Consumption Versus Investment

Spending money can be categorized by roughly two different factors: consumption and investment. When you spend money on consumption, you destroy wealth. For instance, if you spend $50 at the bar drinking, you basically just destroyed some of your wealth. That is, you used to have $50, and now you have nothing but a hangover to show for it.

If, on the other hand, you are a contractor and spend $50 on a tool, you still have that $50 of wealth, albeit in the form of a tool worth about $50. However, this tool makes you more productive at your work, resulting in greater income. Voila, you have just created wealth through an investment. Not only is your asset still worth the $50 you paid for it, but you are generating additional income.

OK, now let's all understand that there are few absolutes on the consumption vs investment scale. For instance, that tool does lose value over time, and so is consumed, but it should give a return via increased income much greater than its cost.

This is the primary reason the rich are rich: they invest their income in items that retain value and/or generate additional income. Poor and middle class people tend to simply spend all their money on consumption. It's pretty much that simple.

Let's say we perform an experiment and give a poor person $50 million dollars. Will he grow that money, or will he spend it all and end up poor again. Luckily for us, we have already performed that experiment. We call them lotteries. When a poor person wins the lottery, the odds are overwhelming that he will be poor again in 5 years. This isn't the only case. Consider inheritance. When a family has a huge amount of wealth, that wealth has generally completely disappeared by the 3rd generation. In other words, odds are that Bill Gate's grandchildren and great-grandchildren will not manage to retain any of Bill Gate's wealth, even if he leaves it all to his descendents.