Economic Equity: Inequality and Stock Market Participation

November 04, 2020

This 19-minute podcast was released Nov. 4, 2020, as a part of the Timely Topics: Economic Equity miniseries.

YiLi Chien, economist and research officer

“High-income people, they save more, and then the return of their wealth is also higher because of high correlation with the biggest stock market participation rate,” says YiLi Chien, economist and research officer at the Federal Reserve Bank of St. Louis. He talks with RC Balaban, digital communications manager, about the role stock market participation plays in wealth inequality.



RC Balaban: Welcome to Timely Topics, a podcast series from the St. Louis Fed. I’m your host, RC Balaban, and today we’re continuing our miniseries on equity and equality. We’ll focus on some research discussing the role that investing, specifically investing in the stock market, can play in wealth inequality. We’re joined today by YiLi Chien, a research officer and an economist here at the St. Louis Fed. YiLi, thanks so much for joining us today.

YiLi Chien: Thanks for having me.

Balaban: Absolutely. So we’ll get into a bit of your research and what it’s found in a minute. But I did want to set the stage first; just if you can talk a little bit about how participating in the stock market specifically, how that relates to wealth inequality.

Chien: Yes. Excellent question. It is a very important question regarding to the wealth inequality. So let me set up the affects of the state a little bit here. So in making a household accumulative wealth, there are two way. One is they save more. The other way is if they have a high return on their wealth, then their wealth will be accumulated faster.

So the wealth inequality going to relate to the first with the income inequality. If income inequality is high, the poor people cannot afford to save, and rich people able to consume more, and they also able to save more. So the first channel is coming from the income inequality.

The second one is coming from the different return for their wealth. So if you look at the data, you’re going to see that the household portfolio choice is very different between poor and the rich. For the rich household, mostly they hold a much larger percentage in their portfolio into the equity, which is historically they have a higher return.

So in particular you kind of see that this function of operating the data. The first one is the rich people, the high-income people tend to save more. But not only that, but also the high-income people, they save more, and then the return of their wealth is also higher because of high correlation with the biggest stock market participation rate.

Balaban: Okay, that’s fascinating. I think a lot of people of course naturally assume that the wealthier, the more income somebody has; then the more you’re able to invest. So you could see the returns really working from that angle. But it is interesting to hear that even when you have people with less income or less wealth and people with more, there’s going to be differences in just how they invest, with wealthier people or higher income people being able to go after investments that generate even more returns.

Chien: Yeah, totally.

Balaban: Okay. So what are some of the factors that seem to influence, like, people’s participating in the stock market, both from actually just getting in and investing, plus the different things that they choose to invest in?

Chien: Yeah. So this is another very important question. So let me give you a little bit of background information about how this stock market participation rate has been changed over time in the United States.

So in probably get back to several decades ago in the ‘80s, the participation rate is around 20 to 30% in United States. In ‘90s, in the middle of ’90, it start to increase. By the end of ’90, it approached to 50%, okay? And since then, the stock market participation rate is around 50%.

So the first thing is that the increase in ‘90s is highly correlated with the increasement of the retirement cut. So in ‘90s, the United States have a mutual fund, and a lot of companies start to offer the 401(k). So this is the main driving force for increasing participation rate in ‘90s.

One thing is very related to who has the retirement account. So, many companies offer the retirement account. And by default, when you join the retirement account, they have the portfolio choice into, like, lifecycle fund, which is the example of some mixed investment between equity and stock. So naturally even you do not know anything about the stock market, you still participate. So that is one channel there.

But this kind of participation is not exactly what we’ve seen of the stock market participation in general sense because of those people who participate the equity market is through the retirement funding, we see they do not adjust their portfolio rate often. Sometimes they do not adjust their portfolio for 10 years, or they only put very little money in the equity markets. So in general, the stock market participation rate did not increase that much in this sense.

Then for the empirical study, the equity market participation rate is also highly correlated with the income and the education. So this is going to tell you that despite a lot of financial innovation in the past 10 or 20 years, the online trading didn’t get or very popular all this stuff, that all this tend to lower the transaction cost for the people to participate in stock market. But you don’t see much effect of where.

So you know that it’s probably why the now participation rate still remain quite high in United States. A lot of financial go to the not monitoring transaction cost. So where you want to invest in stock, you need to spend a lot of time to understand the nature of the stock, how much, which portfolio you should buy, and all this stuff. So this in terms of the time and a connected cost in your mind, then it could be quite costly for a lot of U.S. household.

Balaban: Okay. So one thing I wanted to circle back on here, it sounds like a lot of people, when it comes to participating in the stock market, it’s more the decision’s getting made for them in a lot of cases and them not necessarily taking their own initiative.

So you mentioned investing in 401(k)s, for instance. It sounds like that might be more being prompted or even automatically enrolled in 401(k) savings vehicles. And then even within 401(k), a lot of times people are participating, but they’re doing so in whatever investment vehicle was initially set up for them, which could be something that naturally has lower expected returns. Is that fair?

Chien: Yeah.

Balaban: Okay. And then something else I was wanting to see if you can expand on a little bit was you talked about, I believe, investing being correlated with income and education. And we’ve covered a little bit on income, but when regarding education, what I’m curious about here is, is the correlation more the effect that education has on a person’s income, where generally the more education a person has, the higher income they end up earning, or is it more the higher education somebody has, the more knowledgeable they are about the stock market and the more comfort they have in investing and making their own decisions?

Chien: I would say it’s both. So all of these are highly correlated. So in empirical study had very difficult to distinguish all of them. So we do see that stock market participation rate, education, income, and wealth, as a result, all of them are highly correlated.

So it’s very difficult for us to know which influence which. So the only way to say in this is that we do see that people tend to be rich, and the rich people tend to participate in the equity market. But it does not necessarily mean that for anyone who participate equity market, they are going to be rich.

Balaban: Diving a little bit more into investing in the stock market, you’ve also looked at trading strategies. And you touched on this a little bit before, where the investment vehicles the people pick certainly can have an impact on their expected returns and thus likely translating into the level of wealth that they’re able to achieve. I was wondering if you could talk a little bit more about, like, how trading strategies have a big impact on the wealth that a person can expect to earn by investing, which of course then feeds into inequality and gaps or growing gaps that some people may be experiencing?

Chien: Right. Thanks for the question; it is very nice question. So we talked about the equity market participation because of the equity market return has been in total quite high compared to some other financial asset. So it’s kind of a little bit puzzling that why some of household willing to forego this high return of the wealth vehicle compared to some other, like, lower return stuff.

Of course the equity market has a risk because of the price fluctuates overtime. But in theory, very difficult to recognize that why some people wouldn’t participate in the stock market and forego high return.

But this could make sense because we do see that even though most people who do participate equity market, they could potentially make some important serious mistakes, such that their return of their wealth is going to drop significantly. So we do see that some of them participate, but they do not participate enough, or they do participate but they do not have a diversified portfolio such that their return, they could suffer unnecessary volatility, or they do adjust, but sometime they adjust in the incorrect way.

So a very popular mistake is that we do see that people have the kind of return-chasing behavior, meaning that when they see the stock market return is high, they tend to buy more. And when it suffers some loss or that some market returns is low, they tend to sell. If this is the case, the study have shown that this is going to reduce your average return quite a lot.

So to experience why some people do not willingly participate in equity market, it might be because of some people understand their limitation of participation, which meaning is that they understand that when they participate in equity market, they might make some mistake, or as a result, they just say, “Okay, I don’t want to participate in the equity market because I will make some mistake.”  Then they choose not to participate. So there is some other study I have in the past.

Balaban: And I was going to ask a little bit about whether you’ve done studies, like, specifically looking at risk aversion because it sounds like people could be fearful of making mistakes when it comes to investing. But there’s also I’m wondering if there are some people who know that they could end up making mistakes, but because of the income or wealth that they’ve already accumulated, that they’re willing to take on those risks in search of higher returns, because you would think that somebody who already has a pretty substantial amount of wealth, obviously they don’t have much of a need to take on additional risks, but they have at least an ability to take on that type of risk because even if they make some mistakes, they have the assets available to try to gain that back and to take on the risk of trying to gain all that back.

Chien: Right. Correct. So your question is exactly the point. So to explain why the wealth inequality is so high is we do see that the relative low-income people, either they cannot afford to save or even they’re willing to save, they cannot suffer—If they suffer some significant loss, they going to lose everything. And that’s exactly why you see that in the middle of the wealthy distribution, most people do not hold equity. So the majority of their asset is the housing.

Only it’s the very top, on the very top, especially the top 1% of people, they hold a lot of equity. And not only do they hold a lot of equities, a lot of their equity is their private equity and not publicly traded equity. So this is going to indicate that for really rich people, they are able to sustain, or they’re able to suffer the loss in the short time. In the return, they can gain much higher return in the long run. So as a result, their wealth is going to accumulate much faster compared to the middle- or low-income people. So this is one of the reasons why the wealth inequality gets high in the United States.

Balaban: OK. We’ve talked a little bit just about some of the other general characteristics. So we’ve mentioned income and prior wealth being something that can affect people and how much they’re willing to participate in the stock market. Are there any other characteristics that we haven’t discussed already that play a significant role in people participating in the stock market and ultimately end up impacting them from an inequality standpoint?

Chien: Yeah. So there is one thing I wrote, a very short article. I used a tax return data, across the United States. So the tax return data going to have to have the information about who has this dividend income. I used percentage of the household have different income as an approximation of the stock market participation rate.

I find that of course the income and the education level is highly correlated with the stock market participation rate. But even you control for these two factors, we also see that across the United States, different states have different stock market participation rate, even in controlling for the income. For example, for Connecticut the stock market participation rate is higher than in Mississippi not only because of Connecticut it is richer state compared to Mississippi, but also if you control for the level income in Mississippi and in Connecticut, you compare these two group, say, both of them earn $150,000 annual income, and they should see the significant amount of the differences in the stock market participation rate.

So this is difficult to explain by, you know, Connecticut cause or some transaction cost because it is difficult to argue that those people in Mississippi, their ability in investing is worse than those people in Connecticut, especially the conditioning of the income level. So I think one possible explanation is in some states, the awareness of the financial planning is less compared to the other states.

So we know that Connecticut, some of the households is very close to the New York City, which is the—A lot of people are in the investment industries. But in Mississippi, the industry is shift toward to other stuff. So probably that is one explanation.

But this finding is that other than your income level and the education, there’s some other factor which you do not understand quite well but could affect the stock market participation rate.

Balaban: I see. So it sounds like that based on the research that you’ve done, we may not know exactly all of the factors that go into it, but it does look like there are factors beyond simply how much income a person has that could influence people participating in the stock market and getting these returns. Who knows what it is. It could be cultural. It could be stuff that’s geographically based, any number of different items that there could be but certainly something beyond just the simple people who have more money are able to invest more in the stock market and then making inequality grow. There may be some other factors at play here.

Chien: Right. Exactly. Thanks for the nice comment.

Balaban: So YiLi, we’ve talked quite a bit about participating in the stock market, but it’s been more from just an aggregate perspective, like the idea of large groups of people and whether they should be participating. But obviously participating in the stock market is an individual or a household decision, and it’s not probably fair to say that people, just everybody should go out to try and invest in the stock market and get whatever returns they possibly can, try and get the most. There may be some other factors at play for whether people, not only whether they should take the right levels of risk, but should they even participate in the stock markets? What are some of your research or some of the thoughts that you’ve uncovered while doing your research related to just people’s individual decisions on participating in the stock market?

Chien: Yeah. This is excellent question. Thanks for asking this. So the stock return is high. But the stock is not necessarily a good investment vehicle for everyone because everyone, everybody, every household have different preferences. They have different financial goals. The financial situation is different. And some people cannot take more risk because of their level of income has already fractured quite a lot.

So here, the personal financial decision is personal in the sense that there is no universal portfolio choice or investment strategy for everyone. And on top of that, if you think about household financial problem, it’s a really difficult problem to solve. The first thing is normally they have some illiquid asset, like housing. They have some non-tradable asset, like their own human capital. They face volume constraints.

Also according to different age, you might have a different goal to achieve. So investing in stock is just one of the options. It might not be the necessary option for everyone. For sure, I don’t think it’s an ideal option for everyone, especially if you are the high-aversion people. And sometimes the fear or the time and energy you need to process all this information about stock market could be really time consuming. This is a difficult problem, and everybody should manage it in their own way and try their best to invest.

Balaban: Well, YiLi, thank you very much for your time today. It’s been a very fascinating look at some of the factors that go into the stock market and how it relates to inequality and growing inequality, for that matter. Really appreciate your time on this.

Chien: Yeah. Thanks so much for having me, and it’s such a great opportunity to say something about my own research.

Balaban: Absolutely. So to follow along with our miniseries on economic equity or to listen to more Timely Topics episodes, visit us at You can also subscribe to our Timely Topics Podcast Series on Apple Podcast, Stitcher, and Spotify. Thank you for listening.

Economists and experts talk about their research, topics in the news and issues related to the Fed. Views expressed are not necessarily those of the St. Louis Fed or the Federal Reserve System.

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