From the January 2009 issue of Research Magazine • Subscribe!

Saving Along Ethnic Lines

I was in Atlanta for a couple of days to attend Charles Schwab's INSIGHT 08 conference. Dorothy A. Brown's sojourn in the South has been considerably longer -- she came to Emory Law School after teaching at Washington and Lee University, in the middle of "real" Virginia. As a pair of true-blue New Yorkers lunching on very authentic French bistro fare in one of the redder states of the nation we couldn't, of course, avoid talking about the impending presidential election.

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Who: Prof. Dorothy A. Brown, Emory Law School

Where: Le Giverny, Emory Conference Center, 1615 Clifford Road, Atlanta

On the Menu: Small salad, overcoming distrust of Wall Street and eliminating the mortgage-interest deduction.

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Pundits have talked about the Barack Obama 2008 campaign as the first "post-racial" presidential election in American history. This may very well be so, but differences between races -- as well as among various ethnic groups -- remain deeply entrenched in the United States. They reflect not only levels of income or places where Americans of different backgrounds live, work and educate their children, but their savings patterns -- especially how they save for retirement.

Pension planners and asset managers would be well-advised to take note of those differences. They certainly pose social challenges to the nation but also -- surprise -- may present profit opportunities to financial advisors.

Risk Aversion

The impact of class, racial and ethnic differences on the way Americans save for their retirement is one of Professor Brown's scholarly interests. Last year, she published an article in the Louis & Clark Law Review titled "Pensions and Risk Aversion: The Influence of Race, Ethnicity and Class on Investor Behavior."

As she takes a bite of her appetizer-sized salad -- she doesn't seem to be a big eater -- Brown notes that industry surveys (including those conducted by Schwab) consistently show that share ownership is directly correlated with class and education. Higher incomes and higher educational attainment are typically associated with a higher proportion of income being invested in stocks. It seems that households in higher income brackets are either less risk-averse or, alternatively, have a longer-term investment horizon. Since a balanced stock portfolio has proved to be the safest and the most lucrative asset class over the longer term, not only do higher income households start out with more money, but they tend to make more money on their investments.

The correlation between incomes and education on the one hand and stock ownership on the other also holds for blacks and Hispanics. But with an important difference.

"These groups," says Brown, "tend to invest into stocks a lot less, in percentage terms, than white Americans in the same income brackets and levels of education. Worse, blacks and, especially, Hispanics, are less likely to own stocks than less educated whites in lower income brackets."

With lower incomes and/or skills, blacks and Hispanics are less likely to work for a company that sponsors a defined contribution pension plan, such as 401(k). Such plans, studies have shown, also tend to be associated with higher pay and more skilled positions. Blacks and Hispanics are also more likely to opt out of such plans even when they are offered by their employer. And, to add insult to injury, Brown says that when they do participate, they tend to invest in their employers' stock.

You don't have to think of the Enron calamity in the early 2000s, or the spate of recent bankruptcies on Wall Street, to see how this seemingly risk-averse investment strategy can badly backfire. If the employer runs into difficulty, you can find yourself out of a job and lose your retirement savings at the same time.

Starting Low, Ending Up Lower

The current debacle on Wall Street notwithstanding, by staying out of the stock market even the black middle class condemns itself to a more precarious financial and economic position vis-?-vis white Americans in the same income brackets. Moreover, for masses of less affluent and poor African Americans, this self-defeating investment pattern is certain to exacerbate the problem that looms large for the rest of the country -- namely, the disappearance of defined-benefit corporate pensions and lack of trust in Social Security. The coming generations of retirees will have to rely almost exclusively on their personal savings.

"The current financial crisis has shown how many people live on the edge of the precipice," notes Brown.

Traditionally, black Americans have tended to trust more tangible investments, holding the bulk of their assets in real estate. Until recently, a home seemed like a very solid, if not especially lucrative investment. During the real estate boom of the 2000s, house prices advanced like a house on fire -- the pun is intended -- only to drop precipitously over the past year and a half. All of a sudden real estate became a dangerous and highly illiquid investment. Moreover, while home prices nationwide have declined, minority neighborhoods have been affected even more severely.

Community Role Needed

Brown sees distrust, or lack of understanding of how financial markets work, as only part of the problem. In her view, there is a more deeply ingrained cultural pattern.

"We don't have a culture of stock ownership," she says. "When we grow up, we don't see our parents or anyone else around the neighborhood investing in stocks."

Brown grew up only a few miles from Wall Street, but her South Bronx neighborhood around Yankee Stadium was culturally light years removed from the world of finance. Still, she not only got a law degree, but worked for brokerage house Drexel Burnham Lambert during the heady years of the junk-bond boom.

Brown is convinced that there is a lot of money that could flow from the black community to Wall Street. However, she says, there needs to be involvement by community organizations, such as the NAACP, to break the distrust for stock investment. And, as in any other community, people who spend time learning about the community will be the most successful in selling such services as financial planning and pension consultancy to its members.

Of course, the current crisis will need to be resolved before retail investors --black as well as white -- will venture back into the stock market. Brown has an interesting perspective on the current crisis, the one which she has gleaned from her other specialty at Emory Law -- federal taxation.

She is not unique in regarding the current financial crisis as the result of excessive borrowing. But she believes that the federal tax system is at least partly to blame, notably by offering a mortgage-interest deduction. "Definitely, mortgage-interest deduction on second residences and on mortgages above $1 million should be abolished," she says.

But will Barack Obama dare to touch this sacred cow that seems as American as apple pie -- especially now, when the housing market is on the skids?

"He probably won't," laughs Brown. "But he is running for president, and I'm teaching at a law school."

Then, she turns serious and insists that the deduction should be eliminated when the housing market recovers. "People will still buy houses, even if their mortgages are not tax-deductible. But real estate bubbles will not be as readily repeated."

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Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at abayer@kafanfx.com. His monthly "Global Economy" column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past five years, 2004-2008.

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