Earning a place among the wealthiest individuals has been achieved by investing in risky assets, such as private businesses, and then multiplying the returns. This holds true irrespective of whether or not they inherited wealth from affluent parents. In contrast, accumulating savings from employment earnings by investing in safe assets like housing is not the most effective approach to achieving one of the top spots among the wealthiest.
Those are the key conclusions from a recent paper from Wharton, which aims to better understand how the super wealthy got where they are.
“We find that there are two types of super-rich: the Old Money, with parents that are rich, and the New Money, who have higher rate of returns and saving rates that bring them to the top,” the researchers explain.
Growing wealth
The findings of the paper were drawn from an extensive study of income and wealth data covering 22 years (1993-2015) for the entire population of Norway. The study used administrative tax and income records to identify the four types of assets that made up a typical household’s total assets: housing, safe assets (bonds, cash, and deposits), public equity (stock and mutual funds), and private equity (the value of private businesses).
The study focused on three main areas: Firstly, it analyzed the evolution of average net worth over the life cycle for different wealth groups. It found that, on average, the wealthiest individuals started their lives significantly richer than other households. For instance, the wealthiest 0.1% of households aged 50-54 owned, on average, about 120 times the average wealth in Norway in 2015.
Secondly, the study examined lifetime portfolio composition and long-term returns. It discovered that the wealthiest individuals invested a substantially higher percentage of their portfolio in equity, particularly private businesses, starting from a young age compared to those with the same wealth and age in the past. Lastly, the study documented the sources of income, which included initial wealth, inheritances, labor income, capital income, and taxes and transfers.
The researchers chose age 50 as a useful marker to determine how the top 0.1% made their “excess wealth” or the degree by which their wealth exceeded that of mid-wealth households. The study found that old money households could attribute their “excess wealth” to higher saving rates, higher initial wealth, and higher returns, with smaller shares from higher labor income and inheritances.
One quarter of the wealthiest individuals, known as New Money households, had to work harder to achieve their status. At age 50, their excess wealth was primarily attributed to higher saving rates (46%), followed by higher returns (34%) and higher labor income (16%).
“On average, the wealthiest start their lives substantially richer than other households in the same cohort, own mostly private equity in their portfolios, earn higher returns, derive most of their income from dividends and capital gains, and save at higher rates,” the researchers explain.
Notable differences
According to the paper, there were significant differences in investment patterns between the wealthiest households and those at the other end of the spectrum. The wealthiest individuals invested a much higher portion of their portfolio in private businesses from a young age and maintained a high percentage of risky assets throughout their lives, with a peak of 89% by age 50.
Their primary source of income was equity, which accounted for 83% of their lifetime income in the 50-54 age group. In contrast, those in the bottom 90% of the wealth distribution earned the majority of their lifetime income from labor services.
The portfolios of the super-rich contained a smaller proportion of safe assets and housing, and their leverage remained low, never exceeding 10% of their total assets. On the other hand, housing made up around 90% of the gross wealth of those in the bottom half of the wealth distribution, and they started their lives with higher levels of leverage, which decreased as they progressed but never fell below 50% of their total assets.
The wealthiest individuals’ initial wealth constituted slightly over one-sixth of their total resources, but it was the most significant component. Interestingly, inheritances were an insignificant portion of resources for all wealth groups, while labor income contributed to nearly a tenth of their lifetime resources.
Among those classified as Old Money, over a quarter had parents in the top 1% of their wealth distribution, while less than 7% of the New Money group had parents in that bracket. In fact, the majority of New Money households were self-made, with 75% of their parents falling in the bottom 90%.
The paper also shed light on how New Money households rose up the wealth ladder despite starting from a low base. For instance, they began their working lives with equity accounting for less than 10% of their investment portfolio, but this grew significantly to 90% by age 50, similar to the private equity share of the Old Money group. The New Money group started with high levels of debt, but they quickly reduced their leverage over the first ten years.
The New Money group earned considerably higher returns across all age groups, with the 35-39 age group earning an average return on net wealth of around 15%, compared to 10% by their Old Money counterparts. Moreover, the youngest in the New Money group earned a remarkable 40% average annual return on their equity investment, compared to 10% for the Old Money group.
