Risk equals reward
Inequality continues to grow globally, but it’s not just that the rich are earning more. Household wealth—including real estate holdings, retirement savings, and other investments—is far more concentrated than the income people collect from their jobs.
Part of the reason why wealth inequality is so severe comes down to how risky people can be with their money, according to a paper in the September issue of the American Economic Review.
Authors Laurent Bach, Laurent E. Calvet, and Paolo Sodini look at the balance sheets of every Swedish household between 2000 and 2007. They say that the richest residents invest in riskier and potentially higher-yield assets.
Figure 2 from Bach et al. (2020)
Figure 2 from their paper shows the average allocation of gross wealth, broken down in different brackets of net worth. Cash is dominant for households in the bottom 20 percent of the wealth distribution. Cash becomes less important as net worth grows and is just 3 percent for the richest 0.01 percent of households. Meanwhile, private equity takes over a dominant role the richer someone becomes. Private equity is negligible in lower and middle-income brackets, but blows up to 62 percent for the top 0.01 percent. The share of risky assets—defined as the weight of risky financial assets, commercial real estate, and private equity in household gross wealth— fluctuates around 10 percent for the households in the bottom 70 percent of net worth. Meanwhile, it’s nearly everything—95 percent—for the richest 0.01 percent.
The paper offers insights into the composition of wealth and which kinds of assets contribute most to the inequality gap. Taxation is often viewed as one of the main avenues for regulating inequality, which means policy must take into account the impact of taxes on household portfolios and risk-taking.