems like a daily sport. Never mind that most of the pundits and commentators lambasting “the rich” are themselves among the highest rich in the country by anyone’s definition! But let us not digress…

As it stands, at the time of writing this the commonly accepted and PC way of definition “the rich” are those with incomes of $250,000 or more. (In some conversation that number is reduced to $200k, $150k, $125k, and even $85,000(!).) It is unclear to MasterPo how or why such a line in the proverbial sand is used (and certainly not clear how or why such persons are now considered public enemy #1!) but that seems to be the standard of the day so let’s work with that figure.

The question is: As time marches on will $250,000 still be considered “rich” after applying years even decades of inflation erosion on purchasing power?

MasterPo normally doesn’t like to resort to number crunching models to make a point. But math is absolute and unquestionable. And a subject like this requires clear illustrations.

The time value of money should be SOP to all investors. As such the basic compound growth formula should also be so basic to all investor as to be able to do the math in yourself:

T = P(1+i)^t

Where “P” is the starting amount (principle), “I” is the rate of growth (annualized), “t” is the number of periods in years, and “T” is the final total after compounding. It’s just basic high school algebra.

Now let’s apply this to the thesis of “the rich”, time, and a real world example.

According to the National Association of Colleges and Employers (as reported by the U.S. Bureau of Labor Statistics) the average starting salary for a college graduate with a Bachelor’s degree in Computer Science is $61.407 as of July 2009 (latest statistics available as of writing this).

So if we presume a mere 3% annual inflation, applying the above formula, then someone born today and graduating college at age 20 would need a starting salary of $111,000 (rounded) to be equal to today’s starting salary.

Let us go further and presume someone graduating 20 years from now and starting with $111,000 salary works for 10 years and receives an annual raise of just 3%, also matching inflation only. At the end of 10 years that person will be making $150,000 (rounded).

That’s pretty darn close to the magical $200,000 mark knocking on the doors of “the rich”.

Take it one step further: Let us now presume this person meets someone else of similar career background, one thing leads to another, and it’s wedding bells time. Now you have a married couple each making $150,000, or now $300,000 combined income – well over the $250,000 “rich” mark!

And if we presume 4% annual inflation then the numbers become $135k, $199k, and $399k respectively in the scenario above.

Plus this does not take into consideration any massive jump in inflation or hyper inflation. Just one year of 10% inflation throws these figures even higher!

MasterPo knows some critics of this scenario will try to make the argument that by that time government will have adjusted tax brackets and various other thresholds to account for inflation adjustments. Can you really count on that? History proves that thresholds for determining “the rich” are coming down and not going up! (MasterPo won’t even go into a discussion of misleading if not outright false inflation calculations.)

Too many people today, either by short sightedness or sheer class envy, just don’t think about policy ramifications on income levels higher than their own. Not really much of a surprise as people are constantly being hounded that anyone who makes more then they must have stolen it somehow.

But as this illustration shows just the power of inflation, as low as it may be, can and will raise people will into levels of “the rich” without actually being “rich”.

It’s always amusing to blame your woes on someone who has more than you. But sit back, relax, have a beer and play some Xbox. You don’t have to worry. You will never be “rich” – or will you?

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