Sometimes referred to as household affluence, household wealth is a term used to describe the net worth of a specific household, or the average net worth of households within a defined geographic area. Calculating this type of personal wealth figure requires identifying the current market value of all assets owned by the household, and subtracting the sum of all liabilities from that total value. Measurements of household wealth are helpful in assessing the stability of a local or national economy, as well as in planning or adjusting the budget for an individual household.
As it relates to understanding the economy of a defined geographical location, determining household wealth provides valuable clues into the changes in the standard of living that apply in that area over time. For example, the average wealth of households in a town may increase or decrease over a five-year period. Analysts will use these changes to determine the level of impact that events in the community had on that local economy. This means that if a business established a manufacturing plant in the area and hired a significant number of residents who were unemployed, assessing the household or residential wealth for the area will provide an idea of how much impact that employer has on the financial stability of the community.
Measuring household wealth is also helpful with individual households. Since the formula requires identifying the value of all assets and the current amount of all outstanding liabilities, it is an easy task to determine if the household increases or decreases in wealth from one year to the next. The outcome of the calculation can aid in assessing how well the household did with the resources on hand. For example, if a household makes regular payments on a mortgage throughout the year and also retires a significant amount of credit card debt, that household’s wealth at the beginning of the New Year will be significantly more than for the same time the previous year. Should the household create new debt as fast as the older debt is retired, there may be little to no increase in wealth over the period cited.
Decreases in household wealth can mean that there is a need to reassess how financial resources are currently employed. This may involve changes in spending habits so that it is possible to funnel more income into some type of interest bearing venture, such as investments or even a savings account. At the same time, efforts to minimize the accumulation of debt may also be in order. When a household is not comfortable with the results of a household wealth analysis, the task is to find out what is contributing to the unfavorable trend and take steps to reverse that trend as quickly as possible.
Do Changes in Stock Values Affect the Wealth of Households?
Yes. Changes in stock values are due to effects in the marketplace, which themselves are affected by larger economic factors. In an economy where the stock market is steadily in decline, the wealth of households should also be on a downward path.
Families that have investments in the stock market will either cash out and wait on the sidelines during economic turmoil, or they will hold their stock positions as they go lower in value. Either way, the household is not in a position of confidence to spend cash, make investments, or take out loans.
Does Savings Increase with Household Wealth?
No. According to the study on what economists refer to as "the wealth effect", households that are increasing in wealth typically decrease in savings. The ratio goes down because the family is more confident in spending and taking out new loans. The shift is toward spending and investing money, rather than saving it.
Accordingly, the wealth effect says that when households are having a decline in wealth, their ratio of money saved goes up. Consumers with less confidence in the economy will invest less and save more cash.
What Are Ideal Conditions for Rising Household Wealth?
The best conditions for increasing household wealth must come from a larger economy that is in a period of growth. Once businesses feel confident enough to expand, hire more workers, and invest in themselves or other assets, this helps grow the economy by spreading cash around to more and more households. The effect is massive growth all around for all families in an affected area.
When the economy is in a booming phase, families will invest in assets and generally buy more things which also drives the economy upward. In turn, these families are not expected to save as much money in proportion to the saving the household did during the last economic recession.
Why Do Households Save More During Economic Downturn?
The term saving in economics refers to a person choosing to not spend money on an item, or choosing to hold the cash value of an asset rather than the asset itself. Due to the economy as a whole being in a recession, people will choose not to wait for an asset to appreciate because there may not be a buyer available to purchase the asset if the entire economy is sliding.
What is the Average Household Wealth?
When asking about the wealth of households, the measurement used is the net worth of homes subdivided into certain age groups. Households with elderly members have a higher average net worth compared to other age groups. The overall average household net worth is about $121,000.
Household wealth factors include income and assets owned by the household, but also the cost of living in a certain area can have an effect on net worth over time. Areas with a higher cost of living might prevent a family from owning assets as quickly as households living in a lower cost of living areas.
Does a Decline in the Housing Market Cause a Rise in Consumer Spending?
No. Similar to the wealth effect, when the value of an area's housing stops rising, the wealth of households remains still or declines. The economy and the housing market are closely linked, but depending on what area a household lives in, the housing market might have a larger direct effect on a household's wealth.
What Assets Do People Buy During Economic Hardship?
People generally don't buy assets during a recession, but there are actually some items that have opposite financial characteristics when compared to a normal asset. In other words, there are things that rise in value when everything else is falling.
Shorting some shares of a stock that is known to be dropping in value is a perfectly legitimate way to make gains on a loss. Smart hedge funds are always looking for stocks to short. In a wayward economy, it gets easier to pick stocks to short, but the reward for shorting goes lower and lower as more people start doing the same thing.
Investing in businesses that thrive during recessions is another great way to make a buck while other households are in decline. Thrift stores, carpooling companies and healthcare-related businesses are all good examples of businesses that either do better during a recession or stay the same.
Regardless of what the rest of the economy is doing, there are good financial moves to be made even in a recession. Buying stock of established companies while they are devalued is a good investment, but only if it's expected to rise back up sometime soon and the stock gets sold while in that gain. Smarter households will make investments based on what direction they believe the economy is headed in. Having access to accurate information is the key.