BackSnap Fact: How investments impact wealth inequality
A study finds that between the years 2002 and 2011, varying investment returns accounted for 84% of the increase in inequality of wealth held in equities
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New Delhi: It is not just income inequality that is driving India’s wealth inequality.
In a new National Bureau of Economic Research working paper, John Y. Campbell of Harvard University, Tarun Ramadorai of Imperial College London and Benjamin Ranish of the Federal Reserve Board of Governors show that differences in investment returns have been a primary contributor to wealth inequality in India, with higher returns making the rich even richer.
Analysing returns in 200,000 randomly selected National Securities Depository Ltd, or NSDL, accounts, the authors find that, between the years 2002 and 2011, varying investment returns accounted for 84% of the increase in inequality of wealth held in equities.
Mixed investment returns can contribute to wealth inequality in two ways.
First, small investors do not diversify their investments; so, as some of them get lucky, others are unlucky, and this leads to wealth levels diverging.
Second, large investors diversify their portfolios more and this allows them to earn higher long-term returns.
The increased diversification limits any idiosyncratic risks associated with stocks.
Beyond highlighting the importance of diversification, these findings support Thomas Piketty’s concern that the rich get richer through higher investment returns.
The paper shows that, between 2002 and 2011, Indians primarily invested directly in stocks, instead of mutual funds or other diversified investment vehicles.
However, the decade since has seen a significant growth in mutual funds investments—it will be interesting to see if this, as the authors would predict, will decrease wealth inequality.
Also read: Do the Rich Get Richer in the Stock Market? Evidence from India.
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