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Basic Skills / Financial Literacy to Fix America’s Wealth Inequality

The math of wealth is actually pretty simple: It all boils down to four things: 1. How much you start with, 2. How much income you make, 3. How much of your income you save, and 4. How good of a rate of return you get on your savings.

So one obvious thing we could do to make wealth more equal is – surprise! – redistribution. It turns out that income redistribution and wealth redistribution have much the same effect on the wealth of the poor and middle-class. Income redistribution is probably a bit better, for two reasons. First, people with higher incomes tend to save more, meaning they build wealth more rapidly. Second, people with higher incomes tend to have less risk aversion, meaning they are more willing to invest in assets like stocks (which get high average rates of return, although they are risky) rather than safe assets like savings accounts and CDs that get low rates of return.

In other words, giving the poor and middle-class more income will boost the amount they are able to save, the percentage they are willing to save, and the return they get on those savings. Part of the reason America’s wealth distribution is so unequal in the first place is that our income distribution is very unequal.

But there are reasons to believe that redistribution can’t fix all of the problem, or even most of it. If you do the math, you discover that in the long run, income levels and initial wealth (factors 1 and 2 from above) are not the main determinants of wealth. They are dwarfed by factors 3 and 4 — savings rates and rates of return. The most potent way to get more wealth to the poor and middle-class is to get these people to save more of their income, and to invest in assets with higher average rates of return.

As I mentioned, income redistribution helps these things a bit, but it doesn’t account for the whole difference. The rich probably save more than the poor for many more reasons besides the simple fact that they’re rich. In fact, being willing to save more is probably a big part of how the rich got rich in the first place. “Cheap” is an insult, but being cheap is how you get rich. If you consume everything you earn, your consumption will be higher today, but lower twenty years down the road; in our consumption-focused society, a lot of people are caught in this trap. And government can and should help them get out.

Chosen excerpts by Job Market Monitor 

The Atlantic

via How to Fix America’s Wealth Inequality: Teach Americans to Be Cheap – Business – The Atlantic.

Related Post:

US / Wealth Inequality (Video)

POSTED BY  ⋅ MARCH 3, 2013 ⋅ 1 COMMENT

Infographics on the distribution of wealth in America, highlighting both the inequality and the difference between our perception of inequality and the actual numbers. The reality is often not what we think it is. via Wealth Inequality in America – YouTube.

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