Wednesday, July 4, 2007

High Net Worth Needs to Be Adjusted for Risk

Last week, Merrill Lynch and Capgemini released their 11th annual study of high net worth and ultra high net worth households. High net worth means that someone has over one million dollars in liquid assets (excluding primary residence but including second homes, investment real estate and liquid investments) while ultra high net worth means that someone has over thirty million dollars. They find that:

"Driven by a strong global economy, the wealth of the world's high-net-worth individuals (HNWIs1) increased 11.4 percent to US$37.2 trillion in 2006...The number of HNWIs in the world increased 8.3 percent in 2006 to 9.5 million and the number of ultra-high-net-worth individuals (Ultra-HNWIs2) grew by 11.3 percent to 94,970."

According to bar graphs on p. 3 and the appendix to the study (p.31), the United States has the most HNWI's, with the number having increased by 9.4% to 2.9 million. According to the Census Bureau, the US population is currently roughly 303 million, so HNWIs are about 0.95% of the US population. However, the number of millionaires is growing more quickly in developing countries like India than in the US.

There has been concern about growing inequality. Globalization and the Americanization of the world economy, some critics might argue, is now causing increasing inequality around the world.

Measures such as the Merrill Lynch Capgemini study are misleading, though. The study notes that high net worth individuals have benefited from a booming global real estate market. Likewise, several years of stock market valuation increases also have contributed to the increasing number of high and ultra high net worth individuals.

About 31% of HNWI's wealth is in equities, 24% in real estate, 21% in fixed income securities and 14% in cash. This a moderately risky investment profile. Wealth is not static. Should real estate, stock and other financial markets contract, the number of high net worth individuals will contract in tandem.

Measures of HNWIs and ultra HNWIs ought to account for the riskiness of their holdings, for example by showing the historical variance in returns of the assets that HNWIs hold. Given that markets in real estate and stocks have been bubbly in recent years, the global bouyancy in the Merrill Lynch/Capgemini numbers may be misleading.

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