The New York Times recently published some original research about the relative wealth of different countries’ middle class. For the first time in history, the USA did not come out on top; we up in the Great White North did. While this is interesting, it is not what I wanted to write about.
What struck me was the angles of inclination of the bars showing changes in income levels from 1980 to 2010. There has always been income inequality, and there always will be. That is not the problem. The problem is the incredible increase in income inequality over the past 30 years, and more specifically, the rate at which income inequality is galloping ahead. Adjusted for inflation, American up to the 10th percentile are actually making less than they were in 1980. From the 10th to the 40th percentile, growth has been mediocre. From the 50th to the 95th percentiles, growth in income has been much more pronounced, with the angle of inclination getting steeper as the percentile increases.
The picture isn’t quite as dire in Canada. (You’re going to need to open the graph in a separate window to follow along. Follow the above link to the original graph, and then hover over the various grey bars to see other countries compared to the USA.)
For one thing, the bars in the Canadian graph all go from lower left to upper right. This means that we are all better off, in a relative sense, than we were in 1980. The troubling aspect for me is that the observation about the angle of inclination getting steeper as one’s income rises still holds true for Canada. Granted, the difference in angles isn’t quite as steep as it is in the US, but the contrast from the left side to the right side of the graph is striking nevertheless.
“You’ve got to be very careful if you don’t know where you’re going, because you might not get there.” Turns out, Yogi Berra might have been a half-decent financial planner.
I am by nature a goal-oriented person. Once I know where I’m going, I make a plan and work towards it, with what I think is probably an above-average level of focus. While this means that I disapear from my friends’ (and somtimes even family’s) view for weeks or months at a time, once I’ve got a goal in mind, I focus a lot of energy attaining that goal. This approach generally works quite well for me.
And yet it occurred to me several months ago that I had no specific goals for my finances. I hope to retire some day, I hope to pay off my house some day, and I hope to be able to pay for life’s little surprises, (like a new water heater this past winter) without having to go into debt to do it. While those are all good goals, they are far from specific. Also, I had no specific order in which I was trying to achieve these goals; house first, or large passive income first? What about simultaneously? I have come to realize in the past year or so that because I didn’t know exactly where I was going, I was having trouble getting there.
When comparing the rate of return on investments, it is helpful to have a consistent standard. By far the most common standard is to simply compare the annualized rate of return. If investment A return 3% and investment B returns 5%, the risk of the two choices being equal, the obvious choice is investment B.
That is good as far as it goes, but what does it really mean in terms of long-term growth? In other words, how meaningful is that 2% difference?
The Rule of 72 allows you to measure investment returns in term of time instead of percentage points. If you use doubling time (how long will it take for money to double) as a standard of measure, you can see how long your investments will take to bear fruit.