Three essays on the capital accumulation ratio
Harness, Nathaniel J.
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It is crucial for the financial planning profession to develop measures and standards to help households make the best financial decisions. According to Black, Ciccotello, & Skipper (2002), for financial planning to be accepted as a profession there needs to be sound empirically based standards recognized by household finance scholars and practitioners. Households make financial decision everyday that potentially affect their financial well-being. Researchers must provide prescriptive models to combat household inequalities, and these models must not ignore basic household limitations for the sake of turgid mathematical modeling. Many consider the capital accumulation ratio (CAR) to be one of the most important ratios for those approaching retirement. However, little research in the field of personal financial planning has comprehensively explored the usefulness of this household ratio. The CAR is traditionally defined as the proportion of net worth held in investment assets and is meant to reflect the share of assets held primarily for future consumption. Results from this research will provide better quality information about the implications of the CAR to household finance scholars, financial planning professionals, and households. This research studies the factors that predict the CAR, the impact of the CAR on wealth, and the effect of variance in the CAR on wealth. This research uses the National Longitudinal Survey of Youth 1979 cohort (NLSY79), a nationally representative panel data set comprised of youth who were between the ages of 14 and 21 on December 31st, 1979. The NLSY79 has surveyed the same households between 1979 and 2004 comprising of 21 waves of this panel, with a 90 percent retention rate in subsequent years. Factors associated with CAR do not appear stable across time. From year to year very few factors consistently predict CAR or meeting CAR guidelines. Prior literature has looked at a cross-section in time; this cannot account for household variation in preferences and macroeconomic shocks that have an immense impact on CAR. Findings reveal that those who have a higher income, greater education, white households, and those with white-collar jobs are positively associated with CAR in most years. Having children, owning a home, minority households, and those with low preferences for stocks are negatively associated with CAR. Meeting the CAR 25 percent guideline resulted in a 28.1 percent increase in the change of net worth from 1994 to 2004. When broken into quartiles the relationship between CAR and wealth was linear between quartile three and four. However, this increase comes at a cost when every one point increase in the CAR increased the standard deviation of net worth from 1994 to 2004 by 8.1 percent. Results from this study suggest that meeting the 25 percent CAR threshold leads to greater wealth over time at the tradeoff of higher wealth dispersion. Individual investor preferences lead to poor market timing choices that can negatively impact wealth over time. Changes in wealth can be greatly impacted by a variation in the CAR across time. Results show that at the median, a 10 percent increase in the standard deviation of CAR reduces that change in wealth by approximately 5.8 percent. Using quantile regression we find having a high standard deviation of CAR results in a lower change in wealth, moreso in the lower percentiles of the conditional distribution of change in wealth.