The Racial Wealth Gap Is About Investing Style, Not Discrimination
(AP Photo/Frank Franklin II)
The Racial Wealth Gap Is About Investing Style, Not Discrimination
(AP Photo/Frank Franklin II)
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During the past year, policymakers and the American public have engaged in ongoing soul-searching about the persistence of racial inequality in American society across many areas of society, including racial differences in financial well-being and access to quality financial products. Much of the scrutiny has focused on notorious policies, such as the federal government’s shameful practice of racial “redlining” of minority homeowners in the post-World War II era. These government policies, along with facially neutral policies such as “usury” limits on permissible interest rates that disproportionately affected Black families, created formidable barriers to wealth-building for many Black families.

Available data reveal the continued legacy effects of these laws today. Black households are more likely to be unbanked and less likely to have a credit card than White and Asian-American households. Although minority household wealth grew more rapidly than White households from 2016-2019, Blacks still have substantially lower net wealth than Whites on average. White households are more likely to own a home than Black households and the home values of White homeowners are higher on average as well. Black families are also less likely to have access to and to participate in a retirement savings plan and, on average, have less money saved for short-term expenses. Wealth also has an intergenerational effect; for example, many first-time homebuyers receive contributions from their parents for an initial down payment and children from wealthier households will find more ready access to support. And to state the obvious, much of the racial wealth gap simply reflects the continued racial income gap, which compounds differences in wealth accumulation over time.

Many of these inequalities are deep-seated and elude easy solutions. Most solutions focus on government-centered redistribution programs such as reparations or affordable housing subsidies. But one overlooked area that could make a difference not only today but for generations to come is better-designed financial literacy education more closely targeted to the particular history and needs of Black households.

To be effective, financial literacy education must people where they are and address their most relevant challenges and opportunities. For example, high school students might need have different needs that young families and higher-income and lower-income families share certain characteristics regardless of race or location. Similarly, different racial groups, whether White, Black, Hispanic, Asian-American, American Indian, or other, face different challenges and opportunities that reflect the particularities of their historical and contemporary circumstances. While all of these inter and intra-group differences warrant further attention and research, the persistence of the Black-White wealth gap has drawn especially intense interest recently.

Although many factors account for these differences, researchers have identified racial and ethnic differences in saving and investing strategies that can compound inequality in wealth building over. Black households, for example, traditionally have exhibited a greater degree of risk aversion in their investment decisions compared to White households. While these different attitudes toward financial risk may be understandable given the different financial histories of white and black families in U.S., these choices exacerbate the racial wealth gap.

For example, compared to White families, Black families are more likely to invest in housing than in financial investments such as the stock market, even after controlling for income and education levels. These choices have implications for building wealth. Although riskier in the short run, financial investments provide substantially higher risk-adjusted returns than real estate over time. From 1928-2013 stocks provided an average return of 9.5% per year while housing increased on average by only 3.7%. Even worse, home values appreciate more slowly on average for Black homeowners compared to Whites. Heavy investment in housing also reduces the ability to diversify risk against unexpected economic shocks such as the 2008 housing crisis or local economic recessions that result in job loss (and resulting declining home values). Moreover, housing equity is a less liquid form of wealth that can be accessed to deal with emergencies or temporary economic dislocation.

As a result, even if White and Black families initially started with the same place financially (which obviously they have not), wealth differences would be predicted to reemerge as a result of pursuing these different investment tracks. This dynamic of differential wealth growth exacerbates intergenerational differences and entrench the status quo, making it hard for Black families to gain ground. This comparative lack of a parental head start (and safety net), along with other factors, may also contribute to the higher propensity for children of Black families to slide back out of the middle class as compared to Whites. But investment choices over time can exacerbate these different starting points.

Research suggests that these differences in investment strategy stem in large part from a relative lack of familiarity with financial assets among minorities. In turn, this difference awareness reflects racial differences in financial literacy levels on average. Differences in baseline financial knowledge among different racial groups are understandable. Financially successful Black Americans may be more likely to be first generation members of the middle class (and thus to have assets to invest) and less likely to grow up with household exposure to investment decision-making than Whites. Blacks may also be less likely to have parents or other older relatives who they can rely on for sound investment advice and to answer questions. In addition, according to the Federal Reserve, higher levels of financial literacy provides individuals with greater confidence to manage their retirement plans and other investments. On the other hand, individuals with lower financial literacy levels are much less likely to invest in stocks than others.

Research finds that traditional financial literacy education shows limited efficacy in improving long-term personal finance habits. In part, this is because of the cooke-cutter nature of financial literacy education, which ranges from how to balance one’s checkbook and fill out tax forms on one hand (relevant to high schoolers) to choosing between a traditional and Roth IRA on the other (relevant to middle age families planning for retirement). Effective financial literacy education meets consumers where they are in their lifecycle and accounts for their unique histories and challenges.

Instead of one-size-fits-all curriculum financial educators should be focused on designing programs tailored to individual needs, including those of the growing black middle class. For example, FINRA has developed a program that trains military spouses as financial counselors specialized in the unique needs of the military community. Similar programs could be designed specifically to address the needs of Black middle class families. Similar targeted strategies could be tailored to other demographic groups, such as women, who also prefer risk-averse investment strategies, in part because they have lack confidence in their financial decisions, resulting in large part from less experience and knowledge of personal finance. Better financial literacy targeted to the particular needs and experiences of middle class Black families is not a panacea and won’t make up for years of government policies and other challenges that have made it difficult to acquire and build wealth. Nor will pursuing higher-yield investment strategies lift up those who are struggling to make ends meet, regardless of their race. But it could be one tool to empower many Black families to help themselves build stronger financial futures for themselves and their children.

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