Are the wealthy rich because they’re smart?

Are rich people rich because they’re smart?

Or to put it another way, are you not rich because you’re not smart enough?

According to a study conducted by the Joseph Rowntree Foundation, 69% of people believe ‘there is enough opportunity for virtually everyone to get on in their life if they really want to’. In other words, if you’re poor, it’s your fault.

This seems to be backed up by a recent study. In the US at least, it’s better to be born smart than to be born rich. ‘Smart kids’, as Robert Kiyosaki’s ‘Rich Kid, Smart Kid’ would have it, do end up earning more. ‘If they were bright and driven, poor kids stood a decent chance of becoming upper-middle-class, or better… Meanwhile, dimwitted children of affluence generally fell down the economic ladder’.

Sound like the perfect meritocracy?

Sadly, this summary glosses over a couple of important facts that the study points out:

  1. Even when rich kids make poor financial decisions, they appear to have a ‘glass floor’ to catch them, which poor kids, regardless of intelligence, lack. That is, their parents often step in and enable them to live a middle class or upper-middle class life when, were their financial rewards based entirely on their own merits, they would be in a much lower bracket. Consider the fate that befalls a unintentionally pregnant teen, or an unemployed 20-something with parents in the upper or lower economic strata.
  2. The smart kids are more often than not the wealthy kids. For many years, the single biggest gap in education in America has between along economic (as opposed to racial or gender) lines.

Generally speaking, the wealthier you are, the ‘better’ schools you can afford to send your children to. Perversely, in Australia, a wealthy family can send a child to a private school and receive more government subsidisation towards their education than a poor family will receive towards their child’s entire upkeep.

So it appears that being wealthy (or at least, having wealthy parents) can make you smarter (at least in terms of standard measures of educational attainment).

But does being smart necessarily make you rich?

The head of Mensa reports that money-making ability appears unrelated to IQ. Mensa members score at or above the 98th percentile on standard IQ tests. But, as quoted in Your Money Personality, on average, they rank only at median levels of income.

But surely the most intelligent people could simply make a killing in the stockmaket and then relax into a cushy life? Again, not so. The most ‘expert of experts’ in a variety of fields (96% of whom had a postgraduate education) were no better at making predictions than dart-throwing chimps, Tetlock found.

The role of financial literacy

Some personal finance authors attribute wealth and high income to a very specific type of smarts – financial literacy. The Armchair Guide to Property Investing opens with some scary statistics: ’20 per cent of our population own over 60 per cent of our private wealth and sadly the bottom 20 per cent of our population only own just 1 per cent of Australia’s private wealth. The top 20 per cent control over 40 per cent of all income and the lowest earn just 7 per cent.’

Why is this?

It isn’t often you see a book on personal finance or investing tackle the issue of wealth distribution and income equality. The authors conclude from this that:

‘It’s very clear that the vast majority of Australians have no real idea about money, finance and investing. Their financial literacy and understanding is below where it needs to be. Those who are in the top 20 per cent are people who have mastered the concepts, theory, mindset, resources and overall knowledge of money, finance and investing.’

Is there a financial literacy gap?

Maybe(Let’s not forget that many investors cannot pass ‘simple’ financial literacy tests either). But do the top 20 per cent who own the majority of the wealth really have superior financial literacy? And if so, what role did that play in their wealthy status?

It turns out that…

The truly wealthy (generally) start off wealthy.

Australia is one of the (majority of) countries on earth whose richest person inherited their wealth.

In America, we might consider the Forbes 400 rich list. While it is frequently trumpeted that the majority made their own fortunes ‘from scratch’, research suggests that one to two thirds were born into privilege. (By comparison, only 5% of the general American population is born into privileged families.)

If everything were equal, we should expect that only around 5% of the rich list would come from privileged families. Instead, the privileged from birth are wildly over-represented. The fact that a third or more of the very rich started out very rich demonstrates that what some people call ‘from scratch’ might be more akin to what Donald Trump describes as receiving a ‘small loan’. Even those who weren’t ‘very rich’ from birth were certainly not poor. And although left and right-wing think tanks might differ in how they define ‘rich‘, even the conservative estimates agree that ‘wealth does confer advantages, particularly in access to education’.

Being rich helps you buy smarts

Of course, simply because rich people stay rich does not prove that they aren’t smart, or that they don’t have better financial literacy than the rest of us. Those born into privileged families may well develop a superior knowledge of money as a result of having access to excellent advisors. (And the Armchair Guide contains some excellent advice for the rest of us to find good advisors). The wealthy can also learn by being surrounded by people who know about money. By being raised with a different attitude towards risk and return than the rest of us have.

As mentioned above, there are also the possibilities of a more expensive education. And although the falling cost of consumer electronics has erased much of the digital divide, a new ‘participation gap‘ is emerging, whereby children from wealthier backgrounds are more likely to have access to specialist, paid, educational apps, while children from poorer backgrounds play casual ‘freemium’ games.

Worrying about money decreases your abilities

It’s hard to disentangle smarts and money, because money tends to help pay for the opportunities and resources one needs to acquire knowledge.

What’s worse, a study of Indian farmers led by Mani found that worrying about money can decrease your cognitive function. Although the farmers had essentially the same diet and lifestyle over the four-month period of the study, during times of money worries related to harvest periods, their IQ scores dropped by as much as 10 points. That is significant – enough to lower you an entire classification, from ‘superior’ to ‘normal’, or from ‘normal’ to ‘dull’.

Just imagine…

Even hypothetical worries about money can decrease your mental abilities. In another study cited by Claudia Hammond, author of Mind Over Money, people in the US who were asked to imagine they had to pay $1500 for car repairs did less well on a test than those who were told they’d only have to pay $150.

Imagine what a lifetime of chronic money worries can do to your ability to function.

And yet, as Hammond reports, between 1994 and 2010, the proportion of people believing poverty was due to laziness increased, and the proportion who saw it as a symptom of systemic problems fell.

The other reason:

There may, however, be another reason that so many wealthy people started off wealthy. As the Economist notes, ‘The key point is that if wealth is concentrated (as it is increasingly becoming) and if the return on capital is high enough, then the wealth becomes self-perpetuating’. In other words, if you are truly wealthy from birth, you don’t really need to become smart to hold on to your money, and even increase it.

First of all, unlike the majority of poor and lower-middle class families, you’ll have easy access to an array of advisors to help you, meaning you don’t need to develop financial literacy on your own.

‘Money makes money’

Secondly, the words ‘self-perpetuating‘ are key. Money does indeed make money as the old saying goes.

Imagine you have, say, $86 billion dollars (that’s $86,000,000,000 – I know it’s hard to visualise). The amount Bill Gates, the top of the Forbes list in 2017, is ‘worth’.

If you invested that at just 1% above the inflation rate (and let’s face it, with that much money, you should be able to find plenty more lucrative opportunities) you would in a year receive $863,952,636. Or over $2.36 million per day.

Now, I could work out how to spend that for a while. But coming up with ways to spend $2.3 million every day for your entire life would be a challenge. And the ‘problem’ gets ‘worse’: say one day, you can only devise ways of spending $1.36 million. Now you have an extra million in the bank – and that starts accumulating interest too.

What a problem to have!

Or maybe you ‘only’ have Gina Reinhardt’s $15 billion. You’d still get a whopping $150 million a year in interest. Or enough to buy a house every day. Forever. And there’s a ‘problem’ too. If you buy assets with your money, they’ll earn you more money that you’ll have to decide what to do with as well. How pesky!

Of course, there are taxes. In the US, the highest income tax bracket is 36.9%, and in Australia, 45%. Of course if you’re ‘smart’ – and you’re rich, so either you or your advisors are likely to be – you’ll probably be earning most of your income under the guise of a company, with a lower tax rate.  So you’ll still have plenty of money to worry about what to do with.

My point is, once you have – or are given, or inherit – a certain amount of money, it’s pretty hard to get rid of the interest let alone the capital, even if you try.

So that’s how the rich stay rich.

What do the smart do?

Why don’t they try to become richer?

‘They probably could make more,’ Mensa’s executive director told Money magazine, ‘but they tend to work at what they like, not what pays best.’

What do smart parents do?

Teach their kids self-control. According to Moffit et al’s (2011) research, parent and teacher reports of children’s self-control between the ages of 3-11 is associated with savings and investment, home and retirement account ownership and self-reported money and credit management success later in life. The good news is that even when IQ and socioeconomic status are taken into account, these findings remain strong. Developing self-control is extremely important for enabling kids to make good financial decisions as adults.

What should we do?

‘One reason why some people blame the poor for their poverty is because they hold on to what’s known as the ‘belief in a just world’’ says Hammond. Rather than holding onto a false belief, I would prefer to acknowledge reality and work towards changing it.

I love the saying ‘Fair isn’t everyone getting the same thing. Fair is everyone getting what they need in order to be successful’. The education system we currently have in Australia (and in most places around the world ) is both unequal (people get different educations) and unfair (the difference is not to provide greater assistance to those who need it more, but rather, to those who often need it the least).

Lesson #1

To me, the first lesson to learn from all of this is that we can all benefit from improving our financial knowledge. We don’t all have the safety net of wealthy parents to look after us. Even those who do may want to be more independent. We may not all have the ability to go to a private school or a pricey university. But we can all try to improve our knowledge. The most valuable lessons I have learned came not from my (public) school or my (publicly funded, yet still expensive and debt-riddling) higher education. They came from secondhand finance books by respected authors, libraries, and the blogs of those who achieved financial independence before me. Those who achieved their goals under their own steam, not from having it handed to them on a platter.

The flipside to the viscous cycle of poverty and education is of course the virtuous cycle. The more we learn to manage our money, the fewer money worries we will have, and the better we will be able to make decisions in the future. 

Lesson #2

Money is not the goal. The smart know this.And the second lesson is that as long as you have enough, money is not the goal. Being happy is. The smartest people know this.

This being said, it is important that we recognise that having money is not merely a function of financial literacy. No amount of improving knowledge of deflation or interest rates alone will counteract the massive inequality that stems from systemic wealth distribution and income inequalities.

We all need to recognise the factors that contribute to poverty rather than simply blaming a lack of financial literacy of laziness.

Want to see how your financial literacy stacks up? Take this quiz!

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