It's true, the rich do get richer—here's why...
The debate over inequality has focused mainly on taxes, fairness and government.
But two new academic papers shed light on one of the biggest drivers of wealth inequality—the higher investment returns of the wealthy. The growing wealth of the rich, and the relative stagnation of the middle class, are due in large part to diverging incomes, but investments also play an increasingly important role.
And it's not just that the wealthy have more investments. They also have better-performing investments.
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In a paper on household wealth over the past decade, economist Edward Wolff at New York University found that wealth inequality rose sharply from 2007 to 2010 and has remained largely unchanged since then.
One reason: The wealthiest 1 percent put three-quarters of their savings into investment assets. By contrast, the middle class had 63 percent of their assets tied up in their homes, with home equity accounting for about a third since they have large mortgage debt.
Wolff found "striking differences in returns by wealth class." The top 1 percent earned an average annual return of 5.91 percent between 2010 and 2013—far more than the 3.27 percent earned by the middle three quartiles. And that was due mainly to having more exposure to the stock market.
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"The differences reflect the greater share of high-yield investment assets like stocks in the portfolios of the rich and the greater share of housing in the portfolio of the middle class," Wolff said.
In an interview, Wolff also said that investments in private businesses and commercial real estate also boosted the returns of the rich. He said that while the middle class was largely divesting and selling investments between 2010 and 2013 (in part to pay down debts), the top 1 percent were growing or maintaining their investments.
"If the middle class had been more heavily invested in financial assets they would have done better," he said.
But stocks aren't the only fuel for the higher returns of the rich. Economists Emmanuel Saez and Gabriel Zucman looked at wealth inequality since 1913 and found wealth concentration has followed a "U-shaped evolution" over the past century.
While stocks played a role, the paper says that bonds may be the real secret to the better investment gains of the rich. "Wealthy families might be able to earn 6 percent on their bond portfolio (e.g., by investing in foreign markets or in high-return convertible bonds) while the rest of the population might earn 3 percent only, and that differential might have increased over time," the paper said.
In the mid-1980s, the top 0.01 percent owned 1 percent of the bonds owned by U.S. households—by 2012 it had grown to 5.4 percent.
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The two papers don't mention another big reason for the better returns of the rich—private equity and hedge funds. While not as accessible to the everyday investor, many private equity funds and hedge funds have outperformed the stock market in recent years and boosted the returns of the rich.
A recent survey from Spectrem Group found that nearly half of investors surveyed with $25 million or more in investible assets are expecting returns of 9 percent or more this year. More than a quarter are expecting returns of at least 11 percent.
Those investors had an average of 29 percent of their investible assets in alternative investments like hedge funds or private-equity funds.
Of course, the rich can afford to lose more—so they can take more risks and make more when times are good. But the lesson is clear: the wealth gap is caused in large part by the investment gap.