argentus-outlook-2014-10-top-10-percent

ARGENTUS OUTLOOK

THE

INVESTMENT SOLUTIONS THAT FIT TODAY’S GLOBAL ECONOMY

October 2014 • Volume 3, Issue 10

A View from the Top: Wealth Among America’s Top 10%

Small Talk

By W. Michael Cox and Richard Alm

The August issue of The Argentus

stocks’ plunge in 2001, the housing bust in 2006, the Outlook mined • Capital and consumption. The essay “Living Above Our Means” highlights the O’Neil Center Great Recession in 2008-9 and the sluggish recovery Federal Reserve data to draw a portrait of America’s overall for Global Markets and Freedom’s annual

of the past six years. These tumultuous events left their wealth. The bottom line: It took six years, but the country’s report. It identifies two factors that spur capital mark on how the Top 10 percent holds its wealth. overall net worth has finally recovered from the battering it

formation—more education and long-term Assets of the Top 10% took during a severe financial crisis and recession. economic freedom. A larger capital stock

Let’s start with the assets that make up the Top We now return to the topic of America’s wealth to look per capita leads to higher consumption per

capita. Economic freedom has been increasing 10 percent’s typical financial portfolio. This wellmore closely at the households that own the lion’s share

globally for decades, so most countries should heeled group has consistently increased its retirement of U.S. assets—the Top 10 percent. Investors make up see living standards rise. The United States is

savings during each three-year period. Assets in IRAs, a large share of this group, which makes its choices and a glaring exception. U.S. economic freedom

401ks and other plans grew from an inflation-adjusted predilections particularly relevant to financial markets. has ebbed since 2000; its consumption per average of $143,000 in 1989 to $645,000 in 2013 Our second look at wealth emerges from

capita should eventually be 20 percent below what it would have been without the loss of (see chart below ).

September’s release of the Fed’s latest Survey of

economic freedom. To read the report, go to When it comes to stocks, the Top 10 percent loaded Consumer Finances.

Conducted every three years, this

www.oneilcenter.org. up in the 1990s, riding the decade’s bull market study provides more detailed information on who holds

• Treacherous taxation. The Tax Foundation higher. However, these investors grew leery of equities the country’s wealth by age, education, occupation

has looked at the 34 Organization for Economic as the market tanked in 2001 and 2007. Among the and other demographic characteristics. Perhaps most Cooperation and Development countries,

wealthiest households, the average value of direct important, it includes data on the distribution of wealth. finding that only France and Portugal have less stock holdings peaked at $473,400 in 2001, then it According to the Fed’s survey, the Top 10 percent

competitive tax systems than the United States. fell to $299,800 in 2010. started at a net worth of $941,700 in 2013. Over the The International Tax Competitiveness Index,

released in September, faults our country for The stock holdings’ uptick to $325,500 in the 2013 past two-plus decades, these households have done

the developed world’s highest corporate rates, survey probably reflects the rising value of existing assets well, with their share of the country’s wealth rising

taxation of worldwide corporate profits, poorly rather than a renewed interest in the stock market. from 67 percent in 1989 to 75 percent in 2013. structured state and local property taxes, high

Leery of stocks for non-retirement holdings, The journey was anything but smooth. Like the top marginal tax rates on individuals and double

the wealthy investors haven’t turned to bonds, the rest of the country, the Top 10 percent faced the task taxation of capital gains and dividend income.

In a globalizing economy, low tax burdens on traditional alternative to equities. Bond holdings have

of building and preserving wealth through the tech business investment and well-structured tax Continued on page 2 codes provide a competitive edge. Estonia, New How America’s Wealthiest Invest: Retirement Accounts Up, Stocks Down Zealand, Switzerland, Sweden and Australia have the most competitive tax system.

1000s of $2013 700

• Low hanging fruit. The O’Neil Center’s Robert Lawson and Capital University’s Saurav Roychoudhury see a simple way to add billions to the U.S. economy. Make entry easier for foreign tourists. Currently, U.S. visa requirements are among the world’s strictest, applying to 80 percent of countries. Many don’t present security risks—i.e., Poland. On a bilateral basis, removing each visa requirement would triple tourist flows. The World Bank figures a typical foreign visitor spends $2,000—so U.S. gains, with multipliers, could amount to as much as $200 million.

Fed Watch and Chart Topper: Page 3

Retirement accounts Stocks Pooled investment funds Transaction accounts Other managed assets Bonds Cash value life insurance Other Certificates of deposit Savings bonds

600

500

400

300

200

100

0

1989

1992

1995

1998

2001

2004

2007

2010

2013

Source: Federal Reserve Board

THE ARGENTUS OUTLOOK Continued from page 1

sagged. Instead, the Top 10 percent has shifted money toward pooled investments and transaction accounts.

Since 1989, pooled investment vehicles have proliferated, with more low-cost options, and wealthy investors apparently see mutual funds, index funds, exchange traded funds and the like as less risky than individual stocks. Average holdings rose from $43,400 in 1989 to $347,500 in 2007.

In the financial crisis’ aftermath, wealthy households lost some of their enthusiasm for pooled investments.

Average holdings fell to $340,000 in 2013—surely another sign that investor confidence, once shaken, takes a long time to rebuild.

The Top 10 percent shrunk their transaction accounts as perceptions about equities’ risk faded in the 1990s bull market. They moved back to cash and its equivalents after the market shocks of 2001 and 2008.

The preference for low-risk holdings has been particularly strong in recent years. Among the Top 10 percent, average holdings in transaction accounts rose from $166,300 in 2007 to $229,900 in 2013.

In times of low interest rates, investors face a choice.

They can take refuge in cash, knowing the opportunity cost is low, or they can seek higher returns by adjusting their risk horizons outward. The Fed data suggest that many of the wealthiest investors—now older and wiser—aren’t comfortable with venturing back into riskier assets.

Net Worth of the Top 10% In addition to their financial portfolios, the Top 10 percent hold significant non-financial assets—primary residences, second homes, land, commercial property and the like. In 2013, they owned 62 percent of the nation’s real assets, up from 59 percent in 1989.

Among the Top 10 percent, average net real wealth—non-financial assets minus the liabilities against them—soared as the housing bubble inflated, peaking at $2.6 million in the Fed’s 2007 survey (see chart below ). Debt was also rising—no doubt driven by mortgages and refinancings. By contrast, net financial assets showed little growth from 2001 to 2007.

Between 2007 and 2013, the wealthiest households saw their holdings of real assets fall to about $2.1 million in 2010 and 2013. They’ve paid down some of their debt. By 2013, net financial assets had bounced back, finally surpassing their 2007 high point. With real assets still lagging, the net worth of America’s wealthiest 10 percent was slightly below $4 million, down about $500,000.

The Top 10 percent owns significant assets. Since the Fed conducted its survey in April 2013, housing prices have risen—that should bolster net worth. The S&P 500, with dividends reinvested, gained nearly 25 percent—that should be good news for net worth.

We won’t know how good until the Fed makes its next Survey of Consumer Finances for 2016.

A final thought. The Fed data offer some tidbits about Top 10 percent households. They’re likely to be in the highest decile of income earners. They’re also likely to be headed by someone older, college-educated and self-employed or working in managerial and professional occupations.

The breakdown by education yields an unexpected result. Since 1995, all of the gains in average net worth have gone to college graduates. Every other group has gotten nowhere on average—even households headed by someone with some college but no degree.

Financial Assets, Real Assets and Debt Among the Wealthiest Americans 4500

1000s of $2013

4000 Net financial assets Net real assets Debt against real property Financial debt

3500 3000

1,804

1,652

1,799

1,905

2,147

2,058

1,802

2500 2000

1,342 817 757

1500

981 2,659 2,194

1000 500 0 -500

1,830 1,438

1,477

1,278

1,216

-103

-130

-120

-156

-170

-248

-279

-275

-229

1989

1992

1995

1998

2001

2004

2007

2010

2013

What It Means for Your Clients

Your clients may find this surprising: They don’t have to be multimillionaires to gain entry into the Top 10 percent of America’s wealthiest households.

The Federal Reserve’s data suggest a threshold net worth of $941,700 will do, so a large number of your clients are probably already in this select group. Most of them probably don’t consider themselves rich.

They worry about money.

Some lessons from the Fed data will help in dealing with these clients: • They’re highly committed to saving and investing for retirement, so they’ll seek clear, focused advice that helps them achieve their financial goals as they move beyond their working years. The demand for retirement products and services should be strong.

• They’re still jittery about investing in stocks—even after several years of outsized gains in the Dow Jones Industrial Average and S&P 500. A return to the 1990s—throw a dart, find a winner—isn’t on the horizon. Getting your clients to consider adding to their stock portfolios will require thorough, factual research and vetting of the risks involved.

• They’re holding large cash balances, which suits them for now. As interest rates rise, however, they’re likely to start considering alternatives—and they’ll need advice on reallocating their wealth.

• All told, the wealthiest American households have been through an unsettling 15 years, with wild swings in asset values. No doubt, they’d like greater certainty. Unfortunately, risks abound— economic growth, corporate profits, Fed policy, interest rates, federal deficits, higher taxes. All are sources of potential uncertainty for your clients.

By Argentus Partners, LLC

Source: Federal Reserve Board

About Michael Cox

Richard Alm

W. Michael Cox is director of the William J. O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business. He is chief economic advisor to Argentus Partners, LLC.

Richard Alm is writer in residence at the William J. O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business

THE ARGENTUS OUTLOOK

W. Michael Cox’s Fed Watch: When it meets this month, the Federal Reserve’s Open Market Committee will finally put an end to years of buying bonds in an attempt to pump additional money into a slowly growing economy. For now, let’s set aside the question of whether this policy of quantitative easing had much impact on growth and employment and focus on the mess it left behind— an unprecedented bulge in so-called base money, including reserves in the banking system.

If banks start lending their excess reserves, inflation could spike, forcing the Fed to raise interest rates sooner and faster than policymakers anticipated, hurting growth and employment.

In textbooks, the Fed shrinks base money by selling securities. However, with today’s excess reserves

so big, the traditional approach might take too long in draining the banking system’s excess reserves; meanwhile, inflationary risks would be inexorably building.

So the Fed may go another way—paying higher and higher interest rates on reserves. In doing so, the central bank would hope to encourage banks to continue holding a lot of reserves, even as rising interest rates give them a greater incentive to lend.

The policy also means the Fed won’t have to flood the market with government debt, helping the Treasury to finance still-large federal budget deficits.

The central bank might also want banks to hold more reserves to reduce the potential for bank failures and financial crises in the future.

What’s not to like about this policy?

First, the Fed won’t return as much profit to the Treasury, so in essence ordinary taxpayers are stuck with the bill for paying interest to Wall Street banks. Second, the Fed will continue to hold massive amounts of Treasury bonds and mortgage-backed securities, acting like a sovereign wealth fund for government debt. Third, and most important, banks would be more involved in helping government, rather than fueling economic growth by lending to the private sector.

In 25 years at the Federal Reserve Bank of Dallas, Dr. Cox rose to chief economist and senior vice president, advising the bank’s president on monetary policy and other economic issues.

Chart Topper Despite Shock of Financial Crisis, Americans Still Saving Less Than They Once Did As individuals, we praise the virtue of saving—setting money aside for the future. As a society, we’re not doing as much of it as we did a generation ago, but we’re doing better than we did a few years ago.

As a share of personal income, the U.S. savings rate was 8.2 percent in 2013, up from 7.2 percent the previous year. Over the past six years, the average has been just shy of 8 percent.

The recent figures look favorable compared to the years before the 2008 financial crisis, when Americans saved at historically low rates. From 1999 to 2006, the savings rate averaged 3.4 percent, with lows of 0.4 percent in 2000 and 1.5 percent in 2006.

Looking back further, the recent readings don’t look as positive. From 1952 to 1986, the U.S. savings rate was above 10 percent in every year except 1985, with peaks of 14.7 percent in 1952, 15 percent in 1973 and 13.4 percent in 1981.

The numbers suggest a broad story line: Americans began to consume more and save less in the late 1980s, continuing the buying spree right up to the financial crisis of 2008.

Since then, households have turned cautious—at least a bit.

Percent of Income 16

14

12

10

8

6

4

2

0 1952

1957

1962

1967

1972

1977

1982

1987

1992

1997

2002

2007

2012

Source: Bureau of Economic Analysis

About The Argentus Outlook A monthly publication of Argentus Partners, LLC, the newsletter strives to deliver current economic information relevant to investing and operating in today’s complex global economy.

Chief Executive Officer: Douglas Gill, CFP® Publisher: Susanna Joiner, Chief Marketing Officer Editor: Richard Alm Contact: marketing@argentuspartners.com

THE ARGENTUS OUTLOOK

For additional information, or to subscribe to the monthly publication, please e-mail marketing@argentuspartners.com

Important Disclosures: Information herein in this newsletter and has been obtained from sources believed to be reliable, but its accuracy and completeness cannot be guaranteed. This newsletter is for informational purposes only, and should not be considered as an offer, invitation or solicitation to subscribe, purchase or sell or any securities, and is not intended to provide any specific investment advice or recommendation. You should review your personal financial situation, investment objectives, goals and risk tolerance prior to investing. All indices referenced are unmanaged and an investor cannot invest directly into any index. The economic forecasts and projections illustrated in the newsletter may not develop as predicted and there can be no guarantee or assurance that strategies promoted will be successful. All expressions of opinion reflect the judgment of Dr. Cox and his research conducted for Argentus Partners, LLC at this date and are subject to change.

Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete.

This research material has been prepared by Argentus Partners, LLC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that Argentus Partners, LLC is not an affiliate of and makes no representation with respect to such entity.