Plutonomy

Plutonomy is a term invented by some analysts at Citigroup. Download their articles here. The central thesis goes against everything you probably thought about people's saving behavior and what is taught in macroeconomics and development economics. They provide evidence that today in the more unequal developed economies - the plutonomies - the rich save less than the poor or the middle class. In order to understand this idea you need to remember that in the national accounts capital gains are not included as part of personal income. Most capital gains go to the highest income and wealthiest segment of a society. If you are a CEO with big options grants it is easy to spend your salary and save the profits from your option exercises and have a zero savings rate. This turns the popular notion that the decline in the US personal savings rate is due to poor and middle income consumers spending beyond their means (by cashing out housing equity in the middle class or running up credit card and other consumer debt in the working class) on its head. Another thing they don't mention is that people who save successfully for retirement are going to end up in the wealthier segment of society and they are dissaving. This phenomenon does not apply to developing economies apparently even though many are far more unequal than the United States. It is certainly an intriguing idea and the evidence looks strong but something is still nagging in my mind that makes it hard to 100% believe in it.

Levels of Frugality and Wealth Creation

There is a lot of personal finance advice out there on the web and a lot of it is quite good, but of course little or none of it is tailored for people's specific financial situations. The things that are going to be important to focus on are going to change not only with people's life stages but also with their wealth and income relative to expenses. I've seen quite a few discussions in the blogosphere about whether paying attention to the latte factor makes a difference or whether PF bloggers are saving too much for retirement. And then there are people with negative net worth giving advice to supposed multimillionaires.

So here are some random thoughts:

1. If you are a student or on a low income the key is not to get into a level of debt which will be hard to stablize or pay down once you start working or get into a higher income job. Being very frugal is going to help. But it doesn't make sense to make undue sacrifices if you know your future income is likely to be much higher. My Dad told me I should be saving when I was a grad student rather than borrowing. I ignored his advice, to my mind that made no sense.

2. If you are earning roughly the average income for your city, country etc and can't make ends meet, then serious frugality intervention is required to get back into balance. This is where the stop buying crap, latte factor etc. are going to be important. Otherwise, I think even if you expand your income, your expenses probably will expand at the same rate. This has never been a problem for me or some others. We are just lucky to have had the frugalness meme instilled in us I guess. So I don't discuss this at all in my blog.

3. Once you have that under control then I think income expansion becomes the next focus whether increasing salary, or business and investment income. My focus in the blog is on the latter and how to manage the money. The key I think is to expand expenditures slowly and smoothly over time so that they always remain far behind income.

4. Once you have money to save then the natural focus is where to put it. When your monthly savings are still relatively large compared to your total wealth, managing the money is probably less important. For example, if the stock market goes down, the dollars you lose will not be very many and your new savings will buy more shares through dollar cost averaging. At this stage all the usual PF advice about building up emergency funds, index fund investing, different types of retirement accounts etc. is most relevant.

5. Soon enough you have more wealth than annual income or several times more wealth than annual income. The absolute dollar impact of each investment decision becomes greater. At this stage, searching for superior investment managers, seeking true diversification, thinking about market timing strategies etc. becomes much more relevant. That is the stage where I am at with financial wealth equal to more than four times annual income. So it's what I am mostly going to blog about. Buying real estate (or not) I think should come in at this stage. Most middle class people are house rich and financial asset poor. No surprise that I'm not a big believer in the usual advice about buying a house. To my mind it would usually be a good idea to get beyond stage 4 at least first, but this will differ with local conditions and personal preferences.

There are stages beyond here of course - when true wealth is reached and you can live off of business income, investment income, or retire. Or take an increasingly proactive role as an investor.