Chart of the Month – August 2019

Components of Wealth by Wealth Bracket (Protection in a Recession)

As we approach what we believe are the final stages of a very long expansion, one must look to protecting one’s assets in the event of a severe recession. This begs the question of who really gets hurt in recessions. The answer to this is usually everybody, to a greater or lesser degree. The most important assets to protect are those that provide food and shelter for the family and also those that provide a means to an income. Clearly the residential home is very important and in many cases a motor vehicle. Following this would be business assets that provide an income and lastly assets that are nice to have but not essential, like recreational real estate, hobby collections, etc. In most portfolios, a good mix of assets is useful in protecting one’s overall net worth, thus I have grouped assets into six categories and plotted them against the various levels of wealth.

The bars in the chart are organized according to liquidity, the top assets being the most easily converted to cash. Some of these asset classes need no explanation, but other categories are as follows.

Business & investment assets: These often include securities traded in public markets, which are very liquid. There may be penalties or taxes for drawing on the liquidity such as using funds from RRSPs and other tax shelters but can be liquidated in an emergency. Business assets may include shares in private companies which are somewhat illiquid but can usually be pledged as collateral against loans, which makes them liquid.

Non-financial assets: Furnishings, collectables, art, etc. are precious and may be emotionally difficult to part with, but buyers may be found amongst other collectors at the top end and pawn brokers at the lower end.

Other financial assets: May include holdings in private companies, partnerships etc. which may be hard to sell.

Real estate (excluding primary residence): Might include recreational property, second houses or raw land which is saleable but may take time to liquidate.

It is clear that the makeup of a person’s net worth has much to do with how well they can withstand the effects of a recession.

The bottom 25% of the population is vulnerable to falling real estate values, particularly in the event of job losses, and they may have to sell their most valuable asset, their home, which may have fallen in value. Another potential source of quick cash is to sell a vehicle. Once again this is a large portion of their net worth but as mentioned above, is likely to be an essential item to maintaining one’s ability to work.

At the other end of the population spectrum, the wealthiest individuals generally have more than 50% of their net worth tied up in business interests. This may include equity investments in private companies which are usually difficult to dispose of in a recession. They frequently have good size positions in non-primary residential real estate and collectables. While it might be painful to sell these assets, their sale does little to affect their lifestyle.

The cohort with the best-balanced portfolio of assets is often the second quartile of the population who would be considered middle to upper middle class. They have considerable business and investment assets which can be sold or pledged to protect their residence, which in any event represents less than 20% of their net worth.

Our conclusion is that those hurt the most by recession are likely the bottom 25% of the population and counter-intuitively the 10-25% top tier if their business and investment portfolios are heavily weighted into a single company that provides the majority of income for the family. Yes, they can sell “play assets” but most of their wealth might be tied up in a business which may be vulnerable in a recession.

The key takeaway from this analysis is that when one plans one’s future it is useful to treat your wealth as a portfolio that needs diversification of asset class, volatility and maybe geography.