|
|
|
|
|
Ranking, the Rich, and the Mega-Rich |
|
|
|
Graph 1: The Distribution of US Household Wealth is Highly Uneven |
 |
|
Whats Going On Here? |
- The wealth distribution in the US is highly uneven, with the wealthiest holding
the overwhelming majority of all assets.
- The graph shows that the top 1% wealthiest US households own 32.7% of the total
US household wealth and that the top 5% hold well over half of all the household
wealth.
- Likewise, the graph shows that the top 10% wealthiest households
collectively own
70% of all household wealth, i.e., that the bottom 90% hold only 30% of total household
wealth.
- The wealth distribution in the US has historically been highly uneven, so the 15-year
period covered by the five Surveys of Consumer Finances (see graph above) is not
unique.
|
|
|
|
Graph 2: Over the long run the “Trickle-down effect” works. |
 |
|
Whats Going On Here? |
- Helped by the strong overall creation of wealth in the US, the absolute amount of
net worth for each wealth bracket has increased over time, even if the relative
share of wealth continues to be distributed very unevenly in favor of the rich.
- About 1/3 of US household had a net worth of less than $50,000 (red plus orange
bars in Graph) as of year-end 2005. About 18% had a net worth of less than $5,000
(red bars in the graph).
- From 1965 to 2005 the portion of US households having a net worth in excess of $100,000
grew from 30% to nearly 50%.
- The portion of US Households reaching the “Million Dollar Club” grew from a mere
1% in 1965 to an estimated 9% as of year-end 2005.
- Similarly, the portion of households with a net worth in excess of $250,000 grew
from 6% to about 33% during the 40-year period from 1965 to 2005.
- Considering that the US population grew by over 100 million (from 194 million to
296 million) during the period 1965 to 2005, the number of family members living
in a household with a net worth of more than $250,000 increased nearly 10-fold from
about 11.6 million in 1965 to nearly 100 million today.
|
|
Lessons
|
- While it may be true that the rich get richer, this graph shows that the poor are
getting richer too. The downwards sloping dividers between wealth brackets demonstrate
that the “trickle-down effect” does work in the long run and that the United States
gets richer as a whole, not just as a few wealth individuals.
|
|
|
|
|
|
|
Wealth Accumulation and Savings Rate |
|
|
|
Graph 1: US Savings Rate and Tax Rate |
 |
|
Whats Going On Here? |
- The graph shows the Personal Savings Rate in the United States, which is found by
averaging the difference between peoples' spending and their disposable incomes.
A negative savings rate consequently means that the american public is spending
more than they are earning.
- The recent negative savings rate (2006-07) has been financed by the boom in the
residential real estate market. Americans have been able to borrow against their
homes (e.g., home equity loans) and consequently spend more money than they make.
While this trend has not yet reversed itself, a negative savings rate is not sustainable
in the long run.
- On a personal level, spending more than you make can boost your short-term standard
of living. However, it will limit the growth of your long-term wealth.
|
|
Lessons: |
- While long-term wealth creation hinges on the types of investments you make and
how well you allocate your resources, the amount you save often plays a fundamental
role in determining which wealth brackets you end up in.
- When considering the power of compounded interest, it becomes especially clear that
saving early in your career is vital to building wealth for the rest of your life.
If you “let your money work for you,” i.e. save and let your money appreciate, after
some years just the annual appreciation can significantly increase you purchasing
power.
|
|
|
|
Graph 2: Appreciation of $1 Invested in Various Financial Assets |
 |
|
Whats Going On Here? |
- As the graph shows, stocks (in particularly small capitalization stocks) lost ground
during the Great Depression, when it was outperformed by more safe investment alternatives
such as bonds and T-Bills. However, for investors with time horizon of more than
10 years, stocks have dramatically outperformed bonds, T-bills and bank deposits.
- Note that the Y-axis on the graph reflects a logarithmic scale. If a linear scale had been used, the developments for the $1.00 investments in bonds and T-bills would
hardly be visible relative to stocks. Specifically, the $1.00 investments in large
and small capitalization stocks compounded to $242 and $1,205, respectively. A $1.00
investment in long-term corporate bonds, long-term Government bonds and T-bills
returned $9.07, $6.32 and $1.67, respectively.
|
|
Lessons
|
- While most investors will not be looking at this long of a time horizon when they
begin investing, the power of compounded interest and the value of saving early
becomes very clear. If one was to invest $1 in Small Cap. stocks 30 years before
retirement, it would appreciate to approximately $13 by retirement. However, investing
that dollar just 10 years earlier would lead over $30 at retirement. 20 years earlier
would lead to $74. Now start with more than just one dollar...
|
|
|
|
|
|
|
|
US Household Wealth and its Distribution |
|
|
|
Graph 1: Wealth Creation and its Split between Existing and New US Household |
 |
|
Whats Going On Here? |
- The graph shows the annual increases in US Household wealth (in $ billions) since
WW2 and how it is split between existing (green) and new (blue) households.
- Nearly 4/5 of the annual wealth creation accrues to existing households. In this
context, existing households are defined as households established the previous
year or earlier. E.g., an immigrant is considered a "new household" the first year,
but thereafter as an "existing household".
- Since 1945 the population has more than doubled from 140 to 296 million and the
number of households has increased more than threefold, rising from 37 to 112 million.
Clearly then, most of the $50 trillion of new personal wealth created during the
past 60 years now lies in the hands of new households instead of going to the 37
million families that held the $711 billion of US household net worth in 1945. Thus,
viewed in a long-term perspective most of the personal wealth created by the dynamic
US economy accrues to "new households."
- The aggregate US Household wealth increased every year, except 1957, 1969, 1974
and the 3-year period 2000-2002.
|
|
Lessons: |
- This graph, like the Trickle-down Effect graph in Ranking, the Rich, and the Mega-Rich,
again demonstrates the United States’ proficiency in created wealth for those other
than the established rich. In particular, this graph shows that a large percentage
of new wealth creation in the US has gone to new households.
|
|
|
|
Graph 2: US Household Asset Allocation 1945-2005 |
 |
|
Whats Going On Here? |
- The portion of total US Households asset invested in real estate grew from 18% in
1945 to about 33% as of year-end 2005 (see blue area in the graph above).
- The value of corporate equity (stocks) has also shown strong growth relative to
other assets during the past 60-year period, roughly doubling its share in the household
asset allocation from 15% in 1945 to about 27% as of year-end 2005.
- The overall share of stocks in the household asset composition has fluctuated widely
in line with the overall market for US stocks. At its lowest (in 1948 and mid-1970),
the share of corporate equity (in percent of total household assets) was below 11%
and at its highest in 1999 it was about 40% of total US household assets.
- Stocks held "Indirect" (e.g., through Mutual Funds) have overtaken direct holding
of stocks by US households (see light vs. dark green area in the graph). Bank deposits,
credit market instruments, pensions and other assets (such as value of insurance
policies) have declined relative to stocks and real estate.
|
|
Lessons
|
- Real Estates share of the net US household wealth has increased significantly in
the past years, as have both direct and indirectly held stocks. Pensions and other
assets have become less used as people have increasingly switched to investing more
in Mutual Funds, Hedge Funds, etc. Real Estate recently became the largest component
of US household wealth for the first time.
|
|
|
|
|
|
|
|
|
|
Real Estate |
|
|
|
Graph 1: Real Estate Dominates Assets Allocation for most US Households |
 |
|
Whats Going On Here? |
- The graph above shows residential real estate as a percentage of US household total
assets across different wealth percentiles. While stocks and real estate have historically
traded places as the 1st and 2nd largest components of total US household assets,
the picture is very different when looking at asset allocation by individual wealth
bracket as opposed to across all US households.
- For most US households (i.e., the households between the bottom 30% wealth percentile,
whom are not amongst the 69% of US households owning their home, and the top 5%
wealthiest households, whom owns most of the stocks), residential real estate often
represents at least two-thirds of their total assets. In other words, once someone
makes the transition from renting to owning a house, they usually end up placing
most of their financial "eggs" in one basket.
- After the transition to home ownership, most families slowly and gradually reduce
their exposure to one single asset (their house) over time. However, on average
US households own 3-4 houses in a lifetime and there is a tendency to "trade up",
thereby prolonging the period of strong exposure to one asset for most of their
professional career.
- While recent surveys show that over 50% of US households own corporate equity, stock
ownership still lags far behind housing as a share of most households' portfolio.
However, the wealthiest 5% of US households own most of all privately held corporate
equity (stocks) and they continue to enjoy almost all of the increases in the corporate
equity value.
|
|
Lessons
|
- Many Americans are "house poor", i.e., they have almost all their financial resources
tied to their homes. While real estate might offer a rather safe form of investment
in the long run, having nearly all your investments in one class of assets subjects
you to your local market conditions while also leaving you almost no flexibility
to pursue other forms of investing.
|
|
|
|
Table 1: Appreciation of US Residential Real Estate for the past 30 years (1975-2005)
by State |
 |
|
Whats Going On Here? |
- The table above summarizes the appreciation rates of residential real estate for
all 50 states during the past 30 years. The returns (i.e., compounded annual appreciations)
are ranked and given both in terms of nominal figures and real returns after having
adjusted for inflation (CPI) during the period.
- Overall, the US housing market appreciated 6.15% in nominal terms and 1.81% in real
terms, when adjusting for the 4.38% inflation for the period (1975-2005). At first
glance, these returns seem very low, but keep in mind that the returns do not include
the value of living in the home. By adding the value of using the home (i.e., a
rental rate) which has averaged about 4% of the market value of the home, the average
return for the past 30 years have been about 6% p.a.
- Looking at individual states, the performance-range is broad. California generated
the best returns with 9.1% nominal appreciation of homes and 4.7% on an inflation-adjusted
basis. The weakest residential real estate market was in North Dakota, where house
prices appreciated at a rate of 0.82% p.a. below the US inflation rate.
- Eighteen states performed better than the weighted average for the US. Most of these
eighteen states are major economic and population centers located on either the
East or West Coast.
- Five states showed a negative return in the housing market after adjusting for inflation
and the residential real estate markets for 21 states did not appreciate by more
than 1% above inflation.
|
|
Lessons
|
- The large variation in appreciation rates between different areas of the United
States shows that while real estate may be a good investment for some families,
others technically lose money because of the placement of their house. When considering
that stocks appreciated at approximately 5-9% annually in real terms over this same
period, one quickly sees that many Americans could benefit from investing less in
their houses and more in corporate equity. Consequently, stretching yourself while
house shopping and thus making yourself house-poor may not be the best option for
many families. It should be noted that there is a value to living in a house that
holding a stock does not have, but it may not make up for the difference in appreciation
rates between stocks and real estate.
- This difference in appreciation rate between stocks and real estate is also a primary
reason that the "rich get richer" in the United States. Since the rich can live
in luxury homes without overextending themselves in buying houses, they have historically
held much of the corporate equity and have consequently received the benefit from
the increases in stock value.
|
|
|
|
|
|
|
|
|
|
|
Stocks and Other Financial Assets |
|
|
|
Table 1: Return and Return Variations for Stocks, Bonds and T-bills |
 |
|
Whats Going On Here? |
- The table above shows both nominal returns and real (inflation-adjusted) returns
for various core financial assets for the past 80 years. The table also shows the
standard deviation of return (measuring the annual variability in return) as well
as the serial correlation in the return.
- While more volatile than other investment alternatives in the short term, stocks
have provided significantly higher returns than bonds, T-bills and other money market
instruments over the longer term. Small capitalization stock returned in excess
of 9% compounded p.a. (after having adjusted for inflation). This period also included
the Great Depression in the 1930s as well as the debacle in the small stock market
after the turn of the Century.
- The returns for large capitalization stocks have been slightly lower, but the risk
(variation in return) has also been lower (20.3% p.a. vs. 32.3% p.a. for small capitalization
stocks).
- In other words, the annual variations in return of a well-diversified stock portfolio
were over 20% for large stocks and over 32% for small capitalization stocks. It
would be even higher for a non-diversified portfolio. In general, about 70% of the
risk associated with a stock is considered specific to that company, but if investors
buy a portfolio of 20-40 stocks (equal weight in $-terms) they would generally have
achieved a sound diversification.
- Inflation for the period 1926-2005 was 3.35%, i.e., stocks returned a nominal 9-13%
before adjusting for inflation.
- Interests on T-bills and bank deposits barely kept up with inflation for the 80-year
period. If you consider that you need to pay taxes on the interest each year, the
actually return came even closer to zero.
- Long-term Government Bonds yielded 2.3% on an inflation-adjusted while long-term
Corporate Bonds yielded 2.8% for the period.
- The low serial correlation for stocks (+/- 0) just means that they "bounce around"
from year to year, without any relation to what the market did the year before.
However, inflation comes in waves and since bank deposits, T-Bills, and bonds are
primarily a hedge against inflation, they also have a positive serial correlation.
The same holds true for real estate.
|
|
Lessons
|
- This table at its core demonstrates the risk-return relationship. Other than a few
slight variations, the more volatile the stock the higher the real return. Even
the Small Cap. stocks, the most volatile of the groups, have never had negative
returns in a period longer than ~20 years. This does not mean that if you put all
your money in a small cap. stock you cannot lose your money in a period of longer
than 20 years, but rather that if you have a diversified portfolio of small cap.
stocks you historically would never have lost money for holding periods of longer
than 20 years. Consequently, if your investing early in your career, more volatile
stocks can be a great tool for helping you build long-term wealth if looking at
a long time horizon.
- This huge standard deviation of smaller stocks also shows why it can be prudent
to invest more in fixed income financial assets as your nearing retirement. You don’t want to be caught needing money in a year financial markets are struggling.
|
|
|
|
Graph 1: US Household Allocation of Financial Assets |
 |
|
Whats Going On Here? |
- Amongst financial assets held by US households, retirement accounts represent the
largest component accounting for 28.4% as of 2001.
- The graph above shows that US households has been shifting their share of financial
assets held directly towards some form of assets managed by third parties. E.g.,
transaction accounts and certificates of deposits fell from 19.0% to 11.5% and from
10.2% to 3.1%, respectively.
- The relative share of stocks and mutual funds (excluding money market mutual funds)
grew from 15.0% to 21.6% and 5.3% to 12.2%, respectively, during the 12-year period.
|
|
Lessons
|
- Americans have begun putting more and more of their money in managed assets such
as mutual funds and "other managed assets" while financial assets such as transaction
accounts and certificates of deposites have fallen in popularity.
- The fall in bond popularity and rise in stocks shows that Americans are drawn to
the higher potential return of stocks instead of focusing on the safety of bonds.
|
|
|
|
|
|
|
|
Debt and Borrowing |
|
|
|
Graph 1: US Debt Levels |
 |
|
Whats Going On Here? |
- The equity in your home is the difference between the value of your house and your
mortgage. The fall in the equity in peoples homes means that people have taken out
more and more money against the value of their house. This is also seen in the rise
in Real Estate Equity as % of Household Equity. A rise in the blue line indicates
that the total real estate equity is rising as household equity falls.
|
|
Lessons
|
- The rise in the debt levels in the US means that Americans are becoming more and
more leveraged. The latest fall in home equity is also a symptom of the negative
savings rate, which is a problematic reason for a fall in home equity. In general,
taking out money against your home can offer wealth-creation potentials since home
equity loans often offer lower interest than the appreciation of some financial
assets.
|
|
|
|
Graph 1: US Household Allocation of Financial Assets |
 |
|
Whats Going On Here? |
- As the graph shows, by far a majority of US Household Debt is tied to real estate.
Americans borrow foremost for home purchase and for residential property.
|
|
Lessons
|
- There is a fundamental difference between borrowing in order to invest in an appreciating
asset and borrowing to invest in a depreciating asset. Real Estate and residential
property appreciate at different rates depending on where you live, and borrowing
(on margin, etc.) in order to invest in other financial assets (e.g., stocks) may
qualifiy as prudent borrowing. Borrowing for education may return the most in the
long run, and student loans are some of the most favorable for among other things
that reason. Borrowing for other purposes are often less prudent and should ideally
try to be avoided.
|
|
|
|
|
|