I have to admit to rolling my eyes at the headlines around US Household Wealth hitting an all time high, as I felt the number wasn’t particular useful. More specifically unless a total household wealth number is expressed in terms of how it’s distributed, it doesn’t tell you much about the financial health of the typical household or the country overall.
In my opinion, numbers that would actually be valuable would be: wealth increase/decrease for the middle 60-70% of US households, followed by wealth increase/decrease for each quintile of the population. In fact, I daresay you should leave out the top 10-15% when having broad economic discussions, because outside of extenuating circumstances or high-cost situations, people in the top 10-15% tend to be operating with a surplus so even in a down market they’re often at least able to increasing their general savings.
When you’re in the top 15% (and especially the 5-10%) things are just different. An economic downturn typically means “less surplus” rather than “how do we make ends meet”, not to mention it turn into a wealth building opportunity because you can buy stocks on the cheap.*
It goes without saying that this discussion begs the usual inequality arguments, but remember: even with a rising tide that lifts all boats, the tide will always benefit wealthier people disproportionately more because they have more assets to put towards investing, building businesses, etc. The uber-rich are getting richer now, but they would be getting even richer if the middle class was growing instead of shrinking.
From a brass tax day-to-day perspective, what’s more important is whether or not the tide is lifting all boats rather than the gap between average folks and the 1%. That’s why wealth improvement measures that focus on the middle 50-70% are far more valuable than noting that wealth increased overall, a measure that is arguably useless as it may or may not apply to a wide cross-section of the population.
However, there is another side to this: and that’s the balance of liquid vs. illiquid assets and what people are saving their money for, as outlined in a recent Bloomberg piece (emphasis mine):
“…It’s worth drawing attention to the two biggest components of the $80 trillion: household real estate, with a value of $19.4 trillion, and $19.6 trillion of pension entitlements. That second part isn’t exactly what it sounds like to most folks, so let’s break it down further.
The $19.6 trillion pension total includes $4.9 trillion invested in 401(k) plans (which most Americans don’t think of as “pension entitlements”) plus $3.1 trillion in private pensions and $8.5 trillion in government pension entitlements. IRAs hold another $5.7 trillion worth of securities. (For those counting, the rest of that $19.4 trillion is in life insurance.)
So, basically of $80.7 trillion in household wealth, only $10.6 trillion, or about 13 percent is in 401(k)s and IRAs, the key instruments of middle class wealth accumulation…
…Consider the other big component of wealth, that $19.4 trillion in real estate. Except there’s an asterisk here: subtract $9.4 trillion in mortgages, and we’re left with $10 trillion in home equity.”
So the upshot of all of this is:
- First – an asterisk for the asterisk: the report’s $80 trillion number is a “net worth” number that factors in Mortgages, so I’m not sure why the author of the article subtracted it twice. He should’ve just reported that $10 trillion of the $80 trillion is Real Estate Equity.
- Second Math Error: the total pensions (401k, IRA, Private & Government Pensions) = $22.4 trillion, NOT $19.4 trillion + Life Insurance**
- Americans, particularly middle-middle class Americans are very illiquid, as roughly ~40% of total household wealth is comprised of illiquid assets that one either can’t use until retirement OR cannot use without selling one’s home or taking out a home equity loan. Meaning: you’re either paying interest or you sold your home and would have to dedicate at least some of the proceeds to procuring a new place to live.
- The 40% number is especially important for the middle 50-70% as it means a big chunk (if not all) of their wealth can’t be used to invest, weather economic shocks or cover big expenses. I’m sure we all know people who have plenty of home equity & retirement savings but have to use credit cards to pay for their kid’s braces.
- People’s asset allocations more or less mirror what people are socialized (and tax incentivized) to do in order to be solidly middle class: buy a house (arguably at all costs/even if it stretches your budget***), put money into retirement, with a far lower significance placed on general liquidity. As a general rule we Americans place such a premium on home ownership that we consider it better to be a cash poor homeowner than to be a cash rich renter. I’m sure I’m not the only one to observe cash poor homeowners encouraging a renter with a lot of savings to buy a house as a good financial move, rather than saying: “make sure you can actually afford a house before you make the mistake we did”. I have heard people saying: “we’re low on cash these days, but it’s so worth it”
To put the illiquid vs. liquid situation into better perspective, consider the following data around home equity vs. savings balances: the typical savings balance is $3,800.00 while the typical amount of home equity is $65,000.00. I’ve seen other data suggesting the savings amount is as high as $5,300.00, but it doesn’t change the situation much.
Personally I’d much rather have $35,000.00 in liquid assets and a far lower home equity balance, than to be in the situation articulated above. All it would take is one big expense or a job loss coupled with a big expense to find one’s self in a situation where your savings are wiped out and you have to go into debt.
Looking at all of this makes me wish that the typical American had a better understanding of illiquid vs. liquid assets, as it might better inform people as to how to better allocate their resources. This is especially true when you look at the arguments people are having in the comments section of the article, around whether to buy or rent, the cost of renting vs. buying, people noting that buying (from a financial perspective) = renting from the bank, total cost of buying with interest, etc.
I.e. none of those things are the bloody point!
The real point is that far too many Americans are house and retirement rich (or at least stable) and cash poor, a situation that in day to day practical terms probably feels like being poor overall if you have to use credit cards to cover major expenses and/or only have a month or two worth of expenses saved up.
What does it matter if your retirement accounts and housing values are “adding to your wealth” if you have to put your kid’s braces on a credit card? In fact, I’m sure many folks in the middle 50-70% feel poorer than they did in ’06-’09, despite their housing values and retirement accounts recovering, because they don’t have enough liquidity to feel secure.
Either way, all of this begs for a household level rethink of how people approach homeownership, savings and retirement. For the record I’m not saying people shouldn’t buy homes, I’m just saying that they should approach it in a way that allows them to grow their home equity AND their liquidity, as opposed to just growing the former. Thinking of buying a home as “forced savings” that allows you to neglect your liquid asset accumulation is, well, a mathematical farce.****
It’s not savings if you have to pay the bank interest to access asset value, which you’re already paying monthly interest on, it’s just debt.
*I don’t say this to paint people in the 15% in a bad light or to say it’s predatory to pick up stocks when they’re cheap, I’m merely noting a mathematical fact that’s neither bad or good, it just is. Still the delta between trying to survive and recover from a downturn vs. being positioned to emerge from it stronger than ever, is a clear demarcation between life in the 15% vs. the 85%.
**Maybe I should’ve pitched this to Bloomberg, I mean, my math is better and I think my points are just as cogent if not more.
***Yes, yes, I know, many of us live in areas where homes are so expensive that many people may feel they don’t have a choice to buy the cheaper house. However, if you go into that situation understanding the implications of liquid vs. illiquid assets, you can at least go into the situation understanding the risks.
****A conspiracy theorist might say banks like this situation as it forces people to use home equity loans and credit cards to cover liquidity gaps. Still, probably best to wary of folks selling you “investments” (personal residence, stocks or otherwise) when they only make money on the interest, fees, commissions, etc., and could care less whether or not the investment makes YOU money.