Many of you are painfully aware of how many friends or family members are out of work, now under-employed, or who have lost their homes. Geoff Considine, a leading contributor to the Portfolioist, provides his take on what we're calling the "collapse" in household net worth, starting with a recently published report released from the Federal Reserve called the "Survey of Consumer Finances" (SCF).
This study, performed every three years, provides an analysis of household income and wealth across America, and the results will astound you. The SCF is well-worth reading if you want to get a handle on the state of Americans' finances-especially if you want to see how those same finances have changed dramatically in just three short years.About the Survey:
Almost 6,500 households participated. The data was collected in 2010 and the participating households were selected using a method to ensure that they represented an accurate cross-section of the American population.)
The household net worth figures include the value of all household assets, minus all debts. Assets included:
- Real estate holdings
- The value of private businesses (owned wholly or in part, by a household)
- Bank accounts
- 401(k) plans and IRA balances along with other related retirement plans (Net worth figures do not include an estimate of the value of future benefits from traditional pension plans)
- Stock portfolios and other investments
Median household income declined by 7.7% (after adjusting for inflation) from the 2007 survey to the 2010 survey. Far more dramatic, however, is that median household net worth dropped by 38.8% (again, adjusted for inflation) over the same three-year period.
In the 2007 survey, the median household net worth was $126,400. In the 2010 survey, the median household net worth plummeted 38.8% to $77,300-the lowest level recorded by the survey since 1992 (remember, these figures are in inflation-adjusted dollars).
So, is the middle class getting squeezed even harder here? The net worth of households in the top 10% (the 90th percentile) dropped by 0.3% over this same period. The 90th percentile household net worth was $955,600 in the 2007 survey and $952,500 in the 2010 survey. The sharp contrast between the substantial losses in net worth for the median household and the negligible losses for the top 10% is definitely notable.No Exaggeration
Unfortunately, these results are not an exaggeration.
While most of this decline can be attributed to the drop in housing prices, the drop in value of a household's other assets-like household stock portfolios-also added significantly to the decline.
Another new report by the Census Bureau found that median household net worth had declined by 35% from 2005 to 2010. This study also supports the idea that housing-while a substantial drag on net worth-was far from the entire story. CNN's own analysis of the Census Bureau study, "Wealth implosion: It's not just housing" found that household net worth dropped 25% from 2005-2010. (It is also worth noting that the median household net worth calculated by the Census Bureau, once you exclude housing, was $15,000 in 2010).What Does Losing Your "Net Worth" Really Mean?
Think of your household net worth as the foundation for your future income. It's the amount of wealth you grow through non-wage income (i.e., income-generating assets such as stocks, bonds, annuities, or other investments, or your home). As we all know, the income potential from one source of wealth can vary (take bonds for example-we are currently in a low-yield bond environment). However, a 39% decrease in household net worth (through all sources of income) translates directly to a 39% decrease in future non-wage income.
When compared to the median household income, which declined by 7.7%-yes-the decline in income is painful, but it pales by comparison to the estimated 39% investors will lose in future non-wage income from their household wealth. In other words, the decline in income we have experienced over the past three years is minimal compared to the reduction in future retirement income that our savings and assets are likely to provide until (1) asset prices rise with a broad economic recovery, (2) interest rates rise, or both.Two Hard Lessons to Be Learned
The enormous drop in household net worth in just a few years has two primary lessons for all of us:
(1) American households are more sensitive to economic variability. While the main reasons for our current economic condition can be boiled down to (1) low savings rates and (2) high borrowing levels, these two factors combined have made the American household far more sensitive to economic variability.
(2) Americans Need to Remember that Borrowing Has Risks and Rewards. Many of us tend to forget that borrowing of any sort amplifies both risk and reward. Again, let's look at a housing example:
If you made a 10% down payment on your home and the market value of your house goes up 10%, you have "made" a 100% return on your investment (the down payment). This shows the power of borrowing. On the other hand, if the value of your house drops by 10%, you've lost 100% of your down payment. And there's the risk that many American's face today.What Can We Do Now?
Americans who are looking to retire over the next few years and who plan to use the equity in their homes as a source of income to fund their retirement (either by selling their homes or taking out reverse mortgages) may want to think about working part-time, or perhaps (if they can) putting off retirement for a few more years.
For those of us still working, this type of market environment favors investments that rely on current income rather than on expected future growth. Dividend-paying stocks will tend to look more attractive vs. non-dividend stocks, for example. Even so, we all need to be realistic about the recovery of the U.S. economy as a whole and the recovery of our own portfolios.
Unfortunately, both are likely to be long and slow.Related Links:
- Providing the Value of Risk Management in Retirement Planning
- How Much Risk Should a 65-Year-Old Take?
- The Case for Dividend-Focused Investing
The data for this article was provided by Geoff Considine, Ph.D., the leading contributor to the Portfolioist.
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