Better investing will solve inequality

Why do the rich keep getting richer? A new paper published in Sweden puts forward a theory. It's because they are better investors. The paper, from the Stockholm School of Economics, took historical data from wealth surveys to measure how different income groups performed over a long period of time.

In Sweden, households have to report their total wealth, so the data for that country is some of the most reliable in the world. When the numbers were crunched, it found that the top 5% to 10% of households earned 2.7% a year more than the median household. Going up the income scale, the top 1% to 0.5% of households did 4.1% better. And the people at the very top the 0.1% did best of all, outperforming the median household by a massive 6.1% year on year. The richer do better than average and the richer they are the better they do.

There is no reason to think the picture is very different elsewhere. And perhaps it is not much of a surprise. The rich are richer because they were better with money in the first place and they just carried on being better once they had made their pile. But in fact, the study found no evidence that wealthier families were any better at stock picking or timing the markets or any of the other strategies that might make for superior returns. What it did find is that the rich had a different approach to investment and that explained most of the difference.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

As you went up the income scale, people were more willing to take risk. The median household had nearly all their wealth in a single property, just as it usually does in this country. But the wealthiest households had far more of their money tied up in equities and private investments, and the top 0.1% the most of all. The average household had only 21% of its net worth tied up in risky assets, but for the top 0.5% to 1% that rose to 62%, and for the top 1% it went up to 95%, or almost everything. Over time, that explained their superior returns.

A house in the suburbs of Stockholm is not going to generate spectacular returns. Over the medium term, a portfolio made up of shares, bonds, commodities and private-equity holdings from around the world is going to do a lot better. And, as any hedge-fund manager will tell you, the more risk you are prepared to take, the more you will ultimately earn on your cash, even if there are a few bumps along the way.

There is a lesson here. If you want to reduce inequality, the best way to do that might well be to persuade the middle class to rely less on housing wealth and to take on more risk. That would give them a chance to catch up on the wealth being accumulated by the very richest.

How might we go about that? First, give pension schemes a break. The Treasury has steadily been chipping away at the tax reliefs on retirement funds, with one tax raid after another. But after their house, a pension is most people's biggest asset, and it will be mainly invested in the stockmarket. Next, stop chipping away at the tax breaks on Isas. The more generous we are to people saving via the markets, the more chance they will have to build up a decent portfolio over time.

The radical option would be to end the exemption from capital-gains tax for your main home. That would level the playing field between different types of investment. It would be unpopular, especially with the old who were getting close to downsizing their main property. But it might well be the quickest way to reduce inequality, and it would do it by raising the amount of wealth across the system, rather than just punishing the rich. That might well prove popular.