The Wealth Gap: The False Promise of Home Ownership
The Pew Study reports a stark contrast in the wealth of households by racial group. The median wealth of white households is 20 times that of black households. The study very quickly points to differences in home ownership (non-investment real estate) as the main culprit in explaining the differences in wealth. (Because blacks and Hispanics have very similar financial characteristics and those characteristics highly contrast those of whites and Asians, I will use the stats from the black and white populations for these illustrations.) For instance:
- Only 46% of black households owned their own home, while
- Among white households, 74% owned a home.
So right off we can see black households far behind in the primary asset that contributes to wealth – a home. Owning a home is a pervasive and deep seeded American dream. It has been promoted as the sure way to wealth, by our government, our financial advisors, our ministers and any number of late night infomercials. And the above statistic seems to support this idea. Own a home, get rich.
But I am here to say this idea is misguided. It represents one of the biggest fallacies of wealth accumulation in existence. Home ownership is not a panacea. In fact, if pursued to the exclusion of other assets, especially financial assets, it can be an albatross.
To explain what I mean, let’s look deeper into the stats and include those from wealthy households regardless of race. For blacks and whites alike, home equity made up the lion’s share of net worth. For blacks however, owning this asset (or not owning it), proved much more contributory to the rise, fall or existence of net worth. For example:
- For black households that owned a home, home equity made up 56% of its net worth.
- For white households that owned a home, home equity made up 38% of its net worth.
White households tend to be more diversified than black households. Thus they were able to better withstand the downturn in the real estate market experienced of the last few years. In fact, many black households bought at the peak of the real estate bubble during the days of 110% financing and easy credit. Another study conducted by Pew tells us that 35% of black home owners are under water on their mortgage, meaning they owe more on their mortgage than their home is worth. “Only” 18% of white home owners are in this situation.
Being a little more diversified (not too much) protects wealth. Something the very wealthy, regardless of race, have figured out. According to the latest Survey of Consumer Finances:
- Of households in the top 5 percent of wealth (usually $1.5 million or more in net worth), 98% own their own home, however, home equity makes up only 15% of their net worth.
Blacks who are financially upwardly mobile, for lack of a better term, have caught on that home ownership is a great tool for wealth accumulation. But somehow, the forest was missed for the trees. Home ownership if all goes well can be a financial benefit, but in comparison to other assets available in the marketplace, real estate falls way way short on delivering functional (read: spendable) wealth. That usually comes in the form of stock, bonds, cash and business ownership. I will explore those differences in a later post. The next post however, I will look at the differences among racial groups in unsecured debts and ownership of other tangible assets like cars.
Market:
"Tax My Fortune! Please! Why Warren Buffett Should Volunteer to Pay Higher Taxes" by Daniel Gross, Contrary Indicator; Yahoo! Finance
Paying a few billion dollars in taxes that it isn't required to would allow General Electric, and any other company that follows suit, to do what most Fortune 500 firms haven't been able to do since the 1990s: claim the moral high ground. Just as a self-taxing Buffett would, a self-taxing company would garner a huge amount of publicity and positive reputation-building.
"That market plunge was so last week" by Bloomberg; Pensions and Investments
Portfolio:
"Coffee Wars: Is Dunkin’ Donuts More Valuable Than Starbucks?" by Stacy Curtain, Daily Ticker; Yahoo Finance
"Dunkin' Launches K-Cups; Starbucks Soon to Follow" by Karlene Lukovitz; Mediapost
"Starbucks CEO to DC: You've been cut off" by Charles Riley: CNN Money
Life:
"7 Tips for Writing E-mails That Won't Get Deleted" by Jill Konrath; Inc Magazine
"How to Talk with Your Children About Sex" by Planned Parenthood
"I ain't talking 'bout rich, I'm talking 'bout wealth. Wealth is passed down from generation to generation. You can't get rid of wealth. Rich is some shit you can lose with a crazy summer and a drug habit." - Chris Rock
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. One of the tidbits I found very interesting is that Stanley’s research revealed that most millionaires carry mortgages despite the ability to pay them off in full. I thought it’d be interesting to see, given recent years’ turmoil in the mortgage and real estate markets, if these numbers still held up.
and 
, somewhere between 50% and 60% of the millionaires surveyed hold mortgages on homes purchased 23 years prior. Additionally, the current outstanding mortgage on homes belonging to deca-millionaires (those with $10 million in or more in net worth) is equal to 7% of the home’s current value while the typical millionaire (50% have less than $2 million) has a mortgage balance of just under a third of the home’s market value. Thus, I assumed a mortgage of 15% of the home’s value for milionaires between $3.5 to $10 million and overall of 30% for those under $3.5 million. I used the IRS Personal Wealth Statistics from 2004 (
. I am not saying one should not be generous. What I’m saying is charity should start at home. Most 
"Scared money don't make none."
I had a thought about financial "rules-of-thumb". Most don't work. Those that work at all, work in only some situations. What they should call them is financial "Rules-of-DUMB". I can think of a few right off the top of my head. Like:
1. Buy as much house as you can afford.
Now this one is just ridiculous although so many people follow it. Buying a "lot of house" will only serve to make you house rich and cash poor. And usually, what you can afford is determined by some mortgage broker. In my view, that's the last guy you should be listening to. That's like the sheep asking the wolf for advice on how not to get eaten. (No knock against mortgage brokers. I'm just pointing out a conflict of interest there.)
Most of us would be better off buying an easily affordable house. Not "mortgage broker" affordable, but The Millionaire Mind affordable. According to the book's author Thomas Stanley, an easily affordable house is one in which you can afford on HALF your present income for the next FIVE years without disrupting your lifestyle. If this can't be achieved, then consider that you have a house that is not easily affordable.
2. Diversify.
I'll paraphrase Warren Buffett by saying diversification is for the know-nothing investor. The know-something investor should concentrate. Our intent with diversification is to lower our volatility. But what we don't consider is we are also lowering our potential return. If we study our investments a little more and understand them, we'd be better served by concentrating on those investments that offer the highest probability of success. Concentrate to get rich then diversify to stay rich OR stay concentrated to get richer.
3. Save 6 months living expenses for emergencies in cash.
What emergencies are we talking about that would require 6 months worth of expenses? I mean seriously. This is just one of those rules that I think goes too far. If we are properly insured with health, life, disability, home/renter's, auto and the like, most emergencies are taken care of. Most of us, if we were to loose our jobs, will be able to collect unemployment. And if we were to find ourselves in that situation and unemployment doesn't cover our expenses, we certainly wouldn't need that much money in cash (money market fund, savings, under mattress, etc.)!
For most people, having more than say $5,000 in cash is a waste. The rest of your "emergency" funds should be diverted to higher earning liquid assets like stocks. But what if the stock market goes down you ask? Well all I can say is that the stock market is more likely to go UP! In fact, the market goes up about 75% of the time. So it's much more prudent to put your money (your emergency money too) in stocks, though the rule-of-dumb says otherwise.
One of the characteristics Warren Buffett looks for in managers of the companies he owns (read: The Warren Buffet Way by Rob Hagstrom) is rationality. In essence, he's looking for managers that will allocate corporate funds to areas that make the most economic sense. An emotional approach to capital allocation would undoubtedly lead to decisions that would decrease shareholder wealth.
I find that very few financial decisions we make for ourselves are rational. Just the opposite in fact. Almost all of our decisions, especially as they relate to our personal finances, have some emotional component. For example, I'm acquainted with a few single 30-somethings that have recently become homeowners. In every case (except for one), these individuals moved out of a small and inexpensive apartment into a much larger and expensive home. A couple were actually moving out of a rent free situation (they were living with mom). Along the line, each one of them has said to me in one way or another, that they thought they were making a good economic decision. In other words what they were saying is that they thought they were being rational and that they'd be making themselves wealthier by buying a home.
It makes me giggle a little that any of them would actually say that they'd be economically better off. I mean, how much better off can you be economically going from paying next to nothing (small apt/living with mom) to paying a substantial something (buying an expensive home in a historically inflated real estate market). These folks are clearly making emotional economic decisions although they'd like to think otherwise. In no way can a situation in which substantial money is spent be better than a situation in which no money is spent. The only explanation is that judgment was clouded by emotion.
But I'll give these individuals the benefit of the doubt as we all have heard time and time again that homeownership is a sure way to wealth. We've heard it so much that we'll even abide by it when the choice of homeownership is the much more expensive choice for us. We dread doing the wrong things with our money (at least some of us). Our emotions take over and suspend our rational thought. Without rational thought, we wind up making the wrong decisions.
Even in situations when we know better, emotions play a big part in our decisions. As some of you (I'm positive not all of you) may be aware paying down a low interest rate mortgage early is not the best financial decision one can make. One would be far better off putting those extra mortgage payments to work in the stock market (or your own business) where one would probably receive a much higher rate of return. But clearly, this is not simply a financial decision. Emotions play a huge part in personal finance and carrying a mortgage is no exception.
I have a friend and with his and his wife's combined incomes, they will be able to pay off his existing mortgage in a very short time. And they will probably go ahead and do just that. My friend also understands that he'll be better off financially if he never accelerated his payments. When I asked him why he planned on paying the mortgage off early knowing what he knows he simply stated, "Cause debt don't feel good."
"Debt don't feel good" is not rational. It's emotional. In Thomas Stanley's book The Millionaire Mind, he profiled several millionaires and their treatment of their homes and mortgages. It was clear that most millionaires are "less" emotional when approaching their own personal finances. Which is why according to Stanley most millionaires (not all) carry mortgages to full term. When millionaires approach a financial decision, they choose the alternative that puts the odds of being wealthier in their favor. This is why they save instead of spend, buy stocks more than bonds (or real estate for that matter), lead low consumption lifestyles instead of ostentatious spend-thrift lifestyles, run their own business instead of working for "the man". I think most millionaires exhibit some form of economic rationality. Paying down a mortgage early or buying an expensive house isn't economically rational. But like my friend says, debt just don't feel good and neither does living with your mama. And maybe that's more important but it won't help your wallet.
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