Effects of Capital Accumulation Ratio on Wealth

Personal Finance, Military Families February 07, 2017 Print Friendly and PDF

 

Harness, N.J., Finke, M.S., & Chatterjee, S. (2009). The effects of the capital accumulation ratio on wealth. Journal of Financial Counseling and Planning Education, 20(1), 44-57.

Brief Description: The capital accumulation ratio (CAR) is a measure of household portfolio quality used by financial practitioners and in academic research. It measures investment assets divided by net worth. This study tested whether a higher CAR impacted household wealth over a specific decade (1994 to 2004) among respondents in the accumulation stage of the life cycle. Meeting a specified CAR guideline resulted in a 28% increase in net worth over the 10-year period. However, there was also an increase in standard deviation, indicating that there was a trade-off of higher variation in future wealth.

Implications: The CAR measures the proportion of wealth held in investment assets for future consumption. Meeting a 25% CAR standard led to a statistically significant increase in household wealth. However, the classic “risk-reward trade-off” was clearly evident because a greater capital asset allocation leads to greater volatility in net worth. Investors who can stand short-run volatility, however, are often rewarded with significantly greater wealth over time. An investment portfolio heavily weighted toward equity assets (e.g., stocks and stock funds) will be impacted by economic expansions and contractions.

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This work is supported by the USDA National Institute of Food and Agriculture, New Technologies for Ag Extension project.