June 7, 2018
Kevin Lings, Chief Economist
Households around the world are richer than ever before. During the past 15 years, global household wealth rose by a total of 125% in US dollars, reaching a record high of $280.3 trillion in 2017. This equates to an average annual growth rate of 5.6%, including the impact of the global financial market crisis that led to a massive 12.6% decline in household wealth during 2008.
The rate of increase in global wealth has easily exceeded world population growth over the past 15 years, as well as inflation.
Yet the distribution of household wealth, between regions and as well as within countries, remains extremely uneven. This is one of the world’s most challenging social, political and economic problems.
How do most people become wealthy?
There are three components to understanding household wealth. The first is the growth in debt. At the risk of stating the obvious, a surge in consumer debt can quickly undermine the net worth of any household, especially if the debt is being used to fund consumer spending rather than buy an asset such as a vehicle or residential property.
The second component is growth in the value of financial assets such as unit trusts, direct holding of shares, pension funds, retirement annuities or a bank deposit. In many instances this outcome is largely determined by the level of interest rates or the performance of the stock market, which can be volatile over short periods, but in most instances performs exceptionally well over the longer term.
The final component is growth in non-financial assets. These include mainly residential properties, but also vehicles and other durable goods. Over time this category has been expanded to include a wider range of assets, such as art and other collectable items.
Common features in building wealth
A few common features are worth highlighting in analysing the performance of households’ balance sheets across many regions and countries including SA.
The first and perhaps most surprising conclusion is that since the global financial market crisis in 2008 household debt has grown at a very moderate pace. This is despite many countries, especially in the developed world, significantly reducing interest rates to record lows.
In fact, data provided by Credit Suisse on global household balance sheets shows that in 2017 total household debt, in dollars, was still 3% below the peak in 2007. In other words, in recent years both banks and households have been reluctant to return to the rate of credit expansion evident before the financial crisis.
In the US, household debt has shown positive growth but it is still very modest, at an annual average growth rate of 0.9%. In SA the average annual growth rate has actually been slightly negative at -0.6% when measured in dollars.
Unfortunately, this moderation in the use of credit has been especially pronounced in the housing market. In SA household mortgage debt, measured in rands, increased by an annual average of only 3.7% over the past ten years, which is well below the rate of housing inflation. Converting these values into dollars, total outstanding mortgage debt has actually declined by an average of -2.6% a year for the past ten years.
This has two very important implications. The first is that home ownership in SA has tended to stagnate in the past decade, which is a lost opportunity for many households to strengthen their balance sheet. The second is that a vibrant and growing housing sector provides very significant economic benefits including job creation and increased demand for locally produced materials such as bricks and cement.
A reliance on residential property
Non-financial assets, such as residential property, represent a critical component of most household balance sheets. For example, in both SA and the US, residential property accounted for 21% of all household assets in 2017. In some of the large emerging economies, such as Brazil, China, Russia, India and Indonesia, non-financial assets comprise a much large percentage of net wealth. In China the percentage is 55%, while in India it is radically higher at 86%.
Understandably, the aspiration of owning your own home is an important and worthwhile goal for most families and, when financial markets and products are less developed, families’ greatest assets are their houses.
While the value of residential properties has helped to lift the net wealth of the household sector over many years, in most developed countries and some emerging markets, including SA, it is really financial assets that represent the bulk of growth in wealth.
In 2005 financial assets represented a very substantial 61.5% of total household assets in the US, but by 2017 this had risen to just over 70% due to the outperformance of financial assets relative to non-financial assets.
The same trend is reflected in SA, where financial assets comprised 61.1% of total assets in 2005, rising to 66.6% in 2017.
“In SA the growth in the value of financial assets explains 83% of the total uplift in household wealth over the past eight years.”
Financial assets proved resilient long term
The global household sector’s net wealth has fully recovered from the impact of the global financial market crisis. This recovery has been helped by a more prudent approach to the accumulation of debt, while at the same time the value of residential properties has tended to move higher, helped by growth in employment and lower interest rates. The households that have been invested in financial assets, despite the inherent volatility of equity markets, have experienced a more robust increase in wealth over many years.
It is fair to conclude that there is a tendency for wealthy households to become even wealthier since many are able to reinvest the income they earn on financial investments. However, it is never too late for individuals to focus on strengthening their balance sheets.
This highlights the importance of three key household investment guidelines.
- The first guideline is it is important for households to accumulate a diversified set of assets, and not simply focus on home ownership as their only asset.
- The second guideline is, as far as possible, debt should be mostly used to acquire an asset, such as a home, vehicle or education, rather than simply to fund the excess consumption of non-essential items.
- The third guideline is having long-term financial assets in the form of retirement savings or a unit trust is critical to ensuring a more rapid increase in net wealth over the longer term.