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How Much of Your Wealth Is Trapped?

How Much of Your Wealth Is Trapped?
(Dollar Photo Club)

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Friday, 08 June 2018 04:34 PM Current | Bio | Archive

There are about 15.3 million millionaires in the United States. That works out to just under 5 percent of the country’s population.

But a measure of net worth doesn’t describe wealth. And that’s something we need to rethink.

As I noted just a few weeks ago in a piece on real estate, folks are generally letting their home equity build. They’ve come a long way from using homes as ATMs, as many did in the leadup to the housing crisis a decade ago. That means today’s real estate market is a healthier one, as equity continues to build. It also means home prices can drop a bit without precipitating a huge crisis like a decade ago.

But it also means that a lot of homeowner’s wealth is sidelined.

In the go-go real estate market of California, I know a few folks who may have $300-$400 in home equity built up over the past few years thanks to rising prices. But if they won’t (or can’t) access it, is it really something to include in someone’s net worth? It’s a lot of money, but it’s not easily accessible. It’s essentially trapped, unless those homeowners want to make a major life change and downsize or move to a cheaper market.

No doubt many of today’s millionaires are simply folks who have allowed their home to appreciate in value without taking out any of the growing equity.

And what about retirement accounts? Given the hefty penalties for early distribution, and the tax costs of making early withdrawals on a 401k plan or IRA, that wealth isn’t fully or easily accessible either. Folks who manage to squirrel away even a small amount of their paycheck can, over the years, build up high balances in such funds, also in the six-figure range. But it’s money that isn’t accessible without penalty until the age of 59½ at the earliest.

In short, we have a situation where wealth is growing—but some of the biggest sources of wealth created over the past few years are tough to access. We could face a liquidity crisis as a result. When that happens, folks may need to get out of stocks or a home at any price to raise cash—even if it means giving up much of the gains made along the way. That drive toward liquidity could turn a small financial pullback into a bigger crisis.

So, yes, it’s easy to see why we have a growing number of millionaires in this country while we also have a sense of financial unease. Much of that wealth isn’t easily accessible without significant costs and potential life changes. It’s trapped.

Even if you have $1 million in cash right now, few investments look attractive for creating income and getting wealth to work for you. For all the market panic over interest rates hitting 3 percent on 10-year government bonds, $1 million in those bonds will now pay the bondholder $30,000 per year.

In other words, you can be a millionaire and sill live below the poverty line, as measured by income!

At least if interest rates were 7 or 8 percent, you could live frugally off your bond holdings even after taxes. But we’re not there, and probably won’t get there anytime soon.

Stocks, despite a big pullback after a big rally at the start of the year, look more attractive on a risk-reward basis, provided you’re willing to hold them long enough. But their earnings vary wildly, and $1 million in stocks can grow substantially, provided it’s invested in good times and bad. With a 2 percent average yield on the S&P 500 Index, however, $1 million will buy $20,000 a year in income—and a lot of volatility along the way.

In short, one million just won’t buy what it used to thanks to low-yielding bonds and high-priced stocks. And extreme deals in real estate are in short supply as homeowners hoard their home equity.

Add it all up. All these factors leave cash as a compelling alternative. It provides the ultimate liquidity, a necessary part of any investment portfolio. And by having some cash on hand, events like market selloffs can be your friend, rather than a foe. It also means having the security to continue investing, even if unexpected events occur.

It’s not that a million dollars won’t buy what it used to—inflation will ensure that over time. What matters is that many of today’s millionaires are sitting on wealth that they can’t access or change around quickly in a crisis. That’s not true wealth the way a million dollars in cash ready to invest would be.

While I don’t expect a major market crisis this year, I do want folks to be prepared for another potential sizeable selloff.

Take advantage of strong market rallies to raise some cash. Various surveys in the past few years have found that the average American can’t even find put together $500 to $1,000 in case of an unexpected emergency. Don’t be one of them.

Start raising cash gradually and look to have enough to cover six months of living expenses before you stop. That will get you through any run of the mill emergency, and most big ones as well.

It doesn’t matter if you’re a millionaire on paper or not. What matters is having the paper to make ends meet when the unexpected happens. And to profit from events, rather than be a victim to them. Make sure you have some cash free and clear. Don’t let it all be trapped in illiquid places.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2018 Newsmax Finance. All rights reserved.

   
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AndrewPacker
It doesn’t matter if you’re a millionaire on paper or not. What matters is having the paper to make ends meet when the unexpected happens. And to profit from events, rather than be a victim to them. Make sure you have some cash free and clear. Don’t let it all be trapped in illiquid places.
wealth, trapped, invest, stocks, gold
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2018-34-08
Friday, 08 June 2018 04:34 PM
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