Simple Steps to Surpass the Trend

I worry for my kids. I suppose parents have felt concern for their offspring throughout history, so maybe it’s just that my turn has come. Or then again, if the trajectory continues, perhaps I should worry for my grandchildren too.

Families in the under-40 age group lost 43.9 percent of their net worth between 2007 and 2010 according to the Center for Household Financial Stability (CHFS) at the Federal Reserve Bank of St. Louis. This is two-and-a-half times more than the experience of my age group (Boomer); on average, my generation lost 17.4 percent in that time period. A total of $16 trillion in household net worth evaporated in the Great Recession. Economists’ calculations show that on the whole we have recovered all $16 trillion. Then why is the under-40 crowd still 30.2 percent below 2007 figures on average while my generation is down just 1.3 percent?

The CHFS recently reported on the disparity between households that have benefited in the recovery and those that have not. The net worth of about one-quarter of American households has returned to or exceeded 2007 levels. These are called the thrivers in the report. The strugglers, by contrast, have a household balance sheet that on average is lower than it was prior to the recession. Three out of four households have not fully benefited from the recovery, and my children are in the age group that lags behind.

Three Critical Issues

The economists who prepared the CHFS report cite three issues that contributed to the slow economic recovery of young households.

1. Young adults tend to have few funds immediately available. When an expenditure shows up at the party uninvited, the household with no emergency fund faces an awkward situation which might be called a vulnerable financial position.
2. Households slow to recover from the recent economic turmoil are inclined to not own a variety of types of investments. Economists point out that only 12 percent of the recovery of the $16 trillion can be attributed to housing values. By contrast, 86 percent of the recovery is credited to how the stock market has rebounded. Households which own a home but have not invested for retirement, for example, are still underwater when compared with where they were in 2007.
3. Households headed by young adults have been weighed down by too much debt. This is a millstone around the neck that inhibits attempts to rise above the next financial wave. Young adults with large educational and consumer debt face a fragile future.

Net Worth, Not Income

You may have noticed that to this point in the article, income has not been mentioned. The concerns expressed in the CHFS report deal with net worth more than income. The CHFS does describe the “de-skilling” of the labor market where college graduates end up working in jobs that do not require a college education and its effect on income. The cascading effect pushes the lowest skilled workers out of the job market altogether. Those observations should sound an alarm.

But net worth is of greater importance for financial stability than income. Net worth equals what is owned subtracted by what is owed. Net worth is the balance sheet where an emergency fund is an asset and debt is a liability. A household with an income of $25,000 that saves a little every month is building financial security not known by the household with an income of $100,000 that spends every penny and carries a balance on credit cards. Anyone at any income level can systematically build financial security. The primary measure of household financial stability is net worth, not income.

The solution to the vulnerability identified in the CHFS data could not be simpler. Some households may struggle to implement change, but that will not be because the steps are hard to understand. First, every household needs an emergency fund of three to six months of living expenses. This step alone will lower the anxiety level in a family. Second, every household should diversify its financial holdings. Participation in a retirement plan with good asset allocation and home ownership provides a solid, basic plan. Third, eliminate debt. Avoid taking on new obligations.

The CHFS reports that young adults today have a lower net worth than their parents did at the same age. Since they have a poorer starting place, economists project they probably will achieve less wealth in their lifetimes than did their parents and grandparents. And that causes me to worry, unless the trend is surpassed.

Originally published by Pensions & Benefits USA.