Behavioral Finance

Wealth Misconceptions

Wealth disparity is accelerating in the United States.

Wealth disparity is accelerating in the United States. The "shrinking" middle class. The rich are getting richer and the poor are getting poorer. Heard any of these? Unless you've been hiding under a rock for the last 30 years, you've probably read many such headlines.

How many stories have you seen claiming the opposite: that virtually all Americans are actually wealthier than they were a generation ago. You can likely count those with the fingers on one hand.

As it happens, such stories are common as the flightless dodo. Ok, maybe that's an exaggeration…the dodo is extinct! So a story saying Americans are better off than before, that real incomes have risen, that the standard of living has undoubtedly increased from years past, comes across as often as a fisherman hooks a coelacanth off the coast of Madagascar. In other words, it's rare.

The politicians and journalists instead focus on the abundance of studies showcasing a gloomy picture for the middle and lower class in America – a nation of a few haves and many have-nots… a gripe as old as civilization itself. The story is so well repeated that most Americans take it as gospel without skepticism. But is it true? Does the United States posses a growing inequality epidemic?

A new book, Income and Wealth, by Alan Reynolds of the Cato Institute, answers that question with a resounding no. Reynolds dissects a number of popular wealth studies' statistical methods, revealing numerous measurement errors and biases. It's a widely different picture of individual wealth progression in the U.S. than we're used to hearing.

Lying, deceiving, and other forms of general villainy in using statistics is nothing new, and Reynolds demonstrates how income and wealth stats are often used as marketing devices intended to persuade people to support various government policies. The real picture looks quite different.

How is income measured? When an income statistic is cited, the number can vary widely based on what or what is not counted as income, how that number is adjusted for inflation, the definition of a "household", and a plethora of other things. The decision on how a single factor alone is defined can skew results greatly.

How about average income? Many studies choose to use the mean for average rather than the typical median for self-serving purposes because the number tends to be higher. Think about it. Income groups are largely divided into categories yet the top group has no earnings ceiling. So Bill Gates and Larry Ellison are ranked in the same earnings category as anyone making over a few hundred thousand bucks. Does that make sense to you? Reynolds demonstrates that when comparing median averages rather than mean, the growth in real income from 1989 to 2004 was not faster in the top 10% of wage earners than it was in the bottom 20% or 40%. Why do Americans care so much what the top 500 or 1000 people in the US make, anyway?

What is the middle class? The middle class is typically measured as households earning between $30,000 and $50,000 per year. In fact, the middle class is shrinking, but because a higher percentage households make MORE than $50,000 in a year. In that case, let the middle class wither away.

Are wages a "stable pie"? In the book The State of Working America the authors assert, "Much more of the nation's salary income became concentrated at the top, leaving less to be divided among the larger work force." Surely you have heard or read some variation of this line before. Popular media tends to operate under the assumption that capitalism is a zero sum game; that one's personal gain must come at another's expense. If someone gets a promotion, another must get a pay cut or job loss. But blessed we be, the world has no fixed amount of wealth to be divvied up. Capitalism has historically demonstrated that the wealth pie is an ever
E-X-P-A-N-D-I-N-G dessert. Wealth isn't divvied up, it's created.

The pundits and politicians will always tell you how bad things are because that's what gets people's attention. Good news is boring. But don't take any heed. Average Americans have larger individual net worth and consumption power than ever before.

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