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Skimmed Milk Masquerades as Cream — Part I

Wealth amazes. Everybody wants it; few attain it. Some who possess it take it for granted.
Michael McTague, Ph.D., is executive vice president at private equity firm Able Global Partners in New York.
Michael McTague, Ph.D., is executive vice president at private equity firm Able Global Partners in New York.

Image source: Anastase Maragos / Unsplash

July 2021 Myth Buster

Wealth amazes. Everybody wants it; few attain it. Some who possess it take it for granted. Think of Harry and Meghan, who imply they want to be cut off from the source of their riches. Conversely, many who do not possess wealth claim to have it. This series separates the really wealthy from the pretenders and tries to have a little fun doing so. The Myth Buster is not going to show you how to become wealthy. Plenty of people and annoying television ads about cheap trading and the value of gold have that area staked out. 

Part 1 looks at those hard working, successful individuals who earn more than their neighbors — the Joneses — and who think they are doing well financially. Readers will note that this is not a political interpretation. The focus is finance!

Here is a broad financial outline of the successful executive:

  • Works as a Vice President at a respected organization
  • Earns over $100,000 a year (actual salary)
  • Owns a home (holds a large mortgage)
  • Owns two cars (with at least one car loan)
  • Contributes to a 401K plan, which has a corporate match
  • Holds more than $100,000 in mutual funds
  • Invests a small amount of money in gold (just in case)
  • Vacations with his or her family each year and plans to buy property in Florida (in New York, it’s the law!)
  • College graduate. Also completed a Master’s degree

This portrait makes up an enviable financial situation. Many would call such a person “wealthy,” “successful,” even “rich.” Let’s look more carefully.

This executive lives in a home that is worth $700,000 or more. That sounds impressive, but according to Zillow, the average asking price in San Francisco is $1,300,000. The home was purchased five years ago, and the executive still owes $500,000 principal. The monthly payments are more than $4,000, which accounts for more than half of take-home pay. Total mortgage debt in the US totals over $15 trillion according to 

If pressed on the huge mortgage, this successful executive is ready, saying that the home is his or her best investment. That would be true if two things were in place. First, the home would have to be owned outright with no debt. Second, the owner would have to be willing and able to sell the home — after all it is just an investment — and live somewhere else. The massive mortgage debt in the US shows that few can back up this often heard claim.

Then there is food, oil, credit cards and all the other bills. One car is paid off; the second was purchased on an auto loan for which the executive owes $650 a month for the next three years. Two teenage children in the family are expected to attend private colleges. Neither child is a basketball superstar. When husband and wife discuss college, the response is that they have savings and they may set up a separate fund to pay for college. Even though it would save money, the idea of attending a “less expensive” college or getting an Associate’s degree at a community college before transferring to a four year college is shot down quickly. Remember the Joneses! 

Waiting for a Windfall

The successful executive also thinks that the stock market may provide a windfall. The coronavirus notwithstanding, the meteoric rise of the market in 2019-2020 and generally since 2016 might provide the family with a bundle of cash that will cover the high cost years when both children are in college. College costs are rising more rapidly than the market. It should be obvious that while the everyman executive featured here is successful and has worked hard to reach his or her current spot, this is not the profile of wealth. And, we have not even mentioned inflation.

Taxes also present a burden. Have you noticed that you pay capital gains tax after the market rises but typically get little benefit when the market declines, only to be taxed again the next year when the market rises again? To make things worse, consider the substantial stock market gains of 2019. Then the coronavirus came along bringing an early drop in the market. People who own stocks or mutual funds, however, still had to pay substantial taxes for the capital gains of 2019. Those are the vulnerable gains that seem to disappear around tax time.

Becoming a Millionaire

Many observers trumpet retirement plans. Consider the amount of money held in American 401(k) and 403(b) plans, estimated to be over $32 trillion. Fidelity alone manages over $3 trillion, and it has plenty of competitors. The roughly 4% of Americans who become millionaires typically do so through the money accumulated in their retirement plans. The old fashioned pension plan where the employer pays you monthly when you retire — a system now more common to government workers — does not appear as the property of the employee. It is an obligation of the employer. But 401(k) and 403(b) plans are the individual’s personal property. An estimate is that retirement plans in the US account for about one-third of household wealth. 

Keen observers will note that owning assets or “household income” does not really mean you can spend or even access the cash. Yes, you may wind up “cash poor.” There is also a penalty for withdrawing money held in a retirement plan before you retire. If you are still working and take money out, it will likely damage your tax situation.

The title of this series comes from Jonathan Swift: “Things are seldom what they seem. Skimmed milk masquerades as cream.” So far, this myth is holding up very well. The appearance of wealth may involve assets you cannot even touch for many years to come. The next entry looks at a different aspect of apparent riches. 

Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

Equities News Contributor: Michael McTague, Ph.D.

Source: Equities News