How The Rich Got That Way

By Stephen D. Simpson, CFA | February 18, 2011 AAA
How The Rich Got That Way

There is a huge industry behind getting rich. While it's maybe not a universal goal, millions of people spend a lot of time and energy in the pursuit of wealth. Leaving aside the irony that some of this machine seems to involve making people rich by telling other people how to become rich, there is nevertheless a lot of advice out there. What is interesting, though, is that not much of this advice seems to focus on taking lessons from what has actually worked in the past. (Don't just hope for the best - develop a course of action to achieve your goals. See Plan To Retire Rich.)

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To that end, then, it is worth exploring how many of the wealthiest Americans got that way.

It's All in the Genes
Inheritance is clearly one of the proven pathways to getting rich. About one-third of the 50 richest Americans can tie their wealth directly to being the fortunate son or daughter of wealthy parents. Now, to be fair, many of these people received the golden baton from their parents and managed to run even further with it – but the fact that they proved themselves to be good runners in their own right does not erase the reality that they began they race with a sizable head start.

What is there really to say about getting rich through inheritance? Nobody can choose their parents or grandparents, so it is not as though there is a "strategy" to becoming a wealthy heir/heiress. At most, people who have parents of some means can make sure that they are getting good advice and surrounding themselves with trustworthy people. Moreover, those who could find themselves inheriting a viable business may do well to take some interest in the business and the industry with an eye towards running it instead of seeing it sold.

The Business of Business
Overwhelmingly, those who do not inherit their money gain it through founding and running a company. A well-run business is an incredible wealth multiplier, as a collection of assets can produce many times its value in revenue, earnings and cash flow. Moreover, owning and operating a business brings with it the chance to use leverage (ie. "other people's money") to magnify and multiply the returns. In time, then, it really is possible to turn a small garage operation into a multi-billion dollar enterprise.

Clearly there are levels of nuance here as well – Bill Gates of Microsoft (Nasdaq:MSFT) and Warren Buffett of Berkshire Hathaway (NYSE:BRK.A) both grew up in fairly affluent families and it can be fairly argued that starting a business with a "backstop" is something different than truly risking poverty on a business idea. Nevertheless, the fact is they took advantage of their opportunities and made the most of them.

Entrepreneurship really is the best chance regular people have of breaking into the ranks of the wealthy. That said, it is not for everyone. Not every idea is a million-dollar idea and not many people have the willingness to work as hard as it takes to foster a great idea into a great business, to say nothing of the tolerance for risk that a start-up operation requires. (Find out how he went from selling soft drinks to buying up companies and making billions of dollars. check out Warren Buffett: The Road To Riches.)

Super-Wealth from Investing? Very Rare
What is remarkable about lists of the super-rich is how very, very few of them got that way through the stock, bond and commodity markets.

Does Warren Buffett owe his wealth to being a great stock-picker, or to owning very successful insurance businesses that threw off incredible amounts of cash, which he then successfully invested in the market? What about George Soros, John Paulson or James Simons? Undoubtedly, these men are investors of incredible skill, but could they have built so much of their wealth outside of the context of running hedge funds?

In point of fact, it really does not matter if Buffett, Soros, et al are included or excluded from the "got wealthy by investing" list. There are so few of them that even including them basically makes them the exceptions that prove the rule.

There are some solid reasons why the markets are not a prolific source of the super-rich. For starters, building wealth through investments typically involves buying and selling, and every time an investor sells for a profit, there is a tax bill. That's a steep fee compared to the businessman who does not have to pay taxes on the year-to-year appreciation of the valuation of their ownership interest.

It is also the case that investors can only do so much to influence the outcomes of their own investments. For a truly visionary CEO, the sky is the limit for what a business can become. Even the most visionary investor, though, has limits on their influence and may have no other choice than to sell out if a management team does not share that vision.

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No Easy Shortcuts to Real Success
Leaving aside the question of inheritance, there are no shortcuts to wealth. Investors may be discouraged to find relatively so few investors on the list of the super-wealthy, but the fact remains that one does not need to be among the richest people in America to live quite comfortably. To that end, investing is a great way to build and multiply one's earnings and build a more comfortable future. Of course, if anyone reading this thinks they have a great idea for a business and the desire to push that idea to its limits, the rolls of the super-rich show that there are clearly ample rewards for successful entrepreneurship. (The Oracle of Omaha has a net worth in the billions, but his lifestyle is not as rich as you may think. See Warren Buffett's Frugal, So Why Aren't You?)

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