The Rich Get Richer: The supremacy of scale in personal finance

There’s an economics term called the ‘economy of scale’. It’s what you describe a phenomenon that increases efficiency rate as operational size increases. A good way to describe it (which I saw on Wikipedia, heh) would be “When the amount of money you put into the operation doubles, the results more than double”.

Similarly, there is also such a thing as a ‘diseconomy of scale’, which is something that, when you put twice as much money into an operation, causes you to get less than double the results.

Economies and diseconomies of scale are concepts meant to be applied to the operations of businesses: An example of an economy of scale could be bureaucratic consolidation or the ability to pay off politicians, an example of a diseconomy of scale could be controlling so much of a market that your products end up competing against each other (Or, alternately, CEO pay). It’s all a very complex interplay of things.

Individual wealth features economies and diseconomies of scale, as well, but it’s not nearly as complex. In short, individual wealth is dominated by economies of scale, with only a single notable diseconomy of scale, the effect of which will be discussed.

An easy way to grasp the concept of the economy of scale when applied to personal finance is to buy in bulk. This allows you more return on your investment than you would have obtained otherwise. Now, for most goods, a bulk purchase might not be an obvious choice – after all, you might not be using everything you buy.

This works together with another fact, however: that an investment ‘uses’ itself. You need pay no attention for an investment to grow, though you can (which is tied to our one diseconomy, which I’ll get to in a bit). This allows you to buy investments, things which will make money for you, ‘in bulk’, allowing you to make money faster (and/or safer, in fact) when you have more money.

So you can use money to make yourself more money, and if you double the amount of money you’re using to make money, you can more than double the amount of money you get from it, thanks to our economies of scale: But wait, there’s still that diseconomy of scale.

The diseconomy of scale in personal finance is simple: Regardless of how rich you are, you’re only one person, and there’s only so much time in the day to research and select investments. There are investments you don’t need to research, but they have lower return rates or commission fees.

And this diseconomy of scale would matter, if everyone actually invested their own money. As it happens, though, people both wealthy and poor tend not to do that (as everyone has something better to do than to tend to something that makes money without needing to be tended), but instead rely on experts to make their investments, allowing them to mitigate some of their gains in exchange for a decrease in risk (admittedly, the existence of a field of expert finance is a gigantic waste of time, but that’s a subject for another post).

So, uh, yeah. In the event you were not sure, wealth begets wealth, and wealth begets wealth exponentially faster based on the wealth you have to start with. There’s the name and description of why the rich get richer.

The economy of scale. Not as economists typically use it, in regards to businesses, but applied on a personal level.


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