Stock market makes wealthy Americans richer faster than modest investors

A team from Imperial College Business School, the University of Maryland and Columbia University found that the stock market makes wealthy Americans richer faster than moderate investors.

The return on investment, they found, in relative terms is up to 70% higher for rich investors compared to people with modest wealth, when the yields on assets such as bonds and stocks are calculated. A situation that widens the gap between the haves-and-have-nots even more, they say.

An Oxfam International report published earlier this year showed that the richest 1% of Americans captured 95% of the country’s growth since 2009, while the other 90% of Americans became poorer.

The authors say their study is the first to put forward a consistent explanation of the wealth gap generated from financial markets.

Rich investors take more risks because…

Wealthy investors have better access to top advice from asset managers, the researchers say. More moderate investors, without so much access to the best professionals, are less likely to buy riskier shares and bonds that have potentially greater returns on investments.

Co-author Professor Marcin Kacperczyk, from Imperial College Business School, said:

“Understanding how income from stock market activity can add to income inequality is something that has never been fully explored by economists before. Our research shows that some wealthy individuals are making substantial profits on stock markets because they have tools at their disposal that individuals from modest incomes don’t.”

“This further creates a widening income gap between rich and poor, which is bad for society, making it difficult to have equality of opportunity.”

Focusing on labor markets is not enough

When analyzing inequality, economists tend to focus on labor markets when calculating the difference between the highest and lowest paid US workers. They also tend to measure inequality by determining the value of people’s savings and investments, personal valuables, vehicles and homes.

In this latest study, the authors used data from Thomson Reuters that shows how much income investors received from their stock market activity to determine income inequality. They used this calculation when measuring the income inequality between people from higher and lower wealth backgrounds.

The team plan to use their formula to study income inequality in the United Kingdom.

The study, titled Investor Sophistication and Capital Income Inequality,” was written by Marcin T. Kacperczyk, Jaromir Nosal and Luminita Stevens and published in the Social Science Research Network.

Is inequality a problem?

According to a Harris Poll carried out in April, 54% of Americans believe that economic inequality in their country is a major problem, while 79% see it as either a problem or a major problem. Thirty six percent of self-identified Republicans see it as a major problem, compared to 55% of Independents and 70% of Democrats.

An OECD report showed that increasing wealth inequality across member nations has persisted for the last three decades. The top 1% earners carry on capturing a progressively more disproportionate share of income growth. Since 1981, the top 1% richest people in the US and Canada have captured 47% and 37% of overall income growth respectively.

Another OECD study warned that global income inequality could worsen, as well as social divisions. Unless swift action is taken, the authors wonder whether the problems could become entrenched. Early on during the Great Recession, spending on unemployment benefits, disability and family rose, but these areas are currently being cut in several parts of the world.

Before implementing further cuts, the OECD asks policymakers to think them through with caution. Withdrawing support for society’s most vulnerable people may add fuel to future social cohesion problems.