Behavioral Finance

Standard of Misconception

We aren't going to wax political, or even philosophical, on income inequality or standard of living inequality in the world.

We aren't going to wax political, or even philosophical, on income inequality or standard of living inequality in the world. These are not issues for an investment advisor to advocate upon.

However, we are going to tell you how standard misconceptions about those very things can be used to invest more successfully.

A survey released yesterday from the World Institute for Developmental Economics of the United Nations on distribution of wealth is getting much press, specifically in the financial media. It's summarized here:

1. Richest 2% Hold Half the World's Assets
By Chris Giles, Financial Times

2. Study Finds Wealth Inequality Is Widening Worldwide
By Eduardo Porter, The New York Times

There are some truly staggering statistics cited, many of which are either framed incorrectly or are flat out wrong. We don't have the space here to detail all of it, but here are a couple of our favorites:

  • "Many people in high-income countries have negative net worth and, somewhat paradoxically, are among the poorest people in the world in terms of household wealth." (OK, so this makes US citizens among the poorest in the world, right? We're not sure other regions like Latin America would agree…)
  • "China fails to feature strongly among the super-rich because average wealth is modest and wealth is evenly spread by international standards." (Oh. China has some of the best wealth distribution by "international standards." Hooray for communism?!?!?)

Here's another stunning stat pulled from last week's Wall Street Journal:

  • Only 30% of voters from last month's US mid-term election expect "life for the next generation of Americans to be better than life today." (This is an amazing statistic when one thinks about the consistent and exponential increases in average standards of living in the US.)

Standard of living generally refers to the quality and quantity of goods and services available to people and the way these things are distributed within a population. Yet, it's typically measured in some very strange ways: things like income inequality (why would another person's income affect your own absolute standard of living?), and (our favorite) access to certain goods such as number of refrigerators per 1000 people, for example.

Many economists look at standard of living as the ease by which people in a country are able to satisfy their wants. First of all, we didn't realize "wants" were a good way to measure how well a person was living. Second, a "satisfied want" is a psychological issue. This means such measures, no matter now "empirical" they try to be, are highly subjective. In fact, it's been proven that the feeling of "wanting" is dependent on how well you stack up to your close peers. That is, wants are relative, so they're never satisfied. It's a quirk of evolutionary psychology that we are always keeping up with the Joneses no matter how rich we are. These are highly politicized issues—meaning politicians use them to get power and sew fear and worry. If you were to compare the absolute US standard of living to 1) the rest of the world, or 2) the US 100 years ago, just about everyone would be wealthy and happy.

So, these studies are highly subjective, political, and psychological. What's more, they are mostly tracking "inequality" and not an actual agreed upon absolute standard.

Wealth is not a zero-sum game. Economies create wealth, they don't simply divide it up. What matters is whether the mean or median real income of the population is rising or falling. (It's been consistently rising for decades). Thus, these sorts of studies are non-events for the investor: they do not reveal new information that points to the health of an economy or future prospects for growth.

However, many people mistake these studies for just that: an economic indicator. And that's a mistake, but one we can capitalize on because we know it's a false belief. Such studies breed a lot of political rhetoric, fear, and worry. All part of the grander Wall of Worry a market climbs in the midst of a bull market.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.