Compounding interest is a force of nature.
It’s such a daunting force, in fact, that it’s chiefly responsible for 99% of the wealth residing in the hands of 1% of the population.
There are now 1,542 billionaires living among us.
Last year, another 145 multimillionaires cracked the billion-dollar mark.
How’d they do it?
Sure, some shrewd investments were made — but the power of interest on interest makes such fortunes bigger and bigger.
We last saw wealth so ferociously concentrated at the top in 1905. The Guardian sums it up:
The world’s super-rich hold the greatest concentration of wealth since the U.S. Gilded Age at the turn of the 20th century, when families like the Carnegies, Rockefellers and Vanderbilts controlled vast fortunes.
The problem isn’t going away.
Here’s what you need to know now.
The Power of Compounding Dividends
Few people outside of the super-rich can actually conceptualize a billion dollars.
I’m talking about not just having that kind of money but knowing what it means to taste true wealth.
And many Americans are missing out on their best chance to get there…
Allow me to explain.
The stock market is the fastest way for the middle class to get rich.
The S&P 500 has risen by about 275% since the start of current U.S. bull market in March 2009.
And that’s not even including dividends.
With dividends, stocks have more than tripled over the same period.
Yet fewer than half of Americans have even a penny invested in stocks, according to a recent Bankrate Money Pulse study.
That’s a travesty!
To be sure, many investors got burned in the financial crisis.
But the wealth-building powers of stocks and dividend reinvestment are far too great to ignore.
Consider that a mere $1,000 investment into the S&P 500 just 10 years ago — after growing about 5% annually — would be worth $1,677.52, excluding dividends.
Here’s where things really get nuts…
Take that same $1,000 investment into the S&P in 2007 and reinvest the dividends… and the total return comes out to $2,050.63.
That’s more than double your money in just 10 years — and that’s including losses incurred during a major recession.
Over the same period of time, you’d have been lucky to make even 1% in a savings account or 2% in a U.S. Treasury.
Bottom line: Investors may never make a billion dollars on their holdings. But by simply investing in stocks and reinvesting the dividends, you can get a lot closer to that kind of wealth than you think.
An Unfair Advantage
The principal driver behind the new Gilded Age is a decade of ultra-low interest rates.
This has pushed up asset values to unsustainable heights and made it far too cheap and easy for the rich to borrow.
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Someone in the middle class, with few assets, can’t really take advantage of ultra-low rates. Sure, you could refinance a mortgage. That’s not going to make you rich, though.
If you’re rich, with lots of assets, you can borrow against those assets. That allows you to buy more assets and ride the rocket to the moon.
Doing so doesn’t make you a bad person. Just look at our president. Trump suffered six bankruptcies from 1991–2009 but has since ridden the asset bubble to glory.
Now, if funny money just made Trump rich, we could be happy for him. The problem is, it makes us poorer too.
When interest rates are so far from their natural level, all kinds of bad investment decisions are made — causing productivity growth to go to hell.
With no productivity, there are no increases in pay. So nobody except the ultra-rich ever gets any richer.
We’re not alone, either. We’ve seen this happen in the U.S., Britain, EU and Japan as well.
Now U.S. interest rates are beginning to creep up, and maybe productivity growth will return too. We’ll see.
Ultimately, the solution is to push interest rates up to their natural level of about 3% above inflation (at full employment) and let the chips fall where they may.
Stock and asset prices will initially collapse, so you should have a healthy holding of put options. After that, provided we don’t have crazed regulators in government, the markets will adjust.
Overleveraged billionaires will go bust (sorry, Mr. President!). Same goes for companies like AT&T, Boeing and GE — all of which have bought back stock too enthusiastically.
The rest of the people will eventually dig themselves out of the rubble and unearth a healthy economy. One with rapid productivity growth and moderate asset prices.
It may not happen soon. But it will happen.
If You Can’t Beat ’Em…
Talk about presenting two opposing outlooks on the situation, Jonathan and Martin!
In this case, the middle ground is instructive, as is the common thread among both of my colleagues.
Notice that regardless of the outlook — bullish or bearish — both advocated investing.
You have to be in the markets to win in the markets!
Even in small increments, the payoff can be material to the middle class.
Our sights shouldn’t be set on becoming the next billionaire, though. Instead, we should focus on leveraging the resources (big or small) that we’ve all been given.
If we actually take time to track our spending, we’ll be amazed how much “excess” capital we can find to invest.
The key is first deciding to invest — and then committing to stay the course for decades.
Success, like interest, compounds over time, no matter how nasty the global economy gets for brief periods of time.
So don’t bemoan the new Gilded Age. Join it!
Ahead of the tape,
Chief Investment Strategist, Wall Street Daily