Saturday, February 13, 2016

Own It!

This is a most instructive set of graphs.

Starting on the left and moving to the right we discover that 94% of business equity is owned by the wealthiest 10% of Americans. That means if you really want to be rich, don’t worry about the wage your employer is willing to pay. Instead, own the company. This is very much in keeping with the findings of Stanley and Danko in their classic study, The Millionaire Next Door. Roughly 80% of American millionaires own their own business. Even a successful small business is enough to catapult the owner into millionaire status. My observation on the hours worked by small businessmen caused me to comment, “There is no exploitation like self exploitations.” Their workweek often exceeds 60 hours a week. However, most of these men absolutely love their work. They don’t view it as a burden. Not every independent business is successful, but note only 6% of business equity is owned by the bottom 90%.

Moving on, 95% of all financial securities are owned of the top 10%. While they don’t specifically identify what constitutes a financial security, in context it would seem that would consist of anything but stocks and mutual funds. This could include bonds, money market accounts, futures, options, swaps, forex currency trading, and various types of debt backed security including those offered by Fannie Mae, Freddie Mac, and Ginnie Mae. I am somewhat surprised that only 91% of stocks sold on the primary and secondary markets or in mutual funds are owned by the top 10%. I would have expected those numbers to be pretty close to identical. It would appear that the very wealthy, the top 1%, are better able to find investment opportunities in unusual vehicles, such as hedge funds, that are pretty much off limits to even fairly wealthy investors.

84% of the wealth held in trusts belongs to the top 10%. The numbers for the bottom 90% start to creep up in this category to 16%. There are very good reasons for anyone with a 401(k) to at least consider a Charitable Remainder Unit Trust to will money to their favorite charity without ever paying taxes on any of these funds. Trusts are also a method of avoid the expense and time of probate. As the upper middle class begins to understand these vehicles, I am hoping that the Government does not crack down on their uses. If you put money in a trust, you do not own that money. The trust owns the money. You can name yourself as trustee, so you will still control your own money, but now you must manage it for the trust. A trustee has a fiduciary responsibility to use the money for the good of the beneficiary. Trusts can be revocable, meaning you can change your mind on how you want to use the money, or irrevocable. Once you sign on the dotted line, money held in an irrevocable trust must be used for the purpose of that trust. The big problem is finding a trustworthy trustee once you are dead or incapacitated. There are too many horror stories about trustees, both attorneys and family members, looting the trust once the creator of the trust is out of the picture. Trustees get to pay themselves an “appropriate” salary. Appropriate is an interesting word that is open to interpretation.

78% of profit producing real estate of one sort or another is held by the top 10%. The title of this category would seem to exclude vacation homes. This category could contain mom and dad renting out the old family homestead or farm once they retired to Leisure World, conscious investment in commercial buildings, apartments, or renting out single family homes. There is a lot of money to be made in real estate. I suspect a considerable number of the people who own business equity, own it in a real estate business. Even this author, who gets a rash every time he thinks about buying real estate, owner financed the sale of his pre-retirement home near the big city. Getting that check every month feels like I am receiving a second pension.

I think it quite interesting that life insurance is more evenly spread across the wealth spectrum. Most Americans will only need life insurance while they are responsible for minor children. Term life is dirt cheap, particularly when purchased by young healthy parents. You need a lot of life insurance while your children are—children. Rules of thumb include $250,000 per child (that doesn’t include the cost of college) or 8 to 10 times your annual salary. Once the children leave home, most of us have no further need of life insurance. There is an exception. A successful small businessman or family farmer may have several million dollars tied up in their enterprise. Upon their death, estate taxes could cause a liquidity crisis. If you don’t have enough cash on hand when your remains are sent to the undertaker, your children who expected to inherit your business or operate the family farm may need to take out a large expensive loan at an inconvenient time or sell the farm in order to pay the tax man. An appropriately large chunk of single premium whole life insurance could make certain that the family farm stays in the—family, with or without the help of Willie Nelson and Neil Young.

I expect that pension accounts will spread out over time just as happened with life insurance. The 401(k) didn’t exist before 1978 and it took industry over twenty years to destroy the defined benefit pension. People are only just beginning to understand the implications of these changes. They are now responsible for their retirement, not their company. These numbers are further skewed by middle class pensions in the public sector and in what remains of unionized industry. Normally, if you have a defined benefit pension, you don’t have a pension account.

Only 5% of the value of primary residences belongs to the top 1%. Only 21% belongs to the next nine percent. Roughly two thirds of American families own their home. As the net worth of a family increases, typically the value of the primary residence decreases as a percentage of total net worth. An ordinary couple approaching retirement with a net worth of $500,000 could easily have as much as 50% of their total net worth tied up in their home. If a family had a net worth of $50,000,000 even a 10% share in the primary residence would be $5,000,000. In most parts of the country, $5 million is enough to buy a palace. Who would want more than that tied up in their primary residence?

Note that last column. While it is logical that the rich don’t choose to borrow money as often as the poor, it is important to understand that avoiding debt is a key component in finding your way to financial freedom. The misuse of debt almost guarantees poverty.

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