Understanding Growth And Value Investing

Understanding Growth And Value Investing

Knowing how to invest is the best way to build wealth. There are many ways to make or lose money in the stock market. Here, we are focused on growth stocks and value stocks. They differ in their fundamental investment approaches. Each has its disciples who support their respective strategies. To pick what works best, consider your investment goals, risk tolerance, and time frame. You can purchase growth and value stocks individually or through mutual funds or exchange-traded funds (ETFs). Whatever you do, make sure to diversify your portfolio.

Which Is Better: Growth Versus Value Investing?

One question often raised, which is better to invest in, growth stocks or value stocks? There isn’t one answer. Growth stocks have visibly outperformed during the pandemic and can be more resilient during economic downturns than value stocks. Over the past decade, experienced investors will point to growth stocks as the better performers during the longest bull market. That is true. However, value stocks have led the market after significant bubbles, notably the post-dotcom crash in the early 2000s. Some believe growth stocks look like a bubble now.

Many studies point out when value stocks outperformed growth stocks. According to work done by Research Affiliates in California, a portfolio consisting of value companies beat a portfolio of growth companies by a wide margin over a long time horizon. From July 1963 to December 2006, the value portfolio outperformed nearly ten times. Then from January 2007 through September 2019,  the value portfolio has underperformed by 36%. Rotations happen.

Despite Strong Growth Stock Performance, Value Stocks Have Not Lost Their Vigor

Research by Dimensional Fund Advisors compared long term averages for growth and value stocks. They found that growth stocks grew 14.7% during the past ten years, compared to 11.3% since January 1979.  On the other hand, value stocks rose 11.4% in the past ten years, in contrast to 11.9% since January 1979. While the growth fund grew 3.4% in recent years, value funds have mostly tracked their historical average. It is easy to say that value stocks are out of favor, but this study states a misconception given value stocks’ steady performance.

Blended funds are appealing as they contain a mix of growth and value stocks available in one fund. Given the difficulty it is to peg one investment style over the other, blended funds offer diversification and access to stocks of both approaches.

 

Characteristics of Growth Investing

 

“The number one market leader is not the largest company or the one with the most recognized brand; it’s the one with the best quarterly and annual earnings growth, return  on equity, profit margins, sales growth, and price action.”

William O’Neil

 The Positives

Growth stocks appeal to long-term investors who seek higher growth companies. The companies they represent are often leaders in the markets they serve. These stocks recognize the high-risk, high-reward nature of this investing approach. Buyers of these stocks seek companies that promise consistent high top and bottom-line growth in all economic conditions.

As such, these stocks are supported by better than average growth in the company’s revenues, cash flow, and earnings compared to the broad market. Growth companies usually reinvest their profits and capital resources in their business to fuel future expansion rather than pay dividends.  In contrast, emerging growth companies may generate losses longer. As a result, they may need to raise capital to make long term investments during their early growth stages.

Amazon, A Prime Example Of A Growth Stock

Amazon is an excellent example of a successful company dominant in all of its businesses. As the largest global online retailer, Amazon has rapidly invested heavily in fast-growing businesses, notably, subscription, cloud computing products, advertising, grocery, and healthcare. This growth company would rather keep its foot on the accelerator than pay dividends to shareholders and will not do so any time soon.

Growth stocks typically sport higher valuations on price-to-earnings, price-to-sales, and price-to-book value. The calculation of a company’s book value is the value of all the assets less its liabilities.  Typically, book value is different than a company’s market value or capitalization. Market capitalizations or market caps for publicly traded companies is the current price per share multiplied by its outstanding shares. Growth stock values are usually higher than their book value. In contrast, value investors seek stocks trading at discounts to their book value.

Stocks of growth companies can range from small caps to more developed large-cap companies. The smaller companies are at an earlier stage than their large-cap brethren, and as a result, more volatile. They face more significant risks but also provide greater returns to investors.

Origins of Growth Investing

Thomas Rowe Price, )founder of T. Rowe Price) is known as “the father of growth investing.” As an early promoter of growth stocks, he believed that investors could earn superior returns by investing in well-managed companies. The growth expectations for earnings and dividends were to outpace inflation and the economy over the long term. The key was finding companies in their early stages when they were considered emerging growth companies.

In its heyday, Peter Lynch, lead portfolio manager of Fidelity Magellan Fund, refined growth investing by popularizing the PEG ratio. This ratio tracks finding growth at a reasonable price. It divides the price/earnings ratio by the company’s growth rate. A PEG ratio of 1 means that the stock is reasonably valued, and investors need to look for multiples below that level. This concept relates a stock’s price/earnings ratio to its growth level: the lower the PEG, the more attractive the shares.

Benchmarks For Growth Stocks

  1. High earnings growth with a visible track record. However, in recent years, investors have been willing to forego earnings growth in the near term as revenues are ramping up at healthy levels. In essence, investors anticipate that earnings growth will be forthcoming sometime in the foreseeable future.
  2. Along with top-line growth, investors like to see the expansion of gross, operating, and net margins. Over time, the sustainability of those margins becomes key as companies become more mature.
  3. Growth stocks are companies that have competitive advantages. These competitive advantages allow them to become dominant in growing markets with excellent prospects. Morningstar often refers to good companies as having economic moats like a low-cost structure, tough to switch to another provider or a loyal customer base. These attributes protect those companies from advancing competitive threats. Think of Apple and its iPhone users who are devoted but also don’t want to move to another smartphone.
  4. Investors in growth stocks are long term investors seeking higher returns and are usually risk-tolerant. Growth stocks tend to do better than value stocks in weak economies.

Related Post: 18 Financial Ratios To Know

The Negatives

Above-average valuations often price growth stocks for perfection. That means the company results that meet or miss expectations disappoint investors. As such, investors will more quickly dispose of their shares.

Growth shares tend to be volatile, micro-cap, and mid-cap companies early in their development. The beta index is a popular measure of volatility. It accounts for market fluctuations of a stock and how it varies from the rest of the market. A beta value of 1 or lower indicates relatively safe security. On the other hand, growth stocks tend to have betas of 1.5 or more.

Companies tend to pay low or no dividends, preferring to reinvest profits into their growing businesses.

Growth Funds and ETFs

Given their volatile high-risk nature, an excellent way to invest in growth stocks is through growth mutual funds or ETFs. You can buy a basket of stocks in a range of market caps, from large-caps to small caps. Two examples are the Vanguard Growth Index (VIGAX) or Fidelity Growth (FDGRX).  Here is Morningstar’s Best Growth Funds and the best Exchange-traded funds (ETFs). While the tech sector is growth-oriented, you may want to research the many subsectors within that category. Beyond pure tech, other sectors to consider: health care, online retail, and fintech.

Characteristics of Value Investing

 

“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes stocks too cheap). The Intelligent Investor is a realist who sells to optimists and buys from pessimists.”

Benjamin Graham

 The Positives

As a counterpart to growth stocks, value stocks appeal to investors seeking well-managed good companies that pay dividends. A higher dividend yield helps value investors to be patient while waiting for the company to turnaround. They are typically less risky and attractively priced below that of their peers and the broad market average.  These are “diamond in the rough” stocks.

 Investors will look for a potential bounce in these undervalued stocks to believe that the market isn’t always efficient.  Value creation comes from an apparent gap between what a stock is trading at and what it is intrinsically worth. Hence, it may call attention to a hidden gem manufactured when the company experienced a temporary setback. Problems may arise from disappointing earnings, lackluster product rollout, management departure, or an overhang on the stock due to a legal or regulatory problem. Value investors will try to spot short-term issues. 

Bargain Valuations That Are Unwarranted

Cyclical stocks are considered value stocks that do better in the early stages of an economic recovery but lag in sustained bull markets. Unlike growth counterparts, value stocks are less volatile (lower betas) and usually supported by healthy dividend yields. These income streams can benefit investors as they await the potential of these stocks. Value investors look for bargains in the market that may be unwarranted. A deal is when the stock’s market value is trading below the company’s intrinsic or fundamental value of its businesses. Look for attractive valuations for these stocks with above-average dividend yields, low price/sales, and low price/earnings ratios. These cheap valuations are in contrast to the high valuations of their growth counterparts.

Several examples of companies–Apple, GE, Microsoft, and IBM, whose stocks were once growth stocks then fundamentally shifted into value stocks. In particular, Apple and Microsoft have reversed again in recent years and are now part of growth portfolios.  IBM may also be making a comeback to growing more quickly and leave the value nest soon.

The Origins of Value Investing

Benjamin Graham, who wrote The Intelligent Investor and Security Analysis with David Dodd, is often referred to as “the father of value investing.” I have well-worn copies of both of those books. Graham may be better known for having mentored Warren Buffett, one of his students at Columbia Business School.

Graham-Influenced Company Benchmarks

  1. Investment-grade ratings using the S&P system with an earnings-to price yield at least twice the AAA bond yield.
  2. Paying dividends for the long term, yielding at least two-thirds of the AAA corporate bond yield.
  3. A  current ratio of 1.5 or better. This ratio is the current assets divided by current liabilities. Assets should more than cover liabilities for better liquidity.
  4. Maintain low debt loads where long term debt should be below current assets.
  5. Total debt should be less than the book value of the company.
  6. Positive earnings per share growth with no losses reported by the company in the past several years. Annual earnings growth of the prior decade of 7% annually.
  7. Low relative valuations. The price-to-earnings ratio should be less than 40% of the highest PE ratio over the past five years. The stock price should be two-thirds of tangible book value, net of intangibles such as goodwill.

These guidelines, taken from Graham’s book, can provide value investors with some discipline. However, even Warren Buffett admits to underperforming the market when searching for value in a growth-oriented market. That said, he avoided chasing large acquisitions that were outside of his parameter, only acquiring Dominion Energy recently.

Value Stocks Need Positive Catalysts

All stocks, especially value stocks, need positive catalysts to bring rising investor attention to these hidden gems. Catalysts are good and bad triggers directly related to a company or its respective industry. Examples of financial news that may impact a stock positively or negatively are:

  • Earnings report that disappointed, met, or exceeded revenues or other benchmarks;
  • New forecasts for the company;
  • Analysts raising or lowering estimates and price targets;
  •  A new merger or acquisition announcement;
  • Favorable product rollout and customer response;
  • Management departure or new hire in a senior role; and
  • Changes in regulation for the industry.

The Negatives

Finding value stocks requires hard work to determine what a company is worth. An analyst’s paradise to crunch numbers to analyze a particular stock and its peer group and compare it to its market value. It is essential to know what factors are overhanging the shares and whether they are short term or long term.

Patience is essential when investing in a value stock. Often, you may be fighting with the prevailing market sentiment that is viewing the name unfavorably. It can take months, if not years, for that sentiment to change. Sometimes an adverse event has happened to cause a stock to be “dead money.” That slang refers to money invested in a security that has little or no chance of near-term appreciation. Fund managers and other institutional investors may race out of the stocks in the short term, worried about their near-term performance. For more Wall Street jargon, see our post here.

Value investing is less risky as you are already buying a stock at low P/E ratios. However, these stocks may not be as liquid as growth stocks.

Diversification is challenging to achieve as an individual investor. Value funds are probably a better way to go.

Value Mutual Funds And ETFs

The best way to achieve valuation when value investing is to find a mutual fund or an ETF. There are many value mutual funds and value ETFs ranging from small-medium and large caps.  You can find Morningstar’s Best Value Funds here.  A list of recommended Value ETFs is here.

Final Thoughts

Investing is the best means to build wealth. Growth and value investing are fundamentally different approaches to making money in the stock market. When investing, consider your investment goals, risk tolerance, and time frame. Growth and value stocks appeal to different investors regarding risk/reward, volatility, valuation, and dividend payouts. Blended funds, which combine both types of stocks, can be an attractive alternative for the best diversification and exposure to both styles.

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A Letter To College Students On What To Do This Fall

A Letter To College Students On What To Do This Fall

Dear College Students,

This is anything but a normal year for you. Deja Vu!  I had written to you back in April during what I had hoped would be the height of the pandemic. Sadly, it turns out it was not. Coronavirus cases continue to rise at a rapid rate in many parts of the country. I truly feel for you. Experiencing a health crisis is tough enough, but with an economic downturn, it may have already caused major repercussions for you and your family. Hopefully, you managed to get a summer job and socked some money away. Have you already decided what to do about going to college this fall? Many of your universities or colleges have already determined what to do. Some schools are still making their final decisions.

Make no mistake, this situation sucks especially if you are a freshman. Going to college is a lifetime experience filled with intellectual, cultural, and social values. Making longtime friends, engaged in learning, and planning your career is your initiation into independence. This is a teachable moment for you. Things happen out of your control that change your plans. It happens …. all the time. Hopefully, this pandemic is a once in a lifetime event.

I’m Kind Of In Your Camp Too

As a professor, I too am experiencing this disruption to the coming academic term. My college students are from a diverse community college in an urban setting. Their communities have been among the most severely impacted by the pandemic. Most work while attending school. Many are first responders or working in essential roles as healthcare workers while taking care of family members. While this letter is for them, I am writing to all college students.

Our college is going largely online on a synchronous basis meaning we will meet online at a scheduled together, however, recordings will be available who need more flexibility because of work schedules. I am revamping my online materials to the best of my abilities for my business majors in my law, marketing, and finance classes. The spring term was like a fire drill for students across the country. We need to do better.

What Are Your Choices For The Fall Semester?

A hint: none of the choices will give you a traditional experience. Colleges and universities have been announcing plans over the past few weeks. The Chronicle of Higher Education had been tracking a list of announced plans by higher education. Initially, a consensus back in late April seemed to indicate that a majority (63%) of schools were having in-person classes only,  online classes only (7%), hybrid classes (7%), and 9% were undecided. Classes will likely be mostly online to mostly in person. Student housing agreements have likely been amended to reflect new limitations on campus. Should there be an outbreak, refunds will not be available.

Each college has been reviewing its final plans as the Fall semester approaches taking into account the respective situations they face. Frankly, none of the choices are ideal but reflect the reality of this continued health crisis. College administrators are balancing the needs of their students along with the heavy financial costs that come with opening campuses for classes. Chancellor Timothy White pegged a $25 million cost per week for Cal State University. The cost for keeping students and employees of the University of California could be as high as $1 billion. It is not like most higher education institutions are rolling in funds.

Options At College: No One Size Fits All

 

In-Person Classes

Having in-person classes, that is, a return to normalcy, may represent the highest risk, particularly if they are of full size. Most schools are planning for smaller classes so that social distancing can be maintained. Masks, of course, will be required on campus. Plans to limit student density may require staggered schedules between classes, activities, events, and dining. Even showers need to be arranged according to a timetable.

Can you picture the amount of work, debate, and thought that has to go into this potential logistics nightmare?  Stringent precautions must be put in place and taken by students known for their socialization and invincible attitudes that they don’t need to be protected.

High Costs May Be The Financial Straw That Breaks The Camel’s Back

The financial costs for these precautions are likely to be high. This may be potentially limiting for financially strapped higher ed institutions to handle this. Even before the pandemic, colleges were facing declining enrollment and lost on-campus revenue. For many schools, the pandemic may be the financial straw that breaks the camel’s back. However, the foregoing “in-person classes only” option may mean lower enrollment and needed funds.

Some universities have been moving up the start of the semester to mid-August or delaying classes into October. Alternatively, some students will be on campus staggered by year. Princeton’s plan is to have their freshmen and juniors be on campus in the fall with sophomores and seniors returning Spring 2021. Most of the university classes will be available remotely.

Virtual Only Classes

The remote learning option seems to be the least risky of all options with the least difficulty for administrators. Colleges have been pointing out that the campus population needs to consider not only their students but faculty, administrators, staff, and maintenance employees. However, the point of college campuses is to interact with large groups of students from varied backgrounds. While students may realize cost savings by the elimination of room and board, the campus experience is lost. According to two recent surveys, 68% of Americans say if remote learning is going to happen, college tuition costs should drop. That is not likely.

The Digital Divide Makes This Unsuitable For Some

On the other hand,  there is a large swath of the country–rural counties– with spotty or poor broadband connectivity. This digital divide handcuffs students who depend on their college campuses for their technology needs. High-speed internet connectivity service is too expensive for families of modest means. Students may not have readily available laptops once they are home. During the spring term, our college, as well as many across the country, made laptops hastily available to those in need. However, this is a bandaid, rather than a solution, to a major gulf between those who have ready access to computers and the Internet, and those who do not.

Hybrid Classes

This option may sound like the best of both worlds. While most schools plan to have every course available online, staggered small in-class settings, designed to space out students will be offered. Harvard, Princeton, and Yale are adopting this model and their decision will likely influence others. Their plans will be to limit their student population on their campuses staggered by year. For example, Princeton’s plan is to have their freshmen and juniors be on campus in the fall with sophomores and seniors returning Spring 2021. Most of the university’s classes will be available remotely. Harvard has targeted a 40% density level on its campus and there will individual rooms for students, rather than dorms.

The financially endowed schools can do this better than most colleges and universities, enhancing their students’ experience.

Alternatives To Going To College This Fall

As college plans are looking less appealing, college-bound seniors have been doing considering alternatives. According to a recent survey, as many as 20% of respondents who intended to go on to a four-year college have considered taking a gap year, attending a community college or taking online courses.

Take A Gap Year

A gap year refers to one year between high school graduation and going to college. You can do this as part of a structured program or independently. Typically, a gap year can provide many benefits such as recovering from academic burnout, working in your field, volunteering, travel, or internships. Creativity is your limit. Due to the pandemic, more students have been considering this option according to reported traffic (over 120%)  on the Gap Year Association (GYA) site who sponsors programs. Despite limitations to some activities given the widespread health crisis, check out their website for available volunteering and community programs.

Typically, approximately 90% matriculate in college within a year according to GYA. Their research has shown that a structured gap year serves to develop an individual into a more focused student with a stronger sense of purpose. According to a survey by Gap Year Association and Temple University, more than half of the individuals who took a gap year reported a GPA of 3.7-4.0.

If you are considering this route, check out your school’s policy and procedures regarding deferrals. Some colleges will automatically defer admitted students for the year while others will consider requests on an individual basis.

Community College Close To Home

I believe attending a community college is a solid cost-efficient alternative to a gap year if you are a college-bound senior. Of course, I am biased by virtue of my role as a professor at a community college.  If you are not pleased about your college’s plans but don’t want to take a gap year, attending a nearby community college for a term or two would allow you to pick up some credits while strengthening your academics. There are many benefits to attending community college that you can read in our post here.  You should make sure that your credits are transferrable to your chosen college.

Find A Job Or Continue Working

If you are not a freshman, you may not be able to take a gap year. Getting a new job in this environment with record unemployment may prove virtually impossible. However, if you have a  summer job you enjoy and are making money, consider talking to your employer about the possibility of staying on through a semester or the academic school year.

Use Your Time Wisely

Get your resume up to date and don’t worry about work or school gaps or internships.  Motivate yourself to use this time to be ready when the job market improves.  You are young, capable, and smart. Go with the flow and use this time wisely. Combining those traits with a good attitude will be an important part of your future value. Make time to work on your Linkedin profile so you can stay connected and be ready for networking.

Take any and every possible remote interview that may come your way whether it is for future internships, part-time work, or a job in your career. Recruiters should be sympathetic to your plight given their own experiences during the Great Recession. Given the strangeness of this year, it is possible you had a change of heart regarding your career and have been inspired by the scientists. Do some research during this time to learn about opportunities in these areas.

Life Lessons For Your Generation

We are all learning life lessons about this once-in-a-lifetime experience. This year has proven to be a year of trifectas. A health and financial crisis has come in tandem with the largest protests we have seen in this country.  Given your youth and greater pliability than most previous generations, there may be a role for you in the workplace or in your community. Generation Z has some defining characteristics that are essential for the workplace. As the only generation that can truly be called digital natives, you are always connected, comfortable with newer technology and social media.

Welcome some of the societal changes coming as a result of this pandemic. It is well known that you like to work either independently or collaboratively, and openly in work areas. Your generation is diverse and was raised with inclusivity. That can be helpful in an environment that wants to reduce social justice and income inequality. Be part of these changes.

Related Post: Financial Literacy May Help The Racial Wealth Gap

Final Thoughts

The pandemic has made this year extraordinarily difficult for college students. Of course, that is out of your control. However, you do have choices about how to use this time to your benefit. Rise up to this challenging time by actively pursuing what you want to do. Start out by doing some research to help you choose a viable path to move forward. We are not living in normal times but learn from this teachable moment. You have some decisions to make whether to go on to college based on your school’s plan or find worthwhile alternatives. You can do this by having faith in your abilities to succeed. Good luck this fall in whatever you decide to do!

Yours Truly,

Professor Linda

PS: Thank you for reading this. I would love your thoughts! Feel free to subscribe to our blog so that you can get some freebies and our weekly newsletters.

Better Financial Literacy May Help The Racial Wealth Gap

Better Financial Literacy May Help The Racial Wealth Gap

I grew up in a racially diverse Bronx neighborhood. It wasn’t until I worked on Wall Street as a financial professional that I encountered people with homogenous backgrounds. Specifically, my colleagues were mostly white people who appeared to be far more advantaged compared to me. As a grad of public schools and a public college, I felt uncomfortable and out of my league. The awkwardness faded over time. One of my bosses actually called me “a junkyard dog” and meant it as a compliment.  With my successes, my confidence grew, but I can still feel that insecurity today.

We come from different backgrounds, not of our choosing. While some may be entitled, many are underprivileged based on demographics. Looking at the statistics, African Americans suffer the greatest of disparities in social and economic inequalities. Social justice is way overdue, and reforms in our criminal system are needed. African Americans face more significant financial gaps in income and wealth than their white peers and other minorities.

Statistics Are Revealing

While I was aware of racial disparities, my research for this blog was eye-opening for the gaps’ magnitude. Statistics tell a story that needs to be shared. More than 4 in 10 Americans say the country hasn’t made enough progress toward racial equality based on a Pew Research 2019 study. However, 8 in 10 blacks say the government hasn’t gone far enough to give black people rights on par with white people. Fully half of blacks say it’s unlikely that the country will ever achieve racial equality.

 Common Factors Believed To Cause Racial Disparities For Blacks Are:

  • Substantially less fair treatment by the police and the criminal justice system;
  • Family instability;
  • Less access to good schools;
  • Lack of jobs;
  • Treated less fairly in the workplace;
  • Difficulties when applying for mortgages or other loans; and
  • lower quality medical treatment.

 

The question I often raise comes from the perspective of financial gaps. That is, whether improving financial literacy can narrow the economic divergences that exist for African Americans? These disparities are not new and remain visible in our society. However, for many, including myself, differences do not exist in our everyday lives. For minorities, especially Black Americans, they impact job prospects, wages, loans, and retirement savings. Financial education cannot wipe away systemic policies stemming from longstanding racial discrimination and accumulated inequalities. It is hard to stamp out these income and wealth gaps in our country that have existed for so long. However, at some point, now especially, it is time to recognize those gaps and find ways to narrow them.

Financial education can make a dent in the gaps in wealth between White and Black Americans. It cannot do so entirely without widespread intervention from the government and private sectors to lessen and erase policies that perpetuate these gaps. However, there may be ways that financial literacy, new technologies, and funding for new businesses can improve African Americans’ financial lives.

Critical financial gaps for African Americans Are:

  1. Less household income, earning about 58% of whites.
  2. College education doesn’t decrease the wealth gap.
  3. Higher unemployment, especially in downturns.
  4. More likely to earn the federal minimum wage (3%) versus 2% for white, Asian, and Hispanic workers.
  5. A smaller percentage of homeownership with more significant difficulties attaining conventional mortgages.
  6. Carry higher debt levels, including credit cards and student loans.
  7. Nearly half of black households are unbanked or underbanked, resulting in less access to financial products. McKinsey found that banks would realize $2 billion in incremental annual revenue if black families had the same access as white families. Overall, their report suggested narrowing the wealth gap for blacks would increase our GDP by 4%-6% by 2028.
  8. Only 54% of Black and Asian employees work for an employer who sponsors a retirement plan vs. 62% for white workers.

Different Realities of White and Black households

 

1. Black Households Earn Less Income

White households earned a median income of $61,200 compared to $35,500 for black peers. Their homes may earn less income than white families because more of their jobs pay wages closer to the minimum wage level. Earning less income means reduced abilities to expand wealth through more significant savings, paying off debt, and investing money.

Fewer blacks are visibly participating in the highest-paid professional jobs despite completing higher education levels. For example, some of the best-paying jobs are in the finance industry, specifically banking, credit, securities, and insurance. However, women and minorities are less likely to be hired as professionals or managers. According to this report, the African Americans’ participation is highest (7%)  in banking and credit areas while lowest in securities at 4.4%, which is typically more financially lucrative according to this report.

Education on its own doesn’t account for the difference in income or wealth between black and white households. The racial wealth gap expands with higher education. Black families where the head graduated from college had less wealth ($23,400) than white families ($34,700), where the head of the household dropped out of high school.

2. Lower Net Worth For Black Households

Typically, the higher the income a family makes, the higher the wealth accumulated. Net wealth or net worth’s calculation is assets minus liabilities. White families had a significantly higher median net worth at $171,000 or 9.7 times that of black families with $17,600 in net worth. While 19% of black families have zero or negative net worth, only 9% of white families generate zero or negative net wealth.

Two factors may account for the lower levels of wealth for blacks. First, accumulated wealth tends to rise with age. Over half of the white households were headed by someone who was 55 or older compared with 38% of their black counterparts. Secondly, family structure plays a role in households headed by a single parent versus a married or partnered head. Black households at just 37% were least likely to have a married or partnered head compared to more than 54% for each of the other groups. White households are the least likely to be headed by a single parent (8%).

3. Different Composition of Net Worth

The composition of assets and liabilities of black and white families are very different and tend to favor white families. A more significant proportion of white families (73%) are homeowners, while only 45% of black families own their primary residence. White households hold considerably more significant equity levels in their homes at $215,800 compared to only $94,400 for black households. White homeowners hold more home equity but housing accounts for only 32% of their total assets than 37% to 39% for Black and Hispanic homeowners.

White households tend to have more assets in investment and retirement accounts.

Lower Contribution To Retirement And Investment Accounts

Preparing for retirement is key for all households. 60% of white households hold retirement accounts, notably IRAs and 401(K) accounts, well above 34% of black families. Owning equity in retirement or other investment accounts reflects a more significant difference. 61% of white households hold equity, nearly double (31%) for black households. As such, Blacks have less access to these financial products from company-sponsored plans and fewer savings for emergencies.

Only one-third of blacks have an actual retirement 401K savings plan at work though 73% are in the retirement planning process, according to a 2018 Mass Mutual study. That study reflected that African Americans are the least prepared for a financial emergency, with only 33% having more than one of the expenses saved. Still, 75% view savings as their highest priority.

The best way to save for an emergency fund or retirement account is through your employer. Employees can deposit a portion of their paycheck directly into an automatic savings feature. However, not all employers provide this benefit. When employers offer automatic enrollment, there is usually higher employee participation.

Also, lower-income for blacks hampers their ability to have the liquidity to contribute to these accounts.

Lower Business Ownership

Whites own a more significant percentage (15%) of their businesses, with black families about half (7%) as likely to do so. It takes capital from family, friends, and bank lenders to build your own business. However, black families have had more significant difficulties getting loans at reasonable rates. According to the State of American Entrepreneurship by American Express, 47% of African Americans run their businesses by themselves compared to 33% of the average small business owners. However, black women entrepreneurs are the fastest-growing group in America. That is an exciting development in recent years. You can read our post: Unique Challenges Faced By Black Women Entrepreneurs.

 Family Inheritances For Blacks

White families receive much larger inheritances, or about twice that of black families, according to the Hamilton Project. Among households receiving an inheritance in 2020, those with an economic income of over $1 million are, on average, expected to inherit $3 million. On the other hand, low earners (under $50,000)  inherit $60,000. And so, the perpetuation of the wealthy gets more so.

4. Access to Credit May Be Tougher Causing Higher Debt

Liabilities can depress wealth. White families have a higher proportion of their primary resident’s debt at 46% versus 32% for their black peers. This mortgage debt is “good debt” because it is associated with an asset that may appreciate. On the other hand, black families carry more outstanding credit card balances (48%) and education loans (31%) than white families. Black families may require more student loans than relying on their savings or that of their families, including extended members.

Credit Scores

Our financial lives rely heavily on our creditworthiness reflected by credit scores. Typically, the higher your credit score, the better your access to credit at better interest rates. Black households face credit inequality associated with longstanding discriminatory banking practices. While there have been some improvements, the perpetuation of these practices takes a toll on black families accessing credit. They face difficulties, whether it is for conventional home mortgages or credit card approvals.

According to a 2017 study by the Urban Institute, more than 50% of white households had a FICO score above 700, compared with only 21% of black families. A 700 score is considered a good score for access to credit at better interest rates for most loan types. Still, African Americans, even when accounting for similar income, loan size, and other factors, are more likely to be denied conventional mortgages than white peers. According to a Reveal analysis of 31 million Home Mortgage Disclosure records, black applicants have disproportionately turned away in 48 metropolitan areas.

To some extent, black families lack access to credit, such as credit cards. Having a credit card often provides people with the ability to show creditworthiness. Yet, 32% of African Americans did not have access to credit cards than 15% of whites in the Fed’s 2018 Report of the Economic Well-Being of the US. In that same report, blacks as a group are more often unbanked or underbanked compared to whites. In the US, 6% of adults do not have a bank account versus 14% of blacks. More than a third of blacks have an account and use alternative financial services such as money orders, payday loans, and check-cashing services, which can be more expensive.

Black Households Need Better Access to Financial Products

Blacks have often encountered restrictions or higher fees at traditional banks in black neighborhoods. Those banks may require customers to deposit a certain percentage of their paycheck to avoid fees and account closures. A more significant portion of loan officers is white (82%), with only 9% of loan officers being black. Only 4% of financial advisors of color are designated Certified Financial Planners or CFPs. As such, it reduces their ability to receive valuable financial advice from someone familiar with their background.

Digital banks such as Chime may be a boon for underserved populations such as African Americans. These fintech companies may help break down some of the existing barriers that have restricted access to financial products.

5. Experience Greater Harm From Economic Downturns

During the Great Recession, unemployment peaked at 10%, but it was over 16% for blacks versus 9% for whites. Subprime mortgages, a significant cause of the downturn, were disproportionately higher for blacks and Hispanics. While 26.1% of white households held those loans, blacks had 52.9%,h the most significant exposure group. A 2010 analysis by the Center For Responsible Lending found that even after considering individual credit scores and other characteristics, African American borrowers were more than 30% likely to receive the more expensive subprime loans.

Between 2011 and February 2020, black unemployment fell to 5.8%, near the lowest levels since the early 1970s. However, as the coronavirus brought down our economy, unemployment for blacks rose to 16.7% in April 2020, while unemployment was better at 14.2% for whites. While 30% of whites can work from home remotely, only 20% of Blacks can. The COVID pandemic has disproportionately impacted the Black community in higher virus-related deaths, losing jobs, and obtaining financial relief. Blacks face a double whammy of far more significant economic and health insecurity.

Visible Gaps For Black Americans In Financial Literacy

According to two major reports, the financial well-being of African Americans lags that of the US population. One study was completed in 2019 by the TIAA Institute and Global Financial Center (GFLEC) at George Washington University. This study reported that black participants scored 38% correct versus 55% for white peers. However, black respondents did best in borrowing and debt management and lowest on insuring. Those black participants who were more financially literate were more likely to plan and save for retirement. Mobile payment users of new digital products were more likely to have more significant non-retirement savings.

The Financial Capability FINRA 2018 study found a widening gap in financial capability among groups. Younger Americans with lower incomes and African Americans exhibited less improvement than other groups. Simultaneously, 42% of white respondents spent less than earned, ahead of (34%) of African Americans. In most categories of the study, African Americans fared worse than whites. Also, blacks generally handled financial literacy questions more poorly than Hispanics, reflecting more significant financial stresses.

10 Recommendations For Improved Financial Well-Being of African Americans

African Americans have dealt with inequalities that have burdened their abilities to build wealth. Institutional differences have resulted in longstanding discrimination creating more incredible financial hardships. I am hopeful that the widespread protests across our country this year will result in a far more equal playing field, removing barriers to financial equality. Economists have talked about greater economic growth potential for our country if Black Americans, 13% of our US population could grow at parity. Our recommendations:

1. Go To A Financial Advisor

When developing your short-term and long-term financial goals, it is a good idea to visit with a financial advisor who is a Certified Financial Planner (CFP), which you can read here. Some advisors may be more interested in selling you financial products. However, seek out a CFP who has a fiduciary duty to serve you in your best interests. While there are less than 4% of financial advisors of color, their growth of 12% exceeds that of all CFPs, according to the CFP Board.

2. Emergency Funds

The emergency fund is a great place to start. Where possible, use automatic savings features available at work or through digital banking. Set aside separate savings account for this purpose. Aim for at least six months’ liquidity to have a buffer for your essential costs: food, rent, or home payments (mortgage, utilities, and such). However, this pandemic proves that a year’s worth of savings may be more prudent for unexpected financial emergencies. Invest these savings in securities such as a more liquid cash-equivalent money market deposit account (MMDA), FDIC-insured. For more on emergency funds, please read here.

3. Plan Early For Your Children’s College Education

Establish a 529 College Savings Plan as early as possible. Like retirement savings accounts, these accounts provide tax-advantages. By saving early for your children, you may help them lessen the debt burden long term.  Automate these savings if possible. Find an appropriate fund to invest your money or go with target-date funds that automatically adjust with your child’s age. See our post on Saving For College Early.

4. Save For Retirement Funds

Putting aside money for your retirement accounts is essential. It is less painful when done early and automatically through your workplace, your own 401K accounts, or create your own IRA/Roth IRA. Like 529 savings accounts, there are tax advantages to gain from establishing these accounts. Read our blog on saving for retirement as early as your 20s.

5. Investing In Taxable Investment Accounts

To build your wealth, investing in investment accounts remains vital for your long term time horizon. Studies have shown that 67% of African Americans earning $50,000 or more are investing in stocks and stock mutual funds. With digital technology enabling several fintech companies such as Robinhood, there are more excellent opportunities to purchase stocks in fractional shares without requiring minimum amounts and commissions. While stock investing carries higher risks, they tend to generate higher returns. Using prudent strategies like diversification through low-cost index funds can lessen some of their risks.

6. Spend Within Your Means

Spend less than you earn by having a monthly budget to understand your costs better. Track your spending on an app or whatever is comfortable for you to recognize patterns you may want to change. According to FINRA, only 40% of Americans spend less than their household income. See our post on creating a budget. Review and tackle some of your costs with money-saving ideas.

7. Use Debt Sparingly And Pay It Off

Pay your monthly credit card bills in full, not just the minimum amount. If you can’t pay down all of it, target paying more than the minimum and spend less. Only 32% of Americans pay their credit cards in full. The majority of those who don’t pay the balance in its entirety face a high borrowing rate (15% on average). Additionally, that will stretch out the number of years it will take you to pay down the debt and increase your total borrowing costs.

8. Review Your Credit Reports Periodically

Our financial lives depend on our creditworthiness. Reviewing credit reports for accuracy and for ways to improve your score, enhance your financial flexibilities. Your credit report is not just for lenders but often requested by the landlord, your workplace, insurers, and utility companies. There are ways to raise your credit score so that you can get the best loan rate.

9. Shorter Mortgage Terms Are Better

When taking out a mortgage loan for your home, consider the 15 years versus 30-year terms. You will make higher mortgage payments, but your total borrowing costs are significantly lower by cutting your time in half. The same premise goes for borrowing for vehicles where you pay lower interest overall when your borrowing period is shorter.

10. Insurance Products To Protect Your Family For The Unexpected

If you have a young family, consider life and disability insurance as a means to protect your family, especially if you are the main earner. Look into your company benefits plan to see if you have insurance coverage and whether you have access to lower rates. We discussed  8 Insurance Types You Need here.

Final Thoughts On How To Close The Racial Wealth Gap

African Americans have long suffered inequalities in many aspects of their lives. These gaps, hidden in plain sight, are a result of systemic policies. We reviewed many financial disparities that remain but need to be eliminated to allow for upper mobility for black Americans to be on an equal playing field. Intervention from the government and private sectors’ racial wealth gap, especially financial institutions,  fully relieves these burdens. In recent weeks, many corporations stepped with funding to combat social injustice. They can do more to help.

Efforts to change policies change can reduce large gaps. They can range from improving education, progressive taxation, and employment opportunities, especially in the financial services industry. Accommodating lending should replace restrictive banking policies in black neighborhoods. Banks need diversity with more black loan officers and CFPs ready to serve a needed market.

At the end of the day, better financial literacy can play a role in strengthening black households’  financial flexibility. Learning how to save, invest, and improving your credit when borrowing can pave a better road to building your assets and wealth.

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