Risky employment, safe assets, and the racial wealth gap

Black Americans hold less than one-sixth as much wealth as White Americans do. That means they miss opportunities to pass wealth to their children. They lack a financial cushion to get through hard times. And because Black families typically hold their wealth in housing rather than financial assets, the explosive stock market returns of the last 40 years have largely passed them by.

Reasons to close the racial wealth gap abound, but to do so effectively we need to know where the gap comes from. New research by Institute visitors Ellora Derenoncourt and Chi Hyun Kim, along with Moritz Kuhn and Moritz Schularick, suggests that the differences in stock market wealth may actually stem from the striking gap in labor market uncertainty.

A simple equation

Building wealth requires one to buy assets, earn a financial return on them, and hold them long enough to see those returns accumulate. Easier said than done, though. And easier done for some Americans than for others, particularly for Black Americans.

The first step, buying assets like homes, stocks, or bonds, requires cash. Black workers earn less on average than White workers, so they have less cash with which to purchase financial assets in the first place.

The last step, holding assets, requires stable enough cash flow to weather hard times without needing to draw on those very assets to get by. Black homeowners, for example, earn less than White homeowners when they sell their homes largely because they more often do so in a short-sale or foreclosure situation, losing money in the process.

But neither of these forces speaks to one of the most important drivers of wealth in the last four decades: stock market returns. In real terms, a dollar of housing in 1980 would be worth about $1.5 today, but a dollar’s worth of stock would be worth $6. Black households with wealth hold less of it in stocks than White households do, which is one reason why they earn a lower overall return on their wealth.

A complicated calculation

So why do Black and White wealth portfolios differ like this? Are Black families making a mistake about how to invest?

According to the research, they are not.

The economists build an economic model that describes the kinds of assets that a worker would invest in given what they know about their likelihood of becoming unemployed and staying unemployed—in economic terms, their labor market risk. Higher risks, it turns out, create an incentive to invest in safe assets like bonds instead of assets that are volatile but potentially more lucrative, like stocks. Because Black workers have significantly riskier work lives, the model suggests that they will make different investment decisions.

For example, recessions tend to push a higher share of Black workers than White workers into unemployment. The figure shows that since 1980 the difference between Black and White unemployment rates widened noticeably during recessions. Black workers also remain unemployed longer than White workers. The authors report that about a third of unemployed Black household heads report having been out of work for a full year, compared with just 17 percent of unemployed White household heads. During these periods, however, Black workers receive lower unemployment compensation than comparable White workers do. All of this amounts to deeper and longer income losses for Black workers, and related evidence shows that their monthly consumption is thus twice as sensitive to changes in income as it is for White-headed households.

These labor market realities affect wealth portfolios because, in a downturn, stock prices typically fall too. Investing heavily in stocks would mean that Black workers’ assets would lose value exactly at the time their earnings fall the most. Better to buy bonds whose value holds even during recessions.

The simple fact that workers know the risks they will face in the labor market shapes their choices about their wealth in a different way than their lived experience does. A worker who actually has low earnings cannot save and invest very much, and one who actually becomes unemployed may need to draw down wealth to get by. Regardless of what will happen to a worker, though, the mere prospect of those ups and downs shapes the kind of wealth they want to hold. That factor, the authors say, could explain the different portfolio choices of Black and White households.

A possible explanation

When the authors feed data on unemployment by race into their model, they find that the theoretical link between labor market risk and optimal portfolio composition is in fact strong enough to explain much of the gap in the share of wealth held in equities. Among workers with any wealth, White workers hold about 35 percent of their wealth in the form of stocks compared with 27 percent for Black workers. The model implies that had Black households faced the same labor market risk as that of White households, the gap in equities would have been just one percentage point, showing that labor market risk is a plausible explanation for different investment choices.

The model, however, cannot explain all of the patterns in portfolio composition. For instance, it predicts that about the same share of White and Black households invest in stocks, but that Black stockholders invest less money. In fact, there is a huge gap—23 percentage points—in the share of Black and White households with any stock market wealth. Why this pattern occurs is still unclear.

Finally, the model shows that even though labor market risk could explain different portfolio choices, investment strategies themselves account for just 15 percent of the racial wealth gap. The lion’s share of racial wealth disparities, in other words, come from other factors, including actual labor market outcomes or structural, historically based barriers to wealth accumulation.

The biggest lesson from these findings is that they demonstrate the complex ways that economic realities can shape wealth. “Unless labor market conditions improve for Black Americans,” the authors conclude, it will not make sense for them to invest in high-risk, high-return financial assets. In that context, booming stock prices lead to wider racial wealth gaps.

This article is featured in the fall 2024 issue of For All, the magazine of the Opportunity & Inclusive Growth Institute