The Poor, the Middle-Class, and the Rich - How to Break the Cycle and Become Wealthy

A rich woman enjoys her plane ride

While the ultimate goal of capitalism was to abolish the previous birth-right based class system, the opposite became a reality. Capitalist society can be divided into three classes:

• The poor

• The middle-class

• The rich

People of these classes experience vastly different lifes just like their feudal predecessors. However, there is an advantage to Capitalism: While it is intentionally difficult, you can break out of your class by your own making.

This article explores the differences between the poor, the middle-class, and the rich as well as how to break the cycle and become wealthy.

Disclaimer: Recently, a fourth class has emerged: the ultra-rich. This class poses a fundamental threat to the stability of capitalism, owning most of the assets in exchange for little work. The underyling root cause is the right of inheritance. For the sake of simplification, the ultra-rich are ignored in this article and will be covered in another story.

Basic difference between the three classes

The poor buy cheap things that they don’t need funded by debt, the middle class owns liabilities believing they are assets and the wealthy invest in assets which pay for their liabilities and generate more wealth. The outcome is that the poor get poorer, the middle-class breaks even but loses out in the long-term due to inflation and taxes while the rich become richer.

The concept of assets, liabilities, and debt

Before getting into the depths of how to break the cycle and move up the class ladder, let’s first delve deeper into the key factors that drive the cycle: assets, liabilities, and debt.

Assets and liabilities

Assets and liabilities are opposites of each other.

An asset is something that continuously generates money. A liability is something that continuously costs money. Money can be equated with value.

Debt

Debt is a liability. It is one of the most dangerous liabilities. Debt allows you to borrow money now that you would otherwise only have in the future.

Debt can be incredibly powerful when used to invest in more assets that generate further wealth due to leverage. It can also be incredibly dangerous when used to invest in more liabilities such as a new car. A person who uses debt to invest in liabilities will not be able to repay the debt in the future because it costs more money.

How the poor, middle-class, and rich work with assets, liabilities, and debt

The poor

The poor spend most of their money on items required for survival such as food, rent, and clothing. They spend the rest on small things that they don’t need that give short-term satisfaction such as a new phone, games, toys, and restaurants. It is telling that you frequently see the kids with the most toys in poor households. Often, these families don't have enough money to pay the bills at the end of the month because they mismanage their money, have unexpected expenses like a car breakdown, and have recently suffered from inflationary pressures and low wages. In turn, they take on credit card debt and tend to forget about it until it’s too late. They remain trapped in the debt cycle until they default and are imprisoned for life.

The middle-class

The middle class takes on large liabilities. Unlike the poor, the middle class has enough money to survive and can afford to spend a lot of money on things that bring medium-term satisfaction, such as a luxury car, a house or a small boat. To finance their lifestyle they take out various loans such as a real estate or a car loan. In essence, they put their money to negative work by investing in liabilities and by multiplying the effect through additional leverage. Quickly, their expenses equal their income. This is called “lifestyle creep”. When they have money left over to invest in assets, they often put all their eggs in one basket. They buy a single stock on the advice of their neighbor and out of fear of missing out (FOMO). This leads to poor asset diversification and often defaults.

The rich

The rich spend their money on assets. Unlike the middle class, the rich do not suffer from lifestyle creep and instead spend their money on assets that bring long-term satisfaction such as stocks, houses that will increase in value, education, or creating a business. Of course, the rich have fun sometimes and buy items they don’t need. However, they will always make sure that their income is greater than their expenses. They use debt to further leverage investments in assets for higher payouts. They spread out their investments in order to not bet on a single horse that might have a bad day.

How to break the cycle and become wealthy

The solution to breaking the cycle and becoming rich seems pretty simple. Act and invest like the rich. However, this is easier said than done, so let’s break it down.

Investing like the rich

To invest like the rich, you need 1) spare money to invest and 2) invest that money in assets. Depending on your current class, having 1) spare money can be a big obstacle already. Here, the advice is to limit expenditures and work hard as well as educate yourself whenever possible to increase your income.

Let’s focus on 2) investing that money in assets since it entails common pitfalls. For that, it is critical to understand the concept of time and money. Investments need time to increase in value. The more money you invest, the higher the potential payout. Herein lies the problem. When you are young, you have time but no money. When you are old, you have money but no time. To fix that, invest as early as possible while working as hard as you can to increase your salary. This way, you can invest more money sooner.

Increasing the top-line

What assets should you invest in? There are infinite possibilities but three stick out that stood the test of time.

1. Stocks - low risk and medium return: Stocks offer a relatively safe way to increase your wealth when well diversifed. The S&P 500’s average annualized return since its inception in 1928 through 2022 is 9.82%. Invest as early as possible in index funds to diversify and take advantage of compound interest. To show the power of compounding: Investing $1000 per month at a 9.82% p.a. return gives $700,000 after 20 years. After 30 years, it will translate to $2,000,000.

2. Real estate - medium risk and medium-to-high return: Buying real estate for value increase and renting out offers marginally better returns than stock investments, albeit at a slightly higher risk while requiring more knowledge and time investment. The big advantage is that you can use owned real estate as collateral to get larger loans, increasing your leverage, for further investments. Therefore, investing in real estate can snowball fast when done right, resulting in very good returns.

3. Founding a business - high risk and high return: Starting a business is still the most powerful way to get rich, albeit the riskiest. There is no guarantee of success and returns can fluctuate dramatically. Depending on the initial investment required to found your firm, risk must not always be incredibly high but given that you will likely spend a lot of time on your business, it is always a big trade-off. A good way to test the waters is to start an online business, be it a blog, a video course, or as an independent contractor on websites such as Fiverr.

Besides investing in assets, you should further maximize your income and invest in your own education.

Typical jobs that make you rich on salary alone are strategy consulting, investment banking or other financial roles such as Private Equity, and big law. These jobs offer a safe way to becoming wealthy since you don’t have to risk much. However, keep in mind that you will have to sacrifice a lot of lifetime in exchange and that the reward is still less than the potential payoff from founding your own business. Therefore, it is advisable to use these jobs as a first career boost, but not as a long-term solution to rise to the elite class of the rich.

Improving the bottom-line by reducing expenses

Besides increasing your income stream you should look further into reducing expenses. Next to lifestyle creep, taxes are particularly worth looking into, especially after reaching higher income levels. There are great books out there on how to reduce taxes.

Often, founding a company or foundation can be a great lever for reducing taxes. Essentially, you transfer direct ownership of your money from yourself to a company or organization, thereby benefitting from tax incentives focused on boosting the economy. You can still access your money through ownership of your company.

Additionally, it might be worth considering a move to a different country. At higher income levels, you’ll have the huge advantage of global mobility over the poor and even middle-class. Therefore, you can choose the country you live in, thereby reducing taxes further.

A final remark: While reducing expenses can be an incredible lever at higher income levels, it should always come second to increasing the top-line. You can increase your income infinitely, but your bottom line is limited to your income level. Therefore, top-line optimization offers infinitely more potential to increasing your wealth.

Conclusion

Today’s society consists of three classes: the poor, the middle-class, and the rich.

The poor spend money on small items they don’t need. The middle-class spends money on big items that are liabilities. The rich spend money on assets that generate wealth.

To break into the class of the rich, you need to act like the rich. Invest in assets while maximizing your salary and improving your bottom-line through a reduction of expenses, particularly taxes.