How Can They Afford It?

One of Moominmama's friends (from undergrad days in the world's most populous country) told her they have bought a house in one of the most expensive neighborhoods here. They plan to knock it down and build their dream home including a swimming pool. It is in walking distance of their two children's school, the most expensive private school here.  Her reasoning is that it costs AUD 4 million to buy an existing house like they want, and this will be cheaper. Still, a crappy house there costs almost AUD 2 million. They haven't sold their existing town house in our neighborhood yet and they apparently also bought her parents an apartment here. She is an administrator at my workplace on probably AUD 100-110k a year and her husband was an associate professor (AUD 150-158k). He recently moved to Moominmama's employer.

 

AUD 3.5 Million House

My immediate reaction was: "How can they afford to do that?" I think Moominmama gets a lot of her aspirations from following this family, including sending our children to private school. 

More Factoids from the 2019-2020 Australian Income and Wealth Survey

3.2% of households are in both the top income and top net worth deciles. That means their net worth is above $2.258 million and their annual income is above $235k.

2019-20 Australian Income and Wealth Distribution

 

I didn't notice when the Australian Bureau of Statistics released the 2019-20 data on Australian household income and wealth distribution. I previously reported on the 2015-16 and 2017-18 data.

Mean gross household income was $121k per year in 2019-20 (all $ are Australian Dollars). The median was $93k. These are not adjusted for household size. ABS provides data adjusted for household size in terms of the income a single person would need to achieve the economic well-being of the average household. To adjust these to the required income of a household with 2 adults and 2 children requires multiplying by 2.1. I seriously doubt that adding a child only increases costs by 0.3 of the first adult! 

Mean gross household income in the ACT was $150k and the median $124k.

To be in the top 10% of households requires a gross income of at least $235k. To get information on the breakdown inside the top 10% you have to use their data on the number of households within each of different bands of weekly income. 4.7% of households have an annual income above $312k and another 3% between $260k and $312k. Our gross income was $264k (taxable income), so we just fall within this group and, therefore, in the top 7.7%.

Mean household net worth was $1.04 million and the median was $579k. To be in the top 10% you needed a net worth of $2.26 million. We were at $4.44 million at the end of June 2020. To be in the top 3.9% you needed a net worth of $4 million. So I estimate we were at the edge of the top 3.3%. I guess it makes sense given my age that we higher in the wealth distribution than in the income distribution.

1.2% of households had a net worth above $7 million and 0.6% above $10 million.

There is a lot more data on breakdown of assets etc. which I might report on another time.

To be in the US top 1% by net worth required USD 11 million ($17.75 million) in the same period. A top 1% US household income is around USD 600k and above.

Most People Think They are Financially Average

Well not quite. But people think they are more average financially than they are, on average.

But the strange thing is that most people think they are more intelligent than average. Was just chatting with someone on Twitter who stated that the norm in Australia is to get paid weekly and most people don't own a house. In fact, 67% of homes are owner occupied and getting paid every two weeks is most common. On the other end of the spectrum, my wife thinks our financial situation is "normal", when according to the statistics we are in the top few percent.

Mortgage Refinancing: Reality Check

I met today with a "Premier Relationship Manager" at HSBC. We are going ahead with the mortgage refinancing. They will send a valuer to value our house tomorrow...

So, she first checked whether I could service the loan based on the data I submitted. Based on just my salary of AUD 176k per year and our spending and a AUD 500k loan the answer was no. Given my salary is supposedly in the top 5% or higher, our house value is only a bit above the median price for houses here, and lots of people drive luxury cars etc. and we don't, you'd think this wouldn't be a problem. She said our spending was "very high". Either government income data is too low (but the banks ask for tax returns), or people somehow hide spending from the banks (but the banks ask for bank statements), or what? It's hard to reconcile what I see with the data.

Our net worth is in the top 300,000 or so of households and my income in the top 400,000 of taxpayers according to this official data.

By the way, five plus years ago, when we were looking to buy a house, the banks were willing to lend us much more money. Lending standards really have tightened.

Distribution of Income and Wealth in Australia in 2017-18

The latest survey results have been released by ABS. To be in the top 1% in Australia you need to have a household net worth of about AUD 7.5 million (USD 5.25 million). We're in the top 4% according to the data. The mean household has a net worth of AUD 1.022 million and the median AUD 559k.

We're also in roughly the top 4% by household income if we'd earned 2018-19 income in 2017-18... Median household earns AUD 1,700 per week (AUD 88k per year) and mean 2,242 (AUD 117k). Of course, households with children average a lot more than this as the data include pensioners, students, singles etc. These data don't let you compute the income of the top 1% directly.

Do You Feel You are in a Lower Wealth Percentile Than What the Official Data Say?

People tend to think they are less relatively wealthy than they are. You can check out your perceptions against reality for a number of countries here. I'm not surprised. According to the official statistics we are in the top 4% of households in Australia by wealth. But looking around, it certainly doesn't feel like that could be true. Our house is only valued a few percent above the median for our city. Our car is a 15 year old Ford when it feels like the roads are full of luxury vehicles. But it's not like we are saving like crazy. In 2018, we spent almost all of what we earned from salaries. Apparently, a lot of people feel the same way.

How Many Households in Australia are Rich?

Every couple of years the Australian Bureau of Statistics surveys the distribution of household wealth in Australia. The most recent data is from the 2015-16 survey. It doesn't provide a lot of detail though. The downloadable data provides the averages for quintiles and the level at the top of each decile. They report that net worth at the 90th percentile is $1.979 million.

We can get more information by using the reported mean and the Gini coefficients and assuming that the data follow a log-normal distribution. You can get details of the necessary calculation here - use Wolfram Alpha to get the inverse of the erf function.

The distribution fits well for the 30th (ABS: $232k, lognormal: $240k) to 90th percentiles (ABS: $1.979 mil, lognormal: $2.1 mil). Below the 30th percentile the lognormal predicts too much wealth, while right at the top it would predict at most one billionaire in Australia. But I think we could use it up to the 99th percentile without too much error. The top 5% starts at $3.26 million, 4% at $3.7 mil, 3% at $4.3 mil, 2% at $5.3 mil, and 1% at $7.4 mil. All these numbers will be a bit higher now, of course. The most recent figure for mean household net worth is over $1 million rather than $929k here.

The ATO regards anyone controlling more than $5 million as wealthy, so that is the top 2 to 2.5% (with current mean net worth). To be a wholesale investor you need individually $2.5 million of net assets. So assuming a couple have $5 million, that also is the top 2.5%. So, the top 2.5% in Australia are considered "rich". That is roughly 250,000 households.

P.S.
In 2015-16 we were at the 16th percentile.

Money Burning a Hole in Your Pocket

Snork Maiden's stepfather died. He was 80 years old. Her mother is much younger. Snork Maiden has gone to China to be with her mother for a while. Her mother wants to visit Australia later this year, maybe starting in late October for a while and think about spending more time here in the future. She wants to transfer some money to our account here to help pay her expenses in Australia so that she can be more independent than when she and her husband visited last time. If we still are living in this apartment we could try to rent her a furnished unit somewhere nearby. We saw a couple of these last year when were looking for accommodation for a colleague (in the end they stayed on campus), but they weren't that near here.

But she wants to transfer the money today. One reason is so that Snork Maiden can help her with the transaction, which involves moving a "pile of cash" between two banks. Snork Maiden said as well that:

"She is in a hurry because she doesn't want to sit on a pile of money for long.  She got a fixed-term pile of money that is ready to be harvested today, and she wants to decrease the number of transactions as much as possible. I suggested we could put the money in her saving account for the time being, but she said that was too complex and she has never had that much money sitting in her account.    It was my stepfather who dealt with their money, so she has never touched so many cash before, and even the thought of having that much of money in her bank account somehow worries her. "

In the past I heard she would give money away to relatives rather than hold onto too much. It made me think of this story. A lot of people asked how it could be that a 68 year old full professor in a low cost of living location didn't have any savings. One answer is that some people just don't seem to be able to hold onto money for psychological reasons. Obviously, I don't have that problem. So, I'm going to look after her money for her.

Rich or Poor?

Interesting set of profiles in the Guardian. For a comparison, we make around £150,000 a year and have £230,000 in savings. Professor married to a researcher. Our monthly rent is £1300. I think we feel rich until we go to look at houses to buy :) The mortgage on the kind of property we are looking at would be £3,000 a month (we now got pre-approved to borrow up to $A780k). We don't live rich apart from living in exactly the location we want to live in and paying the rent that that means. We have an eight year old Ford car for example.

Australia is the Richest Country in the World by Far

When measured in terms of median wealth per individual in US Dollars at $220,000. Switzerland is richest in terms of mean wealth per individual. Both facts are in the Credit Suisse Wealth Report.

(HT: Enoughwealth)

Average Australian Households

Thanks to high house prices and compulsory superannuation the average Australian household is much wealthier than the average American household.

We are below average with a net worth of about $A510k vs. $A720k for the average household. The average house was worth $A541k for those who owned their home outright and $A521k for those with mortgages. The average superannuation (retirement) balance was $A154k. Here we are above average at $A261k. That includes a couple of US retirement accounts though.

Our income (not discussed in this article) puts us in the top 10% or so probably of households and in the long-run I expect we will end up wealthwise in the top 20% of households who average $A2.2 million.

Asset Allocation of US Estates

More interesting statistics from the US IRS. 34,000 estates needed to pay estate tax in 2009 and the average value of these estates was $5.7 million. Assets were allocated as follows:



Of course, this is the allocation of assets at death and does not necessarily indicate the allocation of typical wealthy people. But it is interesting how it reflects on certain myths floating around in the personal finance world. One meme is that the wealthy invest most of their money in real estate, another would be that retirees should have most of their wealth in safe investments - i.e. cash and government bonds. Neither is true here. There is quite good diversification with a likely 35% or so allocation to stocks directly and via pensions and 401(k)s. We don't know what is in "other" but can assume that that includes direct business ownership and alternative investments. By comparison, my Mom's portfolio is allocated to 29% stocks, 29% bonds, 16% cash, 17% alternatives, and only 9% real estate is a little conservative. Of course, the portfolio is quite a bit smaller than the typical one represented here :)

Tax Returns of the 400 Highest US Taxpayers

The US IRS puts out an annual report on the top 400 US taxpayers. In 2007, the average federal tax rate paid on adjusted gross income was only 19% despite the existence of the alternative minimum tax and a top US marginal tax rate of 35%. This is because 2/3 of their income came from capital gains.

This table shows the effect of the Clinton tax increases and the Bush tax cuts:



From 1993 to 2002 significant numbers of the top tax payers paid an effective tax rate of greater than 35% but none did before or after. The numbers paying less than 15% increased significantly in the later Bush years. Warren Buffett famously said that he paid a lower tax rate than his secretary. At least I'm not paying a higher rate than these billionaires :) Though Snork Maiden is :( Of course, those US figures don't include state taxes, which don't exist in Australia. But they'd likely only add an extra 5 percentage points at most despite so many wealthy people living in high tax California and New York.

How Accurate are Rich Lists?

I always wondered how accurate lists such Forbes are. The payout to the Madoff trustee that Jeffrey Picower's widow is making shows that Jeffrey Picower was at least notionally likely one of the richest US billionaires, but barely on the radar.

Class Matters

Some insights about class. In attitudes and circumstances I think I am on the border between the middle class and owning class. I try to be a non-conformist, think outside the box, and do something different, but in the end fall back on being an employee out of neccessity and lack of ability I guess to do some of these other things. I think the class structure in this article is too broad. There are "middle class" business owners with employees who don't have a high net worth and so aren't in the owning class as well as professionals and managers. And there is a difference between a self-employed professional and an employed professional in attitudes about government, taxes, regulation etc.

Some of the people around me find my relaxed attitude to my current situation rather puzzling. I don't tell them of course that we have more than $A200k in liquidish assets. I do tell them that we can live OK on one salary and while we want to have two salaries in the long-term there is no emergency at the moment.

The deeper question is why we've saved so much money outside of retirement accounts and why we live frugally when we could spend more when many (most?) people expand their spending to match their income. I think it is largely a result of learned attitudes (at least on my part) that relate to these class issues. It isn't so easy to do these things that many personal finance gurus and bloggers promote without deeply embedding the right attitudes, so it's no longer a question of discipline in keeping spending under control.

This isn't the whole story on this complex issue of course. You can see more of my posts on class here.

Social Class and Choice

A comment I posted on "Graceful Retirement" as part of the ongoing discussion about Meg's blogposts:

"I'm not too sure about the correlation you make between being born poor and choices. Poorer parents might not have very high expectations for their children but those children's opportunities are often limited by going to bad schools and hanging out with an unambitious crowd of friends. Children who have money to back them up can do things like graduate degrees in non-professional fields, being an artist, working for NGOs etc. without worrying about increasing their net worth. So I think it cuts both ways. I grew up what I considered lower middle class in England - compared to most of my middle class friends we had a smaller house, car etc. My Mom had a degree in classics and training as a nurse (came from a working class background in Australia and studied on scholarship). My Dad came from a relatively wealthy family in Europe but was a refugee/prisoner/factory worker in the Second World War and then gradually built a career as an engineer without a formal degree. So I think we had higher social class attitudes than our actual income/wealth. My parents were definitely ambitious for us to get well educated and my Dad was somewhat concerned that we don't study something he considered useless but there wasn't big pressure to follow some particular type of career etc. I ended up as a professor - I studied geography which my Dad thought was "useless" and economics and just followed the do what you like and are good at route without worrying much about the money. My brother studied civil engineering and then later switched to computer programming."

Time and Class

Social class is a tricky concept to get a handle on. For one thing, class definitions vary quite a bit around the world. The "middle class" starts at a higher level of income and education in Britain and Australia, where most people define themselves as working class, than it does in the United States, where the majority identify as middle class. It's clearly not just a question of income or net worth, or education, though all those are correlated with it. Maybe it is a question of time. Once I read that the working class is mainly concerned with the present (making ends meet and enjoying the moment), the middle class with the future (studying, saving, getting ahead), and the upper class with the past (ancestry etc.). That's certainly true to some degree. Today I read about Edward Banfield who put it in terms of "time preference" a standard economic concept. Basically, someone with a high time preference discounts the future at a steep rate. It makes sense that working class discount rates would be much higher than middle class ones. Not only is this seen in the behavior mentioned above but in the interest rates available - e.g. comparing payday loans with mortgage rates. Someone born in a working class background who develops a low discount rate will be more prepared to save time and money towards getting educated and moving to the middle class. Of course a lot of people will try and fail for whatever reason, so I'm not saying people are poor because their discount rate is too high. But comparing samples of "working class" and "class people" the average would differ in this way. Some people remain poor because they haven't learned to lower their discount rate and others because circumstances have gotten in the way of using this positive character trait.

An interesting hypothesis then is: "Is the discount rate of the upper class, even lower than that of the middle class?". This paper hypothesizes that the aristocracy and peasant class in early industrial Britain both had high discount rates while the emerging middle class did not. And that this lead to the decline of the traditional aristocracy. Of course, the paper is pure theory (speculation) with no data to back the idea. Maybe instead someone who can preserve inherited wealth and cares about dynastic succession, might have an even lower discount rate than the middle class saver and learner?

The Rich Have Capital Gains the Middle Class Capital Losses

This table which I derived from a spreadsheet I downloaded from the IRS website * contains stunning data. You have probably heard that most traders lose money in the stockmarket but maybe you didn't know how badly most people lose money and how strongly the propensity to lose is related to income. This data is for 2005 and I am guessing contains loss carryovers from the great 2000-2002 bear market. Looking at short-term capital gains, the only income groups that had a net gain in aggreagte were those earning more than $5 million dollars a year. All other income groups had an aggregate net loss. For the $75,000 to $100,000 bracket for example the returns reporting net losses reported losses around four times greater than the returns reporting net gains. It gets worse for lower income groups. For long-term capital gains all income groups earning more than $100,000 reported an aggregate net gain. Again the ratio of gains on tax returns with net gains to the losses on tax returns with net losses rises directly with income.

I excluded the number of returns from the table to make it more legible. The tendency is for the lower income losing returns to lose far more than the winning returns gained. Not for there to be much larger numbers of losers.

If I've interpreted this data incorrectly, let me know. I'm planning on doing some more posts based on this data.

* The New York Times hid the information about this data deep in this article.

Inheritance

Claire is blogging again about money from family. I'm the first commenter on this post.

After reading some of the other comments on Claire's post I think there are some things that I should or could add. Somebody mentioned telling their parents what to spend. I certainly don't do that, except as I said in the post to tell my mother she is rich and can and should spend more money. I only advise on choosing other financial advisers and then work with them to make decisions on investments. My father asked my advice too while he was alive but never gave me any clue about how much money there was in total.

In the posts there is a strong emphasis on the merits of being self-made and self-reliant. I agree that these are very desirable. If I have children (I'm 41 now, but my father was 48 when I was born :)) it is probably something I am going to have to think about regarding them too. I know of cases where people who inherited money young were demotivated. The good cases seem mostly to share the trait that the children worked in the family business alongside the parents and eventually took it over. In my case I had no idea there was as much money as there is till I was 37 years old when my father died. We grew up very much at the lower end of the middle class. My father came from a formerly wealthy family - the main thing we inherited though then was attitudes to investment, risk, debt etc. I sometimes say he was nouveau pauvre - the newly poor and the exact opposite of the nouveau riche - the newly rich. His mother died in 1970 and legal battles among family took up many years after that. What he inherited was art and antiques. His father's family were in the art/antique dealing business. What he received was mainly inventory from his father's business. His father died in 1922 when my father was just 5-6 years old.

Over time he sold most of it. The final sale in 1996 was the biggest. These art works realised far more than the valuation. He was shocked how much he received. At the time he just told me it was much more than the valuation.

The point of this story is that people don't want their parents to sacrifice to leave them money. I fully agree with this. Our case is different in that the core of the wealth was handed down from the previous generation (the little we have salvaged actually - maybe this makes us more upper class than middle class however ludicrous that notion is), though my father saved plenty during his life time too. I think my mother should spend the income on what she has inherited. But she's not.