Lessons from the Wealth Divide

“Every day I get up and look through the Forbes list of richest people in America.  If I’m not on there, I go to work.” – Robert Orben

The wealth divide in this country has been growing for a number of years as the difference between the haves and the have nots continues to widen. Take a look at this video that made the rounds a few months ago and you will probably be shocked at the actual numbers:

http://www.youtube.com/watch?v=QPKKQnijnsM&feature=youtu.be

The Pew Research Center recently released a report that found that the top 7% of Americans by wealth distribution gained 27% in net worth from 2009 to 2011. The net worth of the remaining 93% actually fell 4%. Overall wealth for the country rose in that time period, but as you can see it was concentrated at the very top.

Here is a chart from the study that shows different levels of net worth and how they changed over this time frame:

The initial reaction to the video and net worth statistics for many is shock and anger. Why does the country have to have such a high concentration of wealth in such a small number of our citizens? The unemployment rate remains above 7% yet the rich continue to increase their wealth? How can this be?

It’s easy to blame our government, CEOs, bankers and the rigged stock market when we see statistics such as these. They are all out to screw over the little guy. It’s not fair. This game is rigged by Wall Street and The Fed. And in most cases, these arguments are justified.

For better or for worse, this is the situation that we are in right now. You can take these stats at face value and complain about how unfair this situation is. Or you can learn from them and make changes to increase your net worth. Once you get over the anger of this data there are some takeaways that will hopefully help close the gap in the future.

CLOSING THE WEALTH GAP

1. Financial Education
There is no structured financial education system in this country. This is unfortunate. That means you have to show some initiative to increase your own financial literacy. You can get ahead by keeping things simple but you have to know where to look to get the right information. Start by reading any book by or about John Bogle, founder of Vanguard. Read The Little Book of Common Sense Investing and you will gain more knowledge than probably 90% of investors.

After reading a few books, if you still think you need more help, find a competent financial advisor that will help you through the process of saving and investing for the future. Make sure you find someone who is looking out for your best interests with no hidden agenda (like earning obscene commissions by pushing overpriced investment products on you).

If you happened to catch the Frontline PBS special called “The Retirement Gamble” last week you know that this is easier said than done (if you don’t like to read start your education by watching this video). Talk to others who already have someone they trust and go from there. Do your homework and find someone you are comfortable with.

2. Asset Allocation is Important
In the Pew report we also find out that households with a net worth of $500,000 or more held 65% of their wealth in investments such as stocks, bonds and 401(k) accounts. Another 17% comes from their home. But when you look at the numbers for those with less than $500,000 in net worth, only 33% of wealth is held in investments but over 50% is in their home.

The bursting of the real estate bubble should be a warning to any investor about the dangers of having a concentrated bet on your home (or any investment for that matter). On average, an investment in real estate barely keeps pace with inflation over the long-term.

The less affluent have to think about this investment as both a financial and life decision. Holding a diversified portfolio of financial assets with lower recurring costs is an easier way to build wealth than through an investment in real estate.

The American dream of home ownership needs to be re-examined. I’m not saying people shouldn’t own their homes, but renting is probably more cost effective for most people, especially those that will need to look in other parts of the country for employment. The slowdown in the real estate market has made it much tougher for people to relocate where the available jobs are in this country.

The decrease in home prices and interest rates should not be used as an excuse to buy a bigger, more expensive home. A $150,000 house at 2007 mortgage rates of roughly 6.25% would yield a monthly payment of about $920/month. That same priced house at today’s 3.50% rates would be only $670/month. And home prices have gone down in that time.

We can use this example as a way to show how the less affluent can save some money while purchasing an asset that has declined in value. The extra $250 a month can be used to save for the future in tax-advantaged retirement accounts to build other investments.

3. Take the Right Risks with Your Investments
You will have to own stocks over the long-term if you ever want to have enough saved to increase your net worth. If you think the stock market game is rigged by The Fed, instead of complaining about it and being bitter, you should join the wealthy and use the rigged game to your advantage.

The U.S. stock market had pretty nice returns in 2009, 2010 and 2011 (26.46%, 15.06% and 2.11% respectively for the S&P 500). For the households with $500,000 or greater net worth in 2011, 59% directly own stocks or mutual funds so they were helped greatly by the rising market.

Unfortunately, less affluent households actually had their stock holdings drop from 2009 (16%) to 2011 (13%). There was also a decrease in the number of IRA accounts for these households. So the stock market was up almost 50% from the beginning of 2009 to the end of 2011 and the lower net worth households actually lowered their stock ownership over that time.

A recent study from BankRate.com noted that 76% of Americans say they are not more inclined to invest in the stock market right now. They are obviously still nervous from having two huge drawdowns in the past decade and a half. Having a long-term time horizon is the key here.

It’s not just stocks that you should own to be successful. You need a diversified investment portfolio. Affluent households are 13 times more likely to hold bonds (government, municipal or corporates) than less affluent households.

4. Build Your Wealth Slow and Steady
Obviously those with a lower net worth are going to have a lower salary, therefore there’s no way they can save as much on an absolute basis. On the bright side your lower cost of living means you don’t have to have as large of a nest egg to retire to continue your current lifestyle.

Saving just $50 a month and increasing that amount by 3% a year for inflation over 35 years with a 6% return gets you over $103,000. Not nearly enough to retire on but it’s better than nothing. Using the $250 mortgage savings from above in the same example grows to almost $520,000. You can see how far your money can take you if you take a slow and steady approach to increase your net worth. It’s not going to happen overnight.

STIPULATIONS
Obviously there are some caveats to these lessons. The higher net worth individuals make more money and have more income for savings. Supporting a family in a world of increasing necessity costs (food, gas, tuition, etc.) and stagnant wage growth can be very challenging.  It is not always easy to just save a little more.

The denominator effect comes into play with real estate holdings as well (net worth is smaller so real estate takes up a larger piece of the pie). That is why it is so important to flip the asset allocation mix that we see in this report by slowly increasing savings in financial assets. Small amounts of money can have a very large impact in the long run.

Many people truly are in tough situations and don’t have the ability to save. But there are also those out there that live beyond their means and try to increase their standard of living strictly through spending on credit instead of saving. This only works for so long. Accepting your current situation and not letting envy determine your financial decisions will help. We have to play the hand that we were dealt.

It would be great to have more people take control of their finances to close the net worth gap. Until we get an education system in place to give people a common sense process about how to handle their own finances we are all on our own. Those that take the time to learn and save will have a better chance at increasing their net worth than those who blame others for the situation that they are in.

Sources:
The Pew Research Center

This is a lot of information to digest.  Any thoughts, ideas or holes in my arguments are welcome.

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