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Dear Janet Yellen – Stocks Are The Cause Of Rising Wealth Disparity

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As an investor who self manages a diversified portfolio of financial assets, I find it prudent to pay more attention than I often would like to all sorts of political and economic issues.  In addition to following debates among politicians and economists, I also spend time thinking about a variety of topics.  In an October 17 speech entitled, “Perspectives on Inequality and Opportunity from the Survey of Consumer Finances,” Janet Yellen touched on one such topic, namely wealth disparity.

Wealth disparity has received plenty of attention in recent years.  As I’ve followed the views expressed by those who have access to the bully pulpit, discussions surrounding the causes and potential solutions to wealth disparity seem far too politically and economically convenient for those expressing the viewpoints.  In fact, one of the biggest contributors to wealth disparity is almost never discussed—the stock market.

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While financial pundits and politicians always seem to put a positive spin on the stock market’s role in society, in fact, it could be argued that stocks are among the leading causes of wealth disparity.  Basic math will help illustrate my point:

Let’s pretend there are four individuals invested in the stock market.  Person number one has a $50,000 portfolio.  Person number two has a $200,000 portfolio.  Person number three has a $1,000,000 portfolio.  And person number four has a $5,000,000 portfolio.  In today’s dollars the spread between the highest and lowest portfolio values is $4,950,000.  What do you think will happen to the spreads between the various portfolios as the stock market trends higher over time?  Let’s take a look.

As a random example, let’s assume all four portfolios are invested in the same S&P 500 index fund and experience 8% compounded growth over the next 10 years.  At the end of the 10-year period, the portfolios will be valued as follows:

Portfolio 1: $107,946.25

Portfolio 2: $431,785.00

Portfolio 3: $2,158,925.00

Portfolio 4: $10,794,625.00

Despite the fact that the four portfolios experienced the same compounded percentage growth, the dollar spread between the four exploded wider.  The original $150,000 difference between portfolios one and two grew to $323,838.75 after 10 years.  The $800,000 difference between portfolios two and three grew to $1,727,140.  And the $4,000,000 difference between portfolios three and four widened to $8,635,700.  Remember the original $4,950,000 spread between the highest and lowest portfolios?  After 10 years, that has grown to $10,686,678.75.  I’m sure you can imagine how wide the spreads would grow after 20, 30, or 40 years.

If you are a lower- or middle-income American, you are unlikely to ever be able to invest enough money to keep up with, let alone catch, those who are starting with much higher portfolio values.  The law of compounding returns will work against you.  It is no coincidence that charts of wealth disparity and charts of the stock market look eerily similar.

Furthermore, one could also make the argument that stocks are a contributor to disparate levels of income, especially in recent years.  This is due to the fact public companies have been so intent on keeping their stock prices elevated, they’ve focused on cost-cutting, share buybacks, and dividends, rather than paying their employees more.  While the stock market is perhaps one contributor to income disparity, the link between stocks and wealth disparity is much more clear.  But because it is taboo to express anything but joyous opinions of the stock market, the fact that stocks are a major contributor to wealth disparity will continue to remain on the hush-hush.

If disparities in wealth and income are truly of great concern to Janet Yellen, she might want to rethink the role the Federal Reserve has in causing the very disparity that “greatly” concerns her.  After all, QE forever hasn’t exactly helped narrow the gap in wealth disparity.

 

More from The Financial Lexicon:
The 5 Fundamentals of Building a Retirement Portfolio
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