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Wealth effects: Spend, invest, retire

house money LEAD

By Joel Dresang

The village raised our house assessment by $32,600. I know it means we’ll pay more in property taxes, but I greeted the news as a windfall: It suggests our house is worth more, so I feel richer.

I also know that financial markets have been performing well. I checked my retirement account, and through July, it was up 24% from the year before, including compound investment returns and ongoing contributions from both me and my employer. Compared to two years before, my 401(k) was 52% bigger; 69% if I go back three years.

So, between home equity and investments, I’m feeling comfortable. That’s what economists call the wealth effect.

Spend

Just knowing that home prices are rising and the stock market is strong encourages consumers to spend, which drives 70% of the $22 trillion economy.

For years, economists have been documenting the wealth effect on consumer spending, including a report in 2019, suggesting that for every $1 gain in stock market wealth, U.S. consumers spend an additional 3 or 4 cents. Some estimates go as high as 7 cents.

How wealth affects individuals varies. It’s a frequent conversation Art Rothschild has with investors.

Wealthier than ever
Americans’ net worth eclipsed $129 trillion early in 2021, up 24% from the year before, 70% of it held by those 55 and older.
Housing prices are going through the cliché roof. The S&P CoreLogic Case-Shiller home price index reached a record high in June, up a record 19% from the year before. The National Association of Realtors estimates that the typical homeowner reaped an added $45,000 in house value over the last year.
In the stock market, the benchmark S&P 500 closed at a daily record high 52 times in 2021 through Aug. 31.

“The single most important thing we do really is help our clients realize what their money is for,” Art said in a Money Talk Video. “They’ve worked their entire lives to build up a nest egg that’ll hopefully sustain them in retirement, and there’s nothing more important than talking to them about how much they can spend.”

By my upbringing, I’m not much of a spender. My parents grew up in the Depression. We kids were told to draw on both sides of the paper, even though Dad worked at a paper mill and had access to reams and rolls of free paper samples.

The most impulsive purchase I’ve made in recent memory was a $30 Milwaukee Bucks hoodie I ordered online just before the NBA Finals. I found the sweatshirt on sale (supposedly half off) and showed it to my wife to ask if she thought I should buy it. Then I asked again, just to be sure.

“Many people are good accumulators,” Art told me. “That’s what they’ve done to get what it takes to retire comfortably.” In nearly 30 years of advising, Art has helped clients transition to retirement spending after lifetimes of pinching pennies. He reviews their assets and objectives and talks with them about how much they can afford to spend without depleting their accounts.

Invest

But wealth affects more than our spending. It also influences our investing.

“The amount of money people have gives them confidence,” Art said. “The success of making money over time gives them more confidence and enables them to stay in the game — to hold them instead of fold them, if you will.”

A new study backs that up. Researchers from the London School of Economics and Political Science analyzing ultra-high net worth portfolios found that wealth afforded investors a greater tolerance for risk.

Other Money Talk articles from Joel Dresang

That explains for me why, when the pandemic sent stocks reeling in 2020, I felt myself watching the developments out of curiosity, not despair.

I didn’t really worry. Based on periodic reviews with our advisor and occasional glances in between, I had an idea of the progress our portfolio had been making. When curiosity got the better of me, I saw that our balances were down, but our allocations remained close to what we had planned. Plus, looking past the near-term declines, I could see how much our portfolio still remained ahead from even a couple of years before.

Research from behavioral economics suggests investors can harm themselves by monitoring their portfolios too closely. Market volatility can make them too bold or too meek, depending on the latest prices, and they could succumb to emotions.

In my case, the wealth effect allowed me to be brave enough to look at the numbers and try to be objective about how our progress measured up to our plans.

Retire

Besides affecting spending and investing, the wealth effect can influence retirement timing.

Stockholders during the 1990s bull market moved up their retirements by seven months on average, according to one study. Other research found that homeowners aged 55 to 64 delayed their retirements by nearly three months when their properties lost value during the subprime mortgage crisis.

Amid the recent surge in wealth, retirements have soared. From February 2020 to June 2021, 3.6 million Americans retired, according to the Federal Reserve Bank of Kansas City. That’s more than twice the 1.5 million new retirees economists would have expected in that time.

Of course, more than just fatter accounts is behind the swell of retirements, but to the degree that investors are retiring because of sudden gains in wealth, Dave Sandstrom cautions prudence.

“While this has been great for people’s confidence and for their portfolios, don’t get tripped up and lulled into a false sense of security,” Dave said in a Money Talk Podcast.

Decisions to retire early need to consider the added years of spending to cover and how to pay for health care, Dave said, and they shouldn’t be based on assumptions that recent investment return rates will go on forever.

“You’ve got to be careful,” Dave said. “You’ve got to take a hard look.”

The wealth effect usually is mentioned as a factor in spending, but it also plays a role in investing and retiring. Of the three, I feel it affecting me the most as an investor — but that’s just the phase of life I’m in. And, I figure if I play my cards right as an investor, eventually I’ll be able to retire and feel all the more comfortable with spending.

Joel Dresang is vice president-communications at Landaas & Company.

Learn more
Safe investment withdrawals for retirees, a Money Talk Video with Art Rothschild
5 ways rebalancing calms anxious investors, a Money Talk Video with Marc Amateis
When Should I …rebalance my portfolio, by Art Rothschild
Checklist for circumstances beyond my control, by Joel Dresang
Retirement 101: Having a Plan, a Money Talk Video with Tom Pappenfus
(initially posted September 2, 2021)

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