Riding High On The Market

American Demographics, April, 2000

Our financial assets skyrocketed during the 1990s. So did our debts. Will we crash during the next stock market downturn ?

It's a broken record, literally. Two months ago, the economic expansion became the longest-running boom in American history - 107 months, and still ticking. Unemployment is at a 30-year low, inflation remains under control, and American households are richer than ever. The median net worth of the average household rose an inflation-adjusted 20 percent during the past decade, as stock market gains boosted wealth.

Surely, this is the best of times. But is our toehold on the good life secure, or will our newfound wealth disappear during the next bear market? Even more worrisome, with the amount of debt held by the average household rising rapidly, do many of us risk bankruptcy during the next recession? Maybe not, some experts say. "If the market declines, in general, people will not be in trouble," says David Orr, chief economist at First Union Corporation in Charlotte, Virginia. "They will be in trouble only to the extent to which they have borrowed against their stocks."

Orr explains: "If you put $10,000 in the market and it doubles, you've done well. If it drops in value, that's a disappointment. But if you put $10,000 into the market, watch it double and then borrow against it, you're in for a big disaster if the share value drops."

Other economists are not so sanguine. "The well-documented `wealth effect' - the situation that exists now, in which people are wealthier on paper because of huge market gains - is something to be considered," says Jacob De Rooy, associate professor of economics at the School of Business Administration at Capital College, Harrisburg. "It's important because it stimulates real spending. As their paper assets increase, people feel more confident about taking on more debt or borrowing more against their paper worth. But if the market falls, it will have a profound negative effect."

Who's right? One of the best ways to measure the financial security of Americans is to examine how the average household is doing - its savings, debt, and net worth. Fortunately, we have a tool for doing just that.

The Federal Reserve Board's triennial Survey of Consumer Finances provides the most comprehensive data available on the wealth of American households. The survey examines the components of household assets and debts, revealing just how exposed we are to a stock market downturn. The latest survey data, for the year 1998, were released in January. The Federal Reserve Board interviewed a nationally representative sample of more than 2,000 households, along with a supplemental sample of wealthy households because they control the most assets. The results are both startling and reassuring.

THE MARKET BOOM

In recent years, the action has been in the stock market. Many Americans have gone along for the ride and profited handsomely.

The value of the financial assets owned by the average household rose 36 percent in the three years between 1995 and 1998, after adjusting for inflation, growing from a median of $16,500 to $22,400. Financial assets include such things as stock, retirement accounts, mutual funds, savings and checking accounts, CDs, and the cash value of life insurance.

Nonfinancial assets (homes, cars, business equity, and so on) still account for the bulk of household wealth. But the financial share is growing, rising from just 30 percent in 1989 to 41 percent in 1998. More important, among financial assets, the share held in stocks, mutual funds, and tax-deferred retirement accounts, and other managed assets rose from 48 percent in 1989 to an eye-popping 71 percent in 1998, according to the Federal Reserve report.

Nearly 49 percent of households owned stock directly or indirectly in 1998, up from 32 percent in 1989. Among owners, stocks accounted for the 54 percent majority of financial assets in 1998, up sharply from the 28 percent of 1989. The bottom line: Americans are seriously playing the stock market, but some are more serious about it than others.

The majority of households with incomes of $25,000 or more own stock - either that of individual companies or stocks held by mutual funds and retirement accounts. Among households with incomes of $50,000 to $99,999, fully 74 percent own stock, as do 91 percent of those with incomes of $100,000 or more.

Granted, the median value of stock owned isn't all that impressive: America's stock-owning households have a median of just $25,000 in the market. But this is up from $10,800 in 1989. Households with incomes of $100,000 or more have a median of $150,000 in stock holdings, accounting for 63 percent of their financial assets.

But while many Americans pride themselves on their stock market gains, they're only fooling themselves if they think they're rich. "In reality, you're not rich until you generate sufficient capital off of your investments to sustain the style of living you want to have," says Marshall Acuff, equity strategist at Salomon Smith Barney in New York City. "Many people have accumulated some wealth in stocks, but not nearly enough to sustain a certain lifestyle long-term."