Rich Dad Poor Son

By | August 18th, 2016 08:08 PM EST | posted in Basic ETF Concepts, Custom Strategy Insights, Growth Strategy Insights, Press Releases, Spotlight

Last month McKinsey and Company released their 112-page report on falling incomes in advanced economies.

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The report concluded with a number of disturbing macro trends that demonstrate just how much the socio-economic landscape has, and continues, to change. Index Strategy Advisors (ISA) has extracted what we believe to be pertinent to our investors, and though we can’t predict the future, we can help you prepare for it.

Key Takeaway: Real incomes are flat or shrinking for the majority of American households, and savvy investors must plan today to be prepared for an uncertain tomorrow.

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Source: OECD/McKinsey Institute

As the graph denotes, low and middle-income households have been hit the hardest, while only a portion of the wealthiest 20% of Americans enjoyed relative economic prosperity. For context, the period of 1993-2005 saw less than 2% of all household incomes fall.

Changes in tax laws and wealth transfers like unemployment benefits and social security have helped to lessen the impact of falling incomes; however, the great depression has left an impact on the American psyche.

Why Have Household Incomes Fallen?

Shrinking households, a smaller share of economic output going to wages, and increased automation in the workplace are some attribution factors of income stagnation.

Aging Population

Median population ages in developed nations are rising while we are also experiencing lower birth rates, as people have fewer children, later in life. These factors ultimately diminish aggregate labor participants and household size. As households shrink, the economies of scale enjoyed by cohabitation are diminished.

Wage Share and Technology-Driven Automation

Wage Share is defined as the portion of corporate profits that make their way to employees rather than shareholders. Factors that adversely impact wage share are rising returns of technology investments, smaller returns from labor due to international competition, rising rent, and increased depreciation on capital assets.

Corporate profits in N. America and Western European, as a percentage of GDP, have increased by more than 2% in the last 30 years, which amounts to over 1.5 trillion dollars in 2015 alone. Essentially, corporations, through increased technology-based automation and labor outsourcing have been able to increase the percentage of revenues they keep as profits rather than spend on employees. Investments are being made in “knowledge” and capital as they provide greater long-term profits than investing in labor expansion.

Societal Impact of Stagnating and Falling Wages

Taxes, Entitlements and Wealth Creation

Even maintaining current levels of taxes and transfers could become more challenging. For example, central government debt is close to 100 percent of GDP or higher in Italy, the United Kingdom, and the United States, where it rose from 56 percent of GDP in 2005 to 97 percent of GDP in 2016 (Exhibit 7).

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Prior to 2008, economic growth contributed to 19% of household wealth for middle-income families. In 2015, that number stood at 4%. Not only has wealth been stagnant or falling for the majority of middle-income families, but the share of wealth from economic growth has almost solely been absorbed by those who already have a high household income creating even greater income inequality.

Age and Skill Related Unemployment

Both the production of goods and services have experienced tremendous changes in labor effectiveness since the advancement of things like IT, Cloud services, Global broadband access etc. Organizations can now be formed with fewer headcount, but require those with higher skill sets.

McKinsey estimates that the rate of growth of medium-skilled labor displacement could double in coming years as companies continue to develop technologies that can keep with a low-cost global labor force. As more jobs are removed from the low and medium skilled labor force, demand continues to grow for high-skilled laborers as evidenced by growing income disparities: In 1981, college-educated workers in the United States earned 48 percent more than their non-degree carrying peer. In 2005, the income of college-educated employees was nearly double that of those with only diplomas.

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During prior innovation waves, more jobs were created than destroyed. McKinsey argues that this may no longer be the case as scalability and scope are greater now than ever before. For example, Amazon the retailer has nearly 2 times the revenue per employee of any other major retailer in the United States. Essentially, we need less and less labor input for greater and greater economic output.

How Can A Savvy Investor Plan Ahead?

  • Given the growing need to finance current economic prosperity with future debt, it is reasonable to assume that tax hikes in the future will need to happen in order to manage the growing demand for entitlements by individuals not part of the high-skilled labor force. For example, certain investment vehicles, like a Roth IRA, can help protect you from future tax hikes by taxing contributions today, not in retirement.
  • As corporations continue to increase their investments in technology, structuring your portfolio to reap benefits from these long-term positions can be accomplished through proper asset allocation.

To speak to an advisor about positioning your portfolio to manage the risks of macro trends, visit www.indexstrategyadvisors.com and click “Talk to an Advisor”.

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