The truth about net worth

In this latest installment of my series of net worth articles, I dug up the Federal Reserve’s June 2012 bulletin where they pour over the results of the 2010 Survey of Consumer Finances. They conveniently include results from 2001, 2004, and 2007 as well, making it easier to compare certain statistics to check the trends. This document has a lot of detail and can make for a dry read when you try to read every detail, but my focus was on net worth. How much are people saving? In what ways are people saving money? What about debt? And what are the rich doing, compared to the rest of us? Anything we can learn to benefit our own wealth building

First, how is your own net worth stacking up?

Most of the tables in this report are broken down by either income, age, or ethnicity. To read the tables regarding income percentile, you need to first find out what income percentile you are in. If you look at the table below (from page 8), the first set of boxed income shows the median income rates for each percentile. Which bracket of income are you in?

Remember, median is half above, half below. For example, half of the people in the 60th percentile made above $71,700, and half made below.

Fed Reserve 2012 bulletin – Income by percentile and age

As a bonus, I also drew a box around income levels based on age. Where do you stack up? It appears that in general, as you get older, you make more money, until you reach retirement. It seems that people aren’t making as much in their retirement years. Is that a problem? Is it what you were expecting? If that isn’t in your plan, you may need to recheck things.

If you flip to page 17, there is a chart showing net worth based on both income and age. Using your income percentile you just figured out, check out the median net worth in thousands of dollars. Are you above or below the midpoint?

Federal Reserve 2012 bulletin – Net worth by income and age

Like the previous table, I also included net worth by age. Where you do rank in that? This makes me feel good, because I’m ahead of both. But that isn’t the final answer in this article.

The real question is: do I have enough to retire? I’m not there yet, but my plans should carry me there. What about you?

Another nugget of knowledge is how net worth has shifted since 2001. The table above lets us quickly look at previous years. Net worth for all families from 2001-2010 ranges $106100, $107200, $126400, and $77300. What do you think would account for a 17% increase in 2007 followed by a 39% drop?

Rises and drops in net worth are based on where people have invested their money. The two biggest things people are investing in are 401K plans and primary homes. Those both took a big wallop in 2008, and people’s net worth suffered. My own net worth is still 20% down from where I was before the 2008 market correction. It’s part of the reason I realized I needed to get out and find something better.

These are good reasons to start tracking your net worth. How do you track with these trends? Could you handle a 39% drop in net worth if you were in retirement? If you are investing in the same things as everyone else, then that is what will happen! But if your net worth doesn’t suffer from these types of corrections, you may have developed some adequate financial insulation. No way to tell without tracking things yourself.

One of the reasons real estate does so well as a wealth building vehicle, is because even when the value of your property may take a hit, you will keep collecting rent. As an asset, it will keep yielding returns. You don’t have to sell when your property value drops 20%. If your money is in a mutual fund, enough other people may evacuate the fund when it takes a 20% hit that the manager closes it and moves your money to another fund anyway, even if you didn’t want to!

Hopefully this report will help you notice when you see an article from a finance magazine, or someone talking on TV or radio. Are they preaching how investing in our 401K tied in with the magic of compound interest will give us a huge savings? So, where are the people saving up huge chunks of retirement money in mutual funds? That last chart says that the median person in their 60s only has about $200,000 dollars in net worth. How much do you think is in accessible cash vs. home equity? I have been hearing this message for 15 years, so I figured this report would show it, but it flat out doesn’t.

When you hear your financial advisor saying he or she will help you build a portfolio worth over a $1 million, give him a double take and ask him if he really can place you close to the top 10% of people! That is what he is trying to sell you. The chart above proves it. The question is, are you buying? Ask him to show you proof that his other clients are doing this well. If he hems and haws, and tries to show you history of the market instead of history of his clients, run for the door. He is just trying to sell what’s on his shelf, not what’s best for you.

Assets
The report goes on to indicate that cash value life insurance is held in increasing amounts by wealthier people, but overall cash value life insurance assets declined from 2007 to 2010. In fact, all asset classes declined, probably due to people being able to save less and instead consume their income to deal with the economic downturn.
Page 42 has a very clear picture of assets held by people of a non-financial picture.

Federal Reserve 2012 bulletin – Value of non-financial assets

In 2010,

  • In first place, 47.4% of non-financial assets held by people was the equity in their primary residence. 
  • Business equity was in second place at 28.2%. 
  • In a distant third place is other residential property, which would extend to rental property at 11.2%. 

To sum it up, these non-financial assets (which also included vehicles) add up to 62.1% of the total assets people have! With this chart totaling roughly 2/3 of people’s assets, and primary homes being almost half of that, people are investing 1/3 of their money into something that doesn’t generate cash flow in retirement. You may say it keeps you from making a mortgage payment, but that only works if you are setting aside the same amount of money you used to pay on your mortgage into the other cash yielding investments. If you are sitting in your paid off home, and expecting to get by on the measly income from your 401K, you are in for a huge shell shock. Time to brush up on your Walmart greeting.

Looking for more information about rental property, the report says that 14.4% of families own some form of residential real estate, including second homes, time shares, 1-4 family rental properties, etc. Unfortunately, it is hard to break out which types of property are generating which types of cash flow. Second homes don’t yield cash flow. They may generate good family times (something to NEVER underestimate), but they won’t fund your retirement.

Sadly, for a report extending 80 pages, there is little found when actually searching for the word “rental.” It appears that few people have rental properties, compared with the grand scope of everyone, so there are few questions asked in the original survey to gather this type of information. In fact, this may indicate the lack of rental property. If lots of people owned rental property, it would probably become one of the key questions of the survey. I hope this changes, considering 1 out of 8 Americans is a real estate investor. If as many as 11% of people in this country are investing in rentals, the Federal Reserve should start getting more concrete data on this. It might shed more light on the success and validity of real estate.

The Rich own real estate and businesses

One thing is very clear. Looking at page 49, at the breakdown of non-financial assets across income percentiles, the rich have more real estate and business equity than anyone.

  • The top 10% hold a median value of $475,000 in primary homes, $320,000 in other residential property, $200,000 in non-residential property, and $455,000 in business equity. 
  • When looking at the next group (80-89.9% income earners), this drops off to $250,000 primary home, $120,000 other residential property, $58,000 non-residential property, and $82,400 in business equity.

I know that is a lot of numbers, but it speaks plainly. The rich own real estate and the rich own businesses. The rich keep doing what makes them rich, meaning they didn’t become rich through one mechanism and then suddenly switch to real estate and business. If that was true, we’d see another chunk of statistics reflecting the people that had become rich, but not moved their money into real estate and business. In other words, if you don’t invest in real estate or build your own business, you aren’t going to be rich.

The study also asks people that run one or more businesses, how many people work in them. The median point (half above and half below) for the number of employees per business was two, showing how half of the businesses in this country are comprised of 1-2 people. That should be a positive sign to all of us that we can indeed form a business. The report was clear that businesses with more than 2 people accounted for 79.5% of the value of all such businesses. But remember, the first step towards building a big company is to build a small one. No business started out big, already worth billions of dollars and with thousands of employees. But what’s more important is that no business must become that big for the founder to become relatively rich.

Liabilities

Looking at the liabilities section, mortgages against the primary residence is the biggest factor, accounting for 74.1% of all debt. This has dropped barely from 75.2% in 2001. An interesting nugget in the world of debt is on page 63, where it shows total amount of debt, broken down by percentile of income. The top 10% of income earners hold more debt in primary residence, other real estate, and other things. While they have more credit card debt, the median was $8,000, which isn’t a huge amount for such high income. The big difference is holding $180,000 in other residential real estate compared to the 80-89.9% which hold only $88,000. This is a sign of leverage, and the rich understand this. By taking out extra debt to buy rental property, second homes, and other types of real estate, they can add to their net worth.

Fed Reserve 2012 bulletin – Debt by category and income

It also makes sense that most people, even if they aren’t rich, take out a mortgage to buy a house. Mortgages are one of the best wealth building tools we have. It allows us to build up net worth with a limited set of resources. If we tried to save our way towards a 100% cash purchase of a primary home, we would lose so much opportunity, it would outweigh the interest cost of the mortgage. Considering prime, owner occupied 30-year mortgages are now being sold with 3.5% interest, there is no better time  to get one.

It is also a sign of confidence that this country isn’t full of people carrying around $100,000 in credit card/student loan debt, but instead a more temperate truth that most people carry a modest amount of consumer debt that can be tackled. Many people debate whether or not student loan debt should be considered as evil as consumer debt. With consumer debt, you are buying things you want, but arguably don’t need. Student loan debt is to purchase an education that it meant to be a stepping stone towards a long term career which will yield a cash flow. The trick is the cash flow part. If you get an expensive degree at a high price school that doesn’t produce a decent job, you may have picked the wrong path. Standard 4-year college isn’t the only answer either. Some schools will let you transfer credits from a 2-year community college, allowing you to effectively discount part of your education. Another different path are vocational/trade schools. They also can produce careers. College isn’t for everyone.

Bottom line, we shouldn’t fear debt. After all, the rich use good debt to growth their net worth. With a proper view of bad debt (consumer) and good debt (investment/leverage), and a focus on developing cash flowing opportunities and assets, you have the means to build a business and real estate portfolio to grow your own wealth over time.

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