A front page note entitled Generational Wealth Gap Increases (USA Today Money Section, 11/7/2011) calls attention to the growth of wealth, or not, by American households. Based upon a Pew report, the anonymous journalist’s short note is duplicated as follows:
The wealth gap between younger and older Americans has stretched to the widest on record. The typical U.S. household headed by a person 65 or older has a net worth 47 times greater than a household headed by someone under 35, according to an analysis of census data by the Pew Research Center released today. The gap is more than double what it was in 2005, and nearly five times the 10-to-one disparity 25 years ago, after adjusting for inflation. More young adults are pursuing degrees, taking on debt as they wait for the job market to recover. Others struggle to pay mortgages on homes worth less than their purchase cost. The report spotlights a government safety net that has buoyed older Americans on Social Security and Medicare amid cuts to education and cash assistance for the poor.
There are two distinct parts to this report. The first part is data based, presents objective findings verbatim from the Pew report, and ends after “adjusting for inflation”. This would be an appropriate point to highlight the Pew report’s findings which explain the gap with some clarity. The journalist chose not to do so.
In its place, he/she states the report “spotlights a government safety net that has buoyed older Americans on Social Security and Medicare amid cuts to education and cash assistance for the poor.” This is pure creative writing, and is not to be found anywhere within the Pew report. To suggest that wealth in America is achieved through a government safety net, Social Security and Medicare, flies in the face of any rational thought. The alleged cuts to education and cash assistance to the poor are a liberal’s fantasy. Only in Washington’s are reported budget cuts actual increases in annual federal expenditures.
The importance of the Pew report is its perspective on wealth in America. Wealth is not a fairy tale like Jack’s Bean Stalk which grew to full maturity overnight. Wealth is an asset which grows, or not, over a lifetime of many decades. Wealth is the by-product of deliberate individual and household effort following a prescription which is well known, but not widely practiced. Statistics and ratios add little to understanding wealth, although the findings, on which it is based, are reinforcing for those who tolerate the numbers. For those who know and love America, the Pew report documents numerically the experience of many who live the American dream to the fullest. Household wealth is one measure of this dream. Wealth is not a “given”, but the byproduct of individual and household effort based upon hustling rather than entitlement, working rather than living on the dole.
The primary message of the Pew report is that the American dream over the 25-year period from 1984 to 2009 is alive for some and difficult to achieve. Contrary to President Obama’s public pronouncements of doom and gloom, those who pay attention and follow a clear and relentless prescription for several decades have an opportunity to create a nest egg and retire with some comfort. Data and tables from the Pew report display these stages quite clearly, while common knowledge fills in the major blanks nicely.
The lifelong stages in the growth of household wealth are as follows:
1) Growing to adulthood
2) Young households
3) Home ownership stage
4) Saving and investing
Each stage requires fulfilling basic tasks which allow moving to the next step in the process with a greater opportunity for success. Failure to complete any stage responsibly is likely to reduce the overall growth potential of the individual, and limits his or her eventual household wealth. The Pew report puts numbers on household net worth by age group and arrives at the oldest group, 65 and over, where the level of net worth helps to define the lifestyle that follows. These stages define the household behavior and the individual choices that determine a successful path. The level of success at each stage determines how far up the ladder one may climb.
Growing to adulthood
Childhood and adolescence is a relentless struggle with school. While genetics may play a major role in this first step, growing up in a specific family contributes significantly to doing well in school. In addition to what one learns through twelve years of schooling, the education of both parents is a major contributor to success in school as measured by college admission scores.
Future wealth through education is best addressed by focusing on those skills and abilities that support working, employment, and building a foundation for future learning. The schools do a fair job preparing students through their academic tracks, which are college preparation programs. The schools’ greatest failures are in developing those skills and abilities needed for employment when a college degree is not needed. A great salesman is probably not helped much through higher education. A large numbers of students would have a leg-up if the schools guided the majority of students toward the skilled and semi-skilled occupations in construction, manufacturing, business, and industry. In the most general sense the schools should train individuals to read, write, communicate well, and follow instructions, as many workers learn their basic job performance skills after they are hired.
Illiteracy, on the other hand, and many other gross performance deficits are almost certain predictors of difficulty getting and holding jobs in today’s economy. Steps 2, 3, and 4 above are supported exclusively through steady employment over a full productive lifetime. An increasing number of entry-level jobs today require understanding computers, touch screens, and data entry to perform some simple business or production function.
One widespread myth currently in vogue is that poverty explains the huge gap in student learning. Responsible research essentially takes poverty off the table for individual students even from the poorest of homes, other things being equal. (See High and Low SAT Scores: The Differenced) The gremlin in education is that other things are rarely equal. Poorly educated parents, broken families or no families, and the cultural values of an individual’s surroundings are the major predictors of poorly educated children. They are almost certain predictors of poverty when viewed through wealth in America.
Households under the age of 35 include a wide variety of flavors, from single wage earners to extended families with children. Almost by definition, young households in America have no wealth. In the beginning they are starting a job, a career, and most are working for the first time outside the home. Many live at home with parents, and only the census-process and the IRS determine whether adult children living at home are part of one or more households.
The PEW data on American household net worth across ten household age groups over this single 25-year period is shown in the following table. The comparisons by age group are dramatic. Adjusting for inflation does not make the groups comparable, but makes the basis for comparison more equitable. The essence of the values reported is seen in the change column.
Median net worth by age of household in 2010 dollars
|65 and over||$120,457||$170,494||+42%|
While the median net worth during this 25 year period increased only 10%, or $6,000, the pattern of change across the age groups is startling. The younger each subsequent household age group, the poorer each group performed 25 years later. These change scores are plotted in Table 2 for visual clarity.
Such dramatic and consistent results suggest a single factor is at work which influenced the older groups less, or the younger groups more. While there are undoubtedly many factors in play, this single factor is so powerful that it must be considered the dog that wags the tail. This single factor is the increased use of debt, also known as credit within the national economy. As a general rule wealth is not created through debt. Over 5, 20, or 50 years the cost of credit is a relentless drain upon household finances. A young family may depend heavily upon credit to cover the exorbitant costs involved in raising children and paying its bills. Unless this demon is recognized and managed prudently, young family finances may spiral out of control.
Staying above water financially by young families is accomplished more easily when there are two income earners in a household. At this stage the prudent management of credit and the eventual elimination of most debt is the key to the subsequent growth of household wealth. Over the past few decades the primary pattern of family households is the increased divorce rate, more households with single parents, taking on mortgages with little or no down payment, and making minimum payments on credit card debt. The more recent purchase of new and used homes by individuals with little or no initial equity in those homes is the most recent bubble to erode the net worth of all families. These are the recurrent financial burdens young families face which delay or prevent the growth of household wealth.
Instability is the rule among young families. Renting a place to live is often the expedient first choice for new and growing families. Saving cash for a down payment on a home mortgage is a common struggle on this path. Home ownership is identified in the PEW report as the primary source of household wealth in America over 25 years. Equity in a home builds slowly. It requires many years to mature fully, and may involve buying and selling several homes as each household grows and circumstances change. This is not a foolproof investment, but home ownership, when managed well, accounts for the largest single asset among families with positive net worth.
The comparison tables above show clearly that those folks in the 65 and over group are the only group which performed better than the median 10% growth rate. These folks have been paying on mortgages on their homes throughout their working lives, and many have fully paid off their mortgages by the time they reach retirement. Having no home mortgage is a rare luxury which allows diversification into other assets.
Saving and Investing
As families mature, the hope is for the children to complete school and go to work. Achieving this, the savings may be diverted into other investments. Many of these investments are virtually hidden from view while working. One hidden investment is Social Security whose benefits at retirement depend upon the level of contributions, from working, averaged over a period of many years.
Most employers offer retirement plans based upon individual and company contributions. Funds within these plans are invested in securities which grow over time. Individuals may establish retirement accounts independently of employment that grow through tax paid or tax deferred contributions. Individual investment in stocks is probably not the best plan. A better alternative is to invest through stock funds which are managed by professionals and are traded publicly, like Fidelity’s family of funds.
One known individual purchased 1,000 shares of Aflac as a young working man in his 20s. This may have been the only stocks he ever owned. With the growth of value of these shares over his 40+ working years this single asset grew to an amount greater than that owned by Aflac’s CEO. While he was living primarily on stock dividends and Social Security at retirement, he was such a skin-flint that only his heirs fully enjoyed the wealth he accumulated through his great patience. This is an unusual example of the growth of wealth through stock ownership. He was debt free, but appeared to be unable to fully enjoy this unusual freedom. Practically all retirement funds are heavily invested in America’s publicly traded companies through common and preferred stock, and bonds which may yield a smaller return, but carry an improved risk from default.
The PEW report is a revelation through what it does not say. The youngest households’ net worth is less than a third of what their age-equivalent peers had 25 years earlier. The three youngest groups each had less net worth than their earlier peers. Increasingly what evolved was the introduction of credit, also known as debt, as the means to grow wealth. As debt increases, as it clearly did, household net worth is decreased by an equal or greater amount.
Making only the minimum payment on credit card debt pays off this debt in 22 years, provided no additional charges are added. Virtually all of the payments go toward interest on the debt in the same way that most mortgage payments on a home go to pay interest. It is only the prudent management of debt that allows net worth to grow to positive numbers. Over this 25 year period, the younger households have not learned this lesson, and most are managing their debt into the poor house.
To report a statistical ratio, 47 times, as the meaningful gap in the growth of household wealth does a serious disservice to the opportunity to get ahead in America. Over this 25-year period it is the growth of debt that multiplied the gap in wealth. As ratios like household wealth go, the lower figure, the denominator, is the terminator of wealth. A clearer picture of this negative influence on household net worth is not possible.
It is equally clear that our federal and most state and local governments have been growing debt like Topsy. The vast majority of America’s debt is not even on display, as our congress exempts itself from reporting retirement debt obligations into the future. Debt obligations coming due decades into the future may be ignored at ones peril. Like our younger American households, our federal government seems to believe that increasing debt will, somehow, be converted into wealth. All that is missing is the magic wand.