Why is the gap between income and net worth so large for the top 1%

Income to be in the top 1% is about 515,371. Well and good, that is about the income of a pair of physicians, or highly paid couple who work in law or business.

But the cutoff for the top 1% of wealth is 10.4 million. I guess I don’t understand how thats possible, unless the people in the two groups (top 1% by income vs wealth) are 2 totally different groups.

Even at 500k a year in income, you’d have to have 20 years worth of income in the bank to quality for the top 1% in wealth. And at that level of income you’re paying 40% of your income in various taxes, plus you have your normal living expenses.

Unless you inherit your wealth, I don’t see how most people could amass 10 million over their lifetime unless they are putting 200k a year into high growth investments for several decades.

Contrary to my initial reaction, it appears that inheritance is not so significant here. According to a Fed report from 2013, the top 1% wealth by wealth are inheriting around $1 - $1.5 million in 2013 dollars.

See table 21.

I think the explanation may simply be the high real returns on investment assets in the U.S. over the past decades. Bear in mind that the top 1% by wealth will obviously tend to be older people, so a 30-year time frame seems reasonable, if we assume that a high earner reaches their full earning potential at 30 and retires at 60.

Suppose a 500k earner puts 125k each year into assets (everything in today’s dollars) - that includes primary residence and pension savings, so I don’t think that number is too high. Then a 5% real rate of return gets you to $8.7 million in 30 years. Is 5% a reasonable assumption? I’m not sure, maybe it’s a bit high - the stock market post-war has returned more than that, but bonds and real estate have returned less, and some of it will be taxable.

ETA: and for the primary residence real estate component of their assets, most people are leveraged - they have full equity exposure to the real estate market early in their career, financed by a mortgage. That longer time frame offsets the lower average returns on real estate.

I’m sure that the extra-wealthy have a lot more creative ways of passing on their wealth than simply letting their kids have it after they drop dead. “Inheriting” is quite a small subset of “wealth transfer from older generation to younger generation”, which is really the salient feature we should be thinking of when looking at the disparity between yearly income and amassed wealth

You are probably looking at “income” in typical terms. Someone like Bill Gates, Jeff Bezos, or Warren Buffet doesn’t earn an “income” but rather they have “capital gains” from stock ownership. Their net worth is tied to that amount.

Ordinary people, like folks working in Law or Business, will never catch up. A FB meme going around right now is that if you got a job in 0 BC making 2K per hour and worked 50 hours a week every week and never spent a dime and lived until the present day, there would still be like 50 people richer than you.

5% seems reasonable - The S&P 500 has averaged 8% since 1957 (S&P 500 Average Return) and a younger high income household would likely invest mostly in stocks. Throw in personal real estate (whose return varies quite a bit depending on region) and its not hard to see how a household could accumulate $10 million in a few decades.

Someone like a Warren Buffett owns a lot of highly valued stock, but that “worth” is totally dependent on what the market is willing to pay at that moment for a similar share of that stock. So right now, people are buying and selling Berkshire Hathaway stocks for $340,900 per share. Buffett owns some preposterous number of those shares.

But until he actually sells any, that value is somewhat illusory- it can fluctuate up and down, and so will his net worth, without any actual money exchanging hands, or that value being realized.

Meanwhile, Buffett’s actual income is presumably derived from his actual job at Berkshire Hathaway, and that’s roughly $100k a year.

No it’s not inheritance mainly. But a good deal of it is income variation over time relative to more stability in net worth, of which inheritance is a specific case. The more important case though is where income varies over a given person’s lifespan as opposed to from one generation to next.

An older person who earned $1mil/yr for a decade or more at the peak of their career a decade or more ago very possibly has at least $10mil+ now if they lived relatively modestly (they payed a significant % of the original earnings in tax and spend a significant %, but earned substantial returns investing the money if for many years). Now in semi-retirement/retirement their reportable* income might be 2% or less of the $10mil, well below 99%-tile income, but NW at the 99%-tile. This point is also a more general version of the rare case (in terms of number of people, though a non-negligible % of total national NW) where a person built a now large, household name company but had an extremely high reportable income perhaps only one year (the year the company IPO’d and they sold x% of their interest). Otherwise their dividend income from remaining interest in the company and other assets might be 99.9%-tile on the income scale, where their NW is 99.99%-tile on the net worth scale, same general idea as more numerous people who earned a high wage income at some point of which they saved a lot, but don’t earn a very high income now.

It sometimes becomes a political debate how socially significant it is that the ‘top 1%’ of reportable income turns over substantially year to year. But it does, which makes it easier to understand statistically why 99%-tile NW is such a large multiple of 99%-tile income in a given year.

*stats you quickly Google up on income in the US might include non-taxable income required to be reported on tax returns, like municipal bond interest, hence my term ‘reportable’ income, but generally doesn’t include unrealized capital gains in a given year (which would also cause occasional years where ‘income’ of 99%-tile NW households would be negative, IOW the top income population would change from year to year even more). Net worth however includes cumulative unrealized capital gains.

Morningstar shows an S&P500 index fund delivering an annualized 10.2% since Y2K (this includes both dividends and changes in share price). If we use your scenario with 10.2% per year, then 30 years ends with $23.4M. The actual annual rates of return vary widely over the past thirty years. I couldn’t tell by looking at the chart whether the big % gains were in later years (in which case the final tally would be larger) or the earlier years (in which case the final tally would be lower) or relatively evenly distributed, but it seems likely a person starting in 1990 and investing just $60K annually could have hit the $10.4M mark in 30 years’ time.

Someone who was willing to pursue riskier single stocks (Apple, Microsoft, Amazon, etc.) could have reached a far higher net worth in that same time frame with much smaller deposits.

ISTM to be a combination of unrealized capital gains (as Corry El mentions) and compound interest. I am not worth anywhere close to $10M, but I never made $535 a year either, and my wealth is much greater than the sum of what I invested.

If my house goes up by $100K my wealth has increased but my income hasn’t, to put it that way.


Yeah but the only way to get that stock is to either found the company, inherit it or buy it.

There aren’t enough people who did IPOs to found the company (although I’m sure some of the top 1% were early workers with stock options for companies who became successful), supposedly inheritance isn’t it which only leaves buying the stock with income.

That’s total return. We need to look at real returns, adjusted for inflation in order to think in consistent terms in today’s dollars. Otherwise obviously the assumption of 500k earnings or $10 million in wealth would need to be discounted as you go back in time. The real return on the S&P is more like 7%.

The OP is not about the exceptional circumstances of multi-billionaires, it’s about the top 1%, who are generally doing more ordinary things - buying a house with a mortgage, paying into their pension funds, investing in stocks & bonds - just on a larger scale than the average person.

Dangit, missed it by that much!

Looking at the actual article, I can’t figure out where that 10.4 Million dollar figure comes from. It links to an article from Forbes, which is basically just a blog post. That figure seems to be uncited on the Forbes post.

If you look at the Fed paper that I linked to in the second post, there’s a much more extensive analysis and discussion of data sources. From their data (Table 2) the top 1% quantiles for 2013 and in 2013 dollars are:
earnings $570k
income $690k
wealth $7.9 million

So, similar numbers to the Forbes article. And if the Forbes data are more recent, it’s reasonable to expect that wealth would have increased more than income in the past 7 years, asset values have risen dramatically.

Maybe you’ll find a check on the sidewalk for $493,819 on the way home today.

I was using Buffett as a well known, extreme example. He has famously low income, and fantastically stratospheric wealth, so I was using that as an example to illustrate how someone could have relatively low income, and high net worth.

It’s not uncommon for people described as merely affluent to have the same situation- I can totally see how someone’s net worth might be several multiples of their income.

For example, let’s say our hypothetical affluent guy makes 75k a year. He owns a house valued at say… 250k. He’s owned it for a while, so he only owes 60k on it. And he has paid into his 401k for a long time- let’s say he has another 250k in there.

Right there, he’s got a net worth of 250k + 190k, or $380k, which is five times his annual income. I don’t doubt that as you go up in the income percentages, that your amount that you can save, and the value of the stuff you have goes up as well.

The amount of success you need in business to reach a $10.4M net worth is pretty low. Having a successful plumbing company, owning a chain of franchise restaurants, being a partner at a regional law firm, all of these at the top end of success can easily reach that number.

As a very rough estimate, small businesses are normally valued at ~2x revenue on the higher end and a 50K salaried employee might cost the company $100K with all other expenses and might be expected to generate 50% margin so a plumbing company owner with ~30 plumbers working under them who started the company from scratch with no debt might easily sell their business for $10M.

Fair enough. You can see though that if a borderline 1% earner over the past 30 years was willing to tolerate a little more risk than an index fund, they could have easily hit the $10M mark today with substantially smaller deposits over that period of time.