This is the final post I’ll do about the IRS personal wealth statistics on the richest one percent in America. At least for a while.
What I am going to do here, therefore, is look at what the rich do that doesn’t make sense.
Note: If you want to look back at the first post that started this three-part series, click here. The first post explains where the personal wealth statistics data comes from and some of the simple math used. Also, note that the IRS data describes the top half percent, not the top one percent. I’m just going to call these folks the top one percent anyway.
Money Mistake #1: Too Little Use of Mutual Funds
Low-cost index mutual funds absolutely count as one of the great wealth building and wealth preservation tools available to people—including the one percent.
Oddly, however, most of the one percent don’t use these investments (except possibly inside their retirement accounts). Furthermore, for the wealthy who do use the mutual funds, the dollar value of the investment appears quite modest relative to their net worth.
I would identify this as the first big mistake the one percent seem to make.
The little table that follows shows the percentages of one-percenters investing in diversified mutual funds outside of their retirement accounts and then the mean account balances. As always with the mean data provided in these posts, remember that the mean probably overshoots the median and so is really not average but “above average.”
| Wealth Tier | People Using | Mean Stock Funds |
|---|---|---|
| Under $5 million | 31.54% | $95,864 |
| $5 million to under $10 million | 44.67% | $223,537 |
| $10 million to under $20 million | 46.98% | $343,570 |
| $20 million to under $50 million | 52.25% | $551,568 |
| Over $50 million | 48.32% | $1,748,380 |
And now peek at the following table which summarizes the typical bond fund holdings of the one percent
| Wealth Tier | People Using | Mean Bond Funds |
|---|---|---|
| Under $5 million | 14.08% | $120,422 |
| $5 million to under $10 million | 23.04% | $230,822 |
| $10 million to under $20 million | 24.06% | $292,092 |
| $20 million to under $50 million | 27.01% | $459,129 |
| Over $50 million | 28.14% | $1,247,775 |
Gosh. These modest allocations shock me.
Mutual funds for stocks, bonds and things like REITs (real estate investment trusts) represent a wonderfully economical way to massively diversify one’s investments.
For example, if a one percenter pays some investment advisor a one or two percent fee for help managing (say) $500,000 of directly owned stocks or bonds, that’s $5,000 to $10,000 a year in fees.
Yet, a fund management company like Vanguard might charge the same investor $500 a year for a mutual fund or two that over time produces returns just as good with considerably less risk.
Furthermore, stock and bond mutual funds offer an easy way to widely diversify one’s investments. An index fund will hold hundreds or thousands of different securities.
Given all these great benefits, you would think a one percenter would make heavy use of these funds. But the rich don’t appear to use them much. Or as much as they should.
Without question, that’s a mistake. Mutual fund balances should be much larger for the typical one-percent-er.
Money Mistake #2: Downplaying Traditional Retirement Account Options
The table that follows shows another surprising mistake that pops out of the personal wealth statistics data: The rich don’t seem to be accumulating their money inside pension funds, retirement accounts and similar containers
| Wealth Tier | People Using | Mean IRA/401(k)/etc |
|---|---|---|
| Under $5 million | 76.71% | $684,477 |
| $5 million to under $10 million | 74.72% | $1,235,904 |
| $10 million to under $20 million | 74.39% | $1,480,327 |
| $20 million to under $50 million | 70.80% | $1,819,814 |
| Over $50 million | 71.19% | $4,441,588 |
Roughly three people in four participate, which sounds good. But that also means that nearly one in four people don’t participate.
Heck, these are the richest people in America. How can they not have utilized something like an IRA or Roth-IRA or 401(k) plan?
What’s more, while I’m a little surprised at the participation percentage–the participation should be closer to 100% percent–the dollar values of these people’s retirement accounts shock me most.
Take, for example, that first tier that shows people with gross assets of less than $5,000,000. As noted in other posts about the one percent, this group enjoys a mean net worth of roughly $3 million.
Yet these people accumulate only $684,477 on average in their retirement accounts. The number should be bigger. That amount is about what one accumulates by saving $40,000 a year for 25 years.
Note: One advantage of using a retirement account to store wealth—perhaps especially an advantage for the wealthy—is that this money often receives very good protection in bankruptcy and against creditor claims. Accordingly, even if one didn’t need to “save” for retirement, one could still prudently use such accounts for storing wealth.
Another weirdness here is that while Roth-IRAs and Roth-401(k)s are over-rated for many of the people who use them, if there’s any group of taxpayers for whom a Roth-type account does make sense, it’s the one percent.
Lack of Diversification
The IRS personal wealth statistics data hint at one other money mistake the rich probably make–and perhaps this explains both why the rich become rich but then often don’t stay rich. The mistake? Too little diversification.
The table below shows the participation rates and then the mean values for the typical dominant holdings, or asset allocations, for people in the first wealth tier:
| Asset Category | People Using | Mean Balance |
|---|---|---|
| Other real estate | 52.84% | $939,988 |
| Closely-held stock | 28.83% | $930,353 |
| Publicly traded stock | 60.93% | $749,287 |
| Noncorporate business | 34.36% | $912,146 |
| Farm | 18.91% | $3,599,928 |
Think about these balances in relation to the other things the data says.
For example, yes, this first tier, stereotypical one percent-er owns a $900,000-ish house. He or she holds around $700,000 in an IRA or 401(k) account. And the person sits typically on a big pile of cash. About $280,000 as explained in another post. (Click here to see that.)
But the preceding table suggests that often much or even all of the rest of the person’s wealth is stored in one or two assets.
Take the case of the farmers. For those first tier members who are farming, the farm represents on average around $3.6 million dollars of net worth. That’s a single basket holding nearly all of the individual’s wealth. That lacks diversification.
And look at the individuals who own a small business either via closely held stock or an interest in a non-corporate business like a partnership. The risk looks only a little better. These individuals often may have a third of their net worth invested in a single asset–the business that provides them and maybe other members of the family with jobs.
Or consider the big chunk of one percent-ers who invest in real estate. Looks to me as if these people on average own $939,988 of other real estate (presumably investment property). It’s very likely these investments are not well diversified. The individuals holdings may consist of single property (an office building?) or be over-concentrated geographically (five rental houses in the same town).
Finally, though 60% of the group do own publicly held stock, those holdings may not be very diversified. People regularly struggle to methodically diversify. A person can easily hold too much stock in his or her employer, for example. Or he or she gets too concentrated in an industry (such as the one the person works in).
So the Good News for One-percenters is…
The good news for people dealing with the money mistakes mentioned above? Fixing the mistakes is easy if you haven’t already been beat up by the mistake.
Sweeping one’s odds and ends into more widely diversified mutual fund investments should be relatively straightforward. You just need to start doing it.
Getting religious about a pension requires filling out some simple paperwork. This is half an hour of work in many cases. And, by the way? If you’re an employer and you do this for your employees, you’ll help them get on the route to riches, too.
Tip: One of the most powerful actions a small business owner can take both to build wealth and diversify is aggressively fund a pension plan. That way, the business owner doesn’t need to hit a home run on the sale of a business to make their personal financial plan work out in the end.
Finally, while many one-percenters will always be challenged with the under-diversification that comes from being a small business owner, you can work to minimize the risks. Anytime you can, attempt to make diversified investments. And look for opportunities to spread your investing around.
A Quick Final Bit of Advice to Aspiring One Percenters
Let me also share a quick bit of advice to any aspiring one percent-ers reading this post since by definition this group amounts to 99.5% of readers.
Clearly, most people in the top one percent get there by bearing more risk and by taking an active approach to investing.
Accordingly, you and your family may decide to bear the extra risk and shoulder the extra effort that comes with owning a business or actively investing in real estate.
Keep in mind however, that you are bearing more risk. You will probably want to always look for opportunities to dial back the risk when and where possible. You may also want to plan to reduce your financial and business risk over time so that as you age, you hold a smaller percentage of your wealth in undiversified assets (like a small business).