Sunday, May 1, 2016

Life Compounds

I have explained before that one of the principal reasons that I am a fiscal conservative is that I understand the power of compound interest. If it is working for you, it makes your life easy.  If it is working against you, it will ultimately bury you.

A wise friend of mine believes the power of compounding also applies to relationships. Developing friends, friendships and a network of relationships has tremendous compounding power. One friend leads to two. Two to four. Four to eight. Those relationships can add a lot to your life and your career. They can nourish and nurture you. They can inform, inspire and increase your sphere of influence. They can be a real force multiplier in your life.

As I have thought about it some more, the reality is that the power of compounding in life is even much bigger than that. Compounding effects actually explains a lot about success (or the lack of it) in life.

All things in our lives are subject to the effects of compounding. One thing most often leads to another---good or bad. And those compound effects add up as tremendous force multipliers over time in our lives.

I have written before of the Brookings Institution study that found if you simply finish high school, marry before having children and have a full time job, you only have a 2% chance of ending up in poverty in the United States. At the same time, your chances of living in the middle class are 74% if you do these three things. That is pretty compelling evidence of compounding effects.

If you drop out of high school you greatly limit your choice of jobs. You also are competing for those jobs with others who did graduate. Compounding effects. If you have a child out of wedlock your choices get even more limited. You may have to limit your job choices due to child care concerns. You may not be able to work full time or take a job that requires any overtime or travel. Compounding effects.

If you drop out of high school it also affects your friendships. Who are you most likely to hang with when most of your contemporaries are in school? It most likely will be with other drop-outs going nowhere. You end up at the same destination that they are heading to. Compounding effects.

And these effects compound over a lifetime. One bad thing leads to another and another and another. It is not easy to get out from under a series of poor decisions that compound. It is much like a debt load that gets too large. The interest on that debt will eventually bury you.

On the other hand, doing the right thing at the right time with the right people leads to success in life. Studying hard, working hard, hanging with friends who have purpose, values and goals will compound to great things. Compounding effects. Selecting the right spouse. Spending less than you earn. Saving for a rainy day and retirement. Staying away from drugs and the use of alcohol to excess. Compounding effects.

Several years ago I cited an American Enterprise Institute analysis that looked at the income characteristics of U.S. households based on various demographic factors such as education, married status, work status and age.

Looking at this data you can see the tremendous impact that demographic factors have on income.  I might add that most demographic factors are choices. You have no control over when you were born but choices are made about graduating from high school, going to college, marriage, children born out of wedlock and the like.  These choices are also not fixed over a lifetime and certainly are not fixed from generation to generation.  People have the opportunity in this country to change their situation.

The first thing you notice in looking at the chart is those that are in the highest fifth of U.S households have earned that status by working.  In fact, 2.03 is the mean numbers of earners per household in the top quintile. There are a lot of two earner households in that top quintile. The lowest quintile only has .44 earners per household. Compounding effects.

Only 2.9% of these well-off households have no earners.  The rich are not people clipping coupons, they are working and earning a living.  On the other hand, 61.7% of those in the lowest quintile had no one in the household with earnings.  No one is going to get rich on government programs. Compounding effects.

78.2% of the high income households are married compared to only 16.7% of the poor. Compounding effects.

It is no surprise that education stands out as a key demographic factor.  Only 1.8% of the highest earners failed to graduate from high school but 26.9% of the poor failed to get that basic educational attainment despite the fact that a free high school education is available to everyone in the country. On the other hand, 62.3% of the richest Americans have graduated from college. Compounding effects.

As you can see, in most of the selected characteristics there is a direct correlation that corresponds with moving up the income scale whether it is number of earners per household, marital status, work status or education. Compounding effects.

There is an old saying, "The rich get richer and the poor get poorer." I think this really describes the compounding effects of life.

However, it is too often the case that people are led to believe that they are victims of their circumstances rather than masters of their fate.

A good example is Donald Trump and his brother Fred, eight years his senior. Fred also carried his father's name into life. Fred, Jr. should have been the heir apparent to their father's real estate business but a series of poor life decisions destroyed any advantages he had by birth. Fred smoke, partied and eventually drank himself to death at the relatively young age of 43.

Donald Trump learned by watching his brother and saw how the compounding effects of bad life decisions could bring even those with talent and advantage down. Seeing his brother's downward spiral was the main reason that Trump has never smoked or drank in his life.

On the other hand, Dr. Ben Carson overcame an impoverished childhood while being raised by a single mother who could not even read. He was heading in the wrong direction but his mother pulled him back on track. She turned off the television and told him to read. The young Ben Carson studied. He worked hard. He got into Yale and that led to medical school and a residency in neurosurgery at Johns Hopkins where he eventually ended up as Director of Pediatric Neurosurgery with a worldwide reputation.

Compound effects.

They explain a lot about life.

Make sure they are compounding the right way in your life,

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