Income is the money one receives for products sold or services rendered. Your paycheck is income. Wealth, however, is the value of one’s financial holdings. Your stocks and property are wealth. Income is cyclical, and typically the result of work, which generates money that you burn through until you get more of it. But wealth is long-term. Permanent, even. The money in your investments (if you’re lucky enough to have income left over to invest) earns interest, produces dividends, or grows in value as the market price of securities rises.
The S&P 500, a popular stock index, has risen, on average, by 8 percent in value annually for the past 60 years or so. That means that over a single year, on average, $50,000 in invested wealth would earn about $4,000 in returns. Compounded over many years, that can add up. If that return held steady and you reinvested every dollar, your original $50,000 would be worth more than $230,000 after 20 years. But that’s only if you don’t spend those earnings (called “passive income,” because you don’t have to work for them). Most people—even those with seemingly substantial wealth—don’t earn enough passive income to live on, let alone to reinvest and compound. Even $100,000 of investment principal yields only $8,000 of earnings at 8 percent a year.
But adding zeroes to the end of that number changes things considerably. One million dollars could earn $80,000 at 8 percent, enough to cover the median U.S. household income of $63,179 and leave $16,000 and change to reinvest. Over time, that wealth would build more wealth. After 10 years, you’d have $1.2 million in the bank, which would earn more than $96,000 in income (enough to account for an annual inflation rate of 2 percent) and leave you with more than $33,000 to reinvest. Of course, the market doesn’t return the same rate every year—one year investments might be up 12 percent, another only 3. That makes the mere millionaire less likely to be able to live on wealth alone.
Add more zeroes, then. Ten million dollars in wealth would produce $800,000 in income at 8 percent returns. Even if you spent half of that, you’d still have $16 million a decade later if you reinvested the remainder at similar returns. Three percent returns would still yield $12 million in wealth and more than $300,000 in annual income.
By the time you get to $1 billion—an unfathomably large amount of money—even paltry returns produce tens of millions of dollars in income. But people with this much wealth don’t earn paltry returns. They hire armies of financiers to manage their holdings. And the assets that produced the wealth in the first place—stockpiles of Microsoft shares, for example—continue rising in value, often far outstripping the market average. Since going public in 1986, MSFT has risen by an average of about 23 percent a year.