The era of the illiquid millionaire is here

Being a millionaire isn’t what it used to be. This isn’t a lament, it’s a fact: As Bloomberg News reported recently, almost one-fifth of US households have a net worth of more than $1 million. Fully one-third of them have gained that status since 2017.

There is, however, an important caveat to this data, which is through 2023: Most of that wealth is on paper.

America may be entering the Era of the Illiquid Millionaire. Compared to the alternative — the illiquid non-millionaire — it is a nice problem to have.

But it also is redefining what it means to be rich, with profound implications for both society and public policy, according to the Tribune News Service.

Americans’ wealth is the result in part of a soaring stock market (up more than sevenfold from the bottom in 2009) and increasing real estate values (up 125% since 2009).

Many Americans benefited from these markets because of deliberate policy choices that encouraged investment in them. In 1989, only 32% of Americans owned any equity; by 2022, about 60% did.

The big change first came from the increased popularity of tax deferred retirement accounts, which are the way most Americans save.

Since the 1980s, retirement accounts have displaced other forms of saving and are now how most Americans invest in markets. But these accounts make Americans feel richer than they are.

First, they are illiquid — that is, investors can’t get their money without paying a penalty (or borrowing against it) until they are 59. Also, most of the time they still owe income tax on the money — and the rate will probably be much higher than the capital gains tax rate on post-tax assets.

Even if retirement assets are reported just like other kinds of financial assets, they are often worth less.

The other big source of wealth is housing, which makes up about 40% of the net worth of a typical American household. Policy also encourages homeownership: with tax incentives, subsidies for the mortgage market, and efforts to keep interest rates low. But a house, too, is illiquid.

Selling a home involves substantial transaction costs, and people who sell their house have to find somewhere else to live.

The housing market can be brutal, with high prices and even higher mortgage rates.

It all adds up to an illusion in which we tell ourselves: We are rich! I fall for it myself. I am doing things I never did before, such as looking at my brokerage account when the market is up and checking real-estate listings for similar apartments.

It feels good, and even though I know better, it is easy to forget that I am actually about 35% less wealthy than it appears.

In some ways this wealth means America’s policy choices encouraging retirement saving and home ownership have been successful.

These policies force people to save for the future, giving them a more comfortable retirement that is less reliant on public benefits.

On the federal level at least, the momentum is to encourage even more illiquidity for retirement investors — such as the White House’s plan to allow private equity in 401(k)s, which is a very bad idea. These proposals tend to come when asset prices are high, less so when prices fall.

But there are downsides. The illusion of wealth can encourage people to take on more debt — and unsurprisingly, home-equity loans and loans against 401(k)s have become more common.

And while retirement accounts may mean more money for the future, they also increase vulnerability to economic shocks today.

And if a price correction in the market makes all these rich-on-paper Americans feel much poorer and cut back on spending, watch out.

Wealth effects can be significant, even when investors are looking at an account they can’t touch for decades.