The Truth About Wealth

[W2R]

This Wall Street Journal article, subtitled "Affluence Is Becoming a Temporary Phenomenon. Here's How to Dodge the 'Beta Trap' and Hold On to What You've Got", might be of interest to some of us. Many of us who are not in the 1% are still trying to accumulate (or have accumulated) greater wealth than most. Many of us are highly dependent on financial markets, as is pointed out.

The Truth About Wealth

On Wall Street, "beta" measures volatility relative to the overall market; a beta of 1.0 signals alignment with the market. Technology and gambling stocks can have betas of 1.5 or more, since they tend to overshoot the market in cyclical ups and downs. Utilities, by contrast, both rise less and fall less than the overall market and usually have betas below 1.0.

The new rich have become the high-betas of our economy. With their dependence on financial markets, their leverage and their hyperspending, the top 1% have income swings that now are more than twice as high as those of the rest of the population.

A study by Jonathan A. Parker and Annette Vissing-Jorgensen of Northwestern University found that the beta of the top 1% nearly quadrupled between 1982 and 2007 to 2.39. The top 0.01% had a beta of 3.96, making even the riskiest tech stocks look safe by comparison. Economists and wealth managers say the betas of the rich have likely soared even higher in recent months as markets gyrated sharply.

"Being a high-beta in today's environment is different from being a high-beta in the '80s or even the '90s," says Craig Rawlins, president of Harris myCFO Investment Advisory Services, which serves wealthy families. "People are more susceptible to making bad decisions than they've ever been. There is higher risk in the marketplace today, with a lot more volatility."

 

[arebelspy]

Lesson? Ignore the markets, stay the course.

Interesting article. I've never really considered it from that angle as much. Thanks for sharing.

 

[pb4uski]

How did you score? I was low beta, but just barely.

I found the statement that "the top 1% have income swings that now are more than twice as high as those of the rest of the population" interesting.

Having worked in proximity to some 1 percenters (not sure if they would be 1% or not but they are high earners) there are a couple things about them that those of less means don't really understand and would probably not be willing to tolerate.

First, most of them have 24/7 jobs where work constantly intrudes on their personal life and they have no work/life balance at all - they continually work long hours (think 9am to 10 pm most days), frequently work all or part of weekends, have to cancel scheduled vacations or work some during vacation, etc and generally recognize that they are in effect trading a normal life for a boatload of money. I think that if you offered many middle class a similar trade of a boatload of money in exchange for working all sorts of nights and weekends that they wouldn't be too keen on the trade (which is fine, we all need to make our own decisions and live with them).

Second, at those upper levels job security just plain doesn't exist. If the boss (or new boss) doesn't want you around then you are gone. No such things as verbal warnings, written warnings, reprimands or probation or anything like that that apply to some other employees. I have a BIL who has been a high level exec for many years and has been let go numerous times, probably not for performance reasons, but more for other reasons (corporate reorgs, political reasons, etc). Those who do it just recognize that it comes with the territory and if you can't tolerate it then go do something else.

 

[donheff]

So are we talking income swings between $300K-$1M? I suspect someone who's income swings between $40k-$45K wouldn't be moved by that kind of beta. Now to the extent that we are talking about tragic swings (e.g. $500K this year $10K for the next three) I think we would see some sympathy.

 

[Birchwood]

300Kto 1mil: This may a diverse group. A lot of specialists doctors are prob. bet. 300-500K easy and their income are more of less stable. Business people who make 300K to 1 mil may see their income fluctuate dep/ on the business cycle.
1mil to 5 mil: a lot of these are CEOs or managers and part of their income may be stocks within the company. As stated above, they may be good for a few years and then, they may be let go, or, some of them are in a lower income for most of their working life, and the high income is in the tail of their careers.

 

[meierlde]

300Kto 1mil: This may a diverse group. A lot of specialists doctors are prob. bet. 300-500K easy and their income are more of less stable. Business people who make 300K to 1 mil may see their income fluctuate dep/ on the business cycle.
1mil to 5 mil: a lot of these are CEOs or managers and part of their income may be stocks within the company. As stated above, they may be good for a few years and then, they may be let go, or, some of them are in a lower income for most of their working life, and the high income is in the tail of their careers.

Add in most pro sports players to the 1% in terms of income, recall that the minimum salary for a rookie in the NFL is now 375k. Of course they can loose it all in a second due to injury, or being cut. But if a player makes it to 10 years the minimum is now 910k. So they have a high spike, but a very long retirement from the sport.

Further NBA and NHL salaries are in the same ballpark, the players have very good unions.

 

[traineeinvestor]

Robert Frank's book on the subject made for good reading: Amazon.com: The High-Beta Rich: How the Manic Wealthy Will Take Us to the Next Boom, Bubble, and Bust (9780307589897): Robert Frank: Books The sections on the impact on tax revenue, a fact well known to the politicians doing the spending, were especially interesting.

I scored 14 - primarily because we have a meaningful part of our net worth in real estate which is illiquid and still have mortgages on most of the properties (questions 1 and 4) and my interpretation of question 7 - I assume my lifestyle will be better in five years because I will be retired (not becuase I will be financially better off), hence another 3 points.

 

[W2R]

I scored a 10, which barely put me in the low beta category. I spend a pretty low percentage of my portfolio right now (maybe 1.9% for this year). In the future, I plan to spend more and if so would probably score an 11.

 

[73ss454]

I'm a 10 no matter how I look at it. (heh)

 

[donheff]

I'm a 12.

 

[Spanky]

My score is low beta.

 

[Spanky]

A lot of specialists doctors are prob. bet. 300-500K easy and their income are more of less stable.

That explains why competition to medical school and residency programs is insanely intense.

 

[Meadbh]

I scored 12, medium beta, mostly because I have property investments. I am a physician but I have never earned as much as $300K in a year. I expect my beta to fall over the next few years.

 

[Gumby]

I question of the utility of the survey in the article and the ability to tie wealth to beta. Indeed, I would expect most middle income and poor people to show a high beta under the metric of the survey.

Consider, for example, a twenty-something working couple, just staring out in their careers. They make $80k per year between the two of them, but they spend most of what they make. They have a house worth $100,000 with about $18,000 in equity and a few hundred bucks in the checking account, but no other assets. The first four questions of the test would each give them a score of three points (debt much greater than net worth, spending greater than net worth, single asset is virtually all of their net worth and it is illiquid), as would the final question (if they are just starting out, it would not be unrealistic to think their lifestyle will be better down the line).

And yet, their wealth beta is actually quite low. Barring a repetition of the boom and bust we have recently seen, their net worth (in the form of their home equity) will probably rise at the rate of inflation plus principal payments. And, as they advance in their careers, they may save more. For a couple like this, it seems meaningless to focus on current assets and debt. Far more important is their current human capital -- their ability to earn money over the next 30-40 years.

 

[Birchwood]

Human capital and earning potential, large salaries, bonuses and then
mix with it is life style, homes, debts, cars, luxury goods, and keeping ups with the Js.

In the end, what is more important is how much, does somebody keep thru the years of productive life- how much does actually save.

 

[kyounge1956]

I question of the utility of the survey in the article and the ability to tie wealth to beta. Indeed, I would expect most middle income and poor people to show a high beta under the metric of the survey.

Consider, for example, a twenty-something working couple, just staring out in their careers. They make $80k per year between the two of them, but they spend most of what they make. They have a house worth $100,000 with about $18,000 in equity and a few hundred bucks in the checking account, but no other assets. The first four questions of the test would each give them a score of three points (debt much greater than net worth, spending greater than net worth, single asset is virtually all of their net worth and it is illiquid), as would the final question (if they are just starting out, it would not be unrealistic to think their lifestyle will be better down the line).

And yet, their wealth beta is actually quite low. Barring a repetition of the boom and bust we have recently seen, their net worth (in the form of their home equity) will probably rise at the rate of inflation plus principal payments. And, as they advance in their careers, they may save more. For a couple like this, it seems meaningless to focus on current assets and debt. Far more important is their current human capital -- their ability to earn money over the next 30-40 years.

I think it's unrealistic for more than young people just starting out, even if there is no big future earning potential or expectation of increasing net worth. I'm in my mid 50's, planning to retire in less than two years. I took the quiz earlier today and IIRC scored 17—3's on the first few questions and 2's on most of the others. Right now about half of my net worth is in home equity and the other half in tax-deferred and Roth retirement accounts, but after I retire I'll have income from SS and a DBP. Neither of those are reflected in my net worth, but they'll make up the majority of my income. IMO the quiz overstates the beta of anyone in similar circumstances.