This is a question that I’ve repeatedly seen in forums of investment and personal finances. Maybe you’ve seen it with a different format such as in “What does the average Joe lack that prevents him from getting rich?” or “Why is it that many people with high incomes never get rich, while others with small incomes make their way to the millionaire club?”. I think that at this point I understand money very well, so I will answer it.

First, note one interesting fact. Most of the people who become rich, stay rich. Plus, most rich people do not actually appear to be rich (read the book “The millionaire next door” and you’ll understand why).

Now, there are exceptions to this rule. People who got rich due to millionaire contracts (such as sport starts), often end up poor or even filing bankruptcy.

Are you already coming to a conclusion? If not, let me help you. Some people understand money. Most people don’t. First, money has this unique characteristic that it can work for you. See it as an extension of yourself, or an employee who works for you… for free. Some, like Mark, understand this concept and apply it. Most, like John, complain that they have way too little money to put it to work “Well, if I had 10 million dollars I would put them in the bank and live off the interest.”. This is where things change for Mark and John. While John complains, Mark starts to put its money to work and, while in the beginning he doesn’t make much money, the figures look better and better as Mark saves more and have the interest he has earned making more money for him (which is called compound interest). For the sake of discussion, let us say that John and Mark have the same salary, of 100K, and have 20K/yr extra.

Five years go by and John appears to be rich, and Mark appears to have a very modest salary. John buys expensive clothes, eats out often and has a membership in a 9K golf club. In contrast, Mark doesn’t have expensive habits and has a Honda Civic that “always takes him where he wants to go”. John bought a Porsche last month. For about the same money, Mark discreetly bought a condo, which he has leased out. Marks salary is already way bigger than John’s: while John has to pay for expensive maintenance of his Porsche, Mark gets a rent from his tenants every month, which he adds to his salary.

Another five years go buy, and John still thinks that Mark is poor: while he just came back from his vacation in Europe, Mark spent his vacation one hour away from home. At this point, John has almost no money saved up. Mark just bought his third condo. Wait… “third”? Didn’t you mean the “second”?

You see, this is why some people understand this game called capitalism. Mark took 5 years to buy his first condo, and took another five to buy two. Why? Well, first, Mark has an income generating asset: his salary increased so he can now buy the same things faster. On top of that, Mark knows how to make his money grow, so the extra 20K a year are actually 22K a year. But this is the first year, because in the second year Mark makes 2.2K from his 22K plus the 20K extra of that year. So after 3 years he is making 20K + 22K + 24.2K. After 5 years, Mark adds the 20K extra to his 22K + 24.2K + 26.2K + 28.862K. Note that simply buy getting 10%/yr, Mark made 8.862+6.2+4.2+2.2 = 21.462 more than John. So after 5 years, Mark gets another “year” of savings. And there are two small details: 1. Mark is saving the money, to invest, while John is spending it. 2. Note that, on the side, Mark is also making 15K from this rental property. Maybe he is still paying the mortgage and only a small portion of this goes into his pocket. But if he is paying the mortgage (with his tenants’ money) he is increasing his net worth, and one day that rental property will be payed, and it will generate more cash.