Shunning stocks and hoarding cash is harming European wealth

Drinks without ice, the best way to make tea and the appropriate amount of vacation are subjects Europeans and Americans can debate. But when it comes to keeping cash in the bank versus investing it in the stock market, there’s no doubt who’s in the wrong: The savings habits of Europeans increase inequality, keep them poorer than they otherwise would be and starve domestic companies of equity capital.

No wonder more companies are angling to list in the US in the hope of a better valuation: over there, the Magnificent Seven and the S&P 500’s record high are acceptable topics of polite conversation, whereas many Europeans equate investing with gambling.

The erosion of purchasing power via inflation and Europe’s aging population — which will make public pensions harder to fund — underscore the urgency of transforming cash hoarders into investors.

First, the good news. Thanks to online brokerages, low-cost exchange-traded funds and social media, it’s never been easier to invest in equities or bonds and find financial advice. Europeans also put aside a far higher proportion of their disposable income than Americans.

The problem is what we do with that money: In countries like the UK, there’s a pronounced bias to getting on the housing ladder, sometimes to the detriment of acquiring other assets. And in places such as Germany, skepticism about the stock market and risk aversion are deeply engrained.

The upshot is that European households (including the UK) held almost €14 trillion ($15 trillion) in cash and bank deposits at the end of 2022, according to a report published last month by the European Fund and Asset Management Association. This cash represents 34 percent of total EU household financial assets, according to Eurostat, and that percentage rises to more than 40 percent if you exclude illiquid stakes in unlisted companies, as EFAMA did in its analysis.

Some of these savings were amassed when people were cooped up during the pandemic and might finally be earning a decent amount of interest for the first time in more than a decade. Nevertheless, it’s hard to argue with EFAMA’s warning that most Europeans “continue to keep a disproportionate amount of money in bank deposits.” In contrast, investment funds account for just 10.5 percent of European household financial wealth (using EFAMA’s definition) while listed shares represent less than 6 percent.

Retail participation in capital markets in Europe is shockingly low. Only 13 percent of euro-area households own mutual funds, while 11 percent directly own listed shares, according European Central Bank survey data. The situation isn’t much better in the UK, where the number of retail investors who directly own stocks has halved to just 11 percent in the past two decades.

The financial consequences are clear: the value of stocks, investment funds, bonds, life insurance and pension fund assets owned by households amounts to only around 90 percent of gross domestic product in the EU, compared to more than 310 percent of GDP in the US and 182 percent in the UK, according to figures compiled by The Association for Financial Markets in Europe for the first half of 2023.

Were European Union families to tweak their asset allocation, increasing their commitment to equities by a modest 5 percentage points, this could unlock €1.8 trillion of capital for productive investment, think tank New Financial calculated last year. Similarly, the UK could unlock £740 billion ($943 billion) of capital if households increased their holdings of equities and funds to one quarter of total financial assets.

Doing so might also help reduce inequality: more than 80 percent of listed shares by value in the euro area are owned by the wealthiest 10 percent of households, whereas the bottom 50 percent own just 2 percent, according to the ECB.

Americans hold just 13 percent of their financial assets in cash, with around half in shares and investment funds. More than one fifth of US families hold stocks directly, and the total increases to 58 percent once indirect holdings such as retirement accounts are included.

These differences are partly cultural and also reflect the US’s less generous social security system, which compels Americans to build wealth via tax-advantaged 401(k) pensions. German Finance Minister Christian Lindner told a Bloomberg event last week that his “big dream” is for Germany to introduce 401(k)-style individual investment accounts, to complement a new sovereign wealth fund that will invest €12 billion annually in global equities starting this year. “The main goal is to overcome Germans’ abstinence towards the capital markets,” he said.

Happily, Europeans’ aversion to owning stocks isn’t homogenous. Nordic countries hold relatively little of their financial wealth in cash and have comparatively high ownership of listed shares and pension funds in EFAMA’s analysis.

So how to convince people to invest? Besides a well-developed pension system, reinforcing financial literacy can help, though I’m skeptical whether classroom lessons about the wonders of compound interest are a silver-bullet (how much do you remember from high school?).

I’m more persuaded by policies that “nudge” consumers to invest without them having to think too much about it, thus overcoming the problem of inertia (something I admit to struggling with too).

For example, Sweden reformed its state pension more than two decades ago so that employees were required to invest 2.5 percent of earnings into a so-called “premium pension.” Unless individuals specify otherwise, the money is invested in a default fund that generated an average annual capital-weighted return of 9.8 percent between 2000 and 2022. Similarly, the UK introduced auto-enrolment in occupational pensions in 2012, and has mandated a minimum contribution of 8 percent of earnings since 2019; membership increased tenfold between 2011 and 2019.

Tax-efficient investment accounts, such as Sweden’s Investeringssparkonto,Italy’s Piani Individuali di Risparmio savings plans or UK Individual Savings Accounts are also good ways to get people to put more money to work.

However, the UK system can be improved: too many people pick a cash ISA instead of one invested in stocks despite the latter offering higher potential returns. Britain should also consider overhauling ISAs to prioritise investment in domestic companies and thereby revive London’s moribund capital market — UK Chancellor of the Exchequer Jeremy Hunt sounds open to the idea.

To reduce inequality, I’m in favour of providing children with taxpayer-funded trust funds invested in a well-diversified stock index. That way, poorer families can also get a feel for the stock market and the recipient can observe the magic of compounding directly.

Europeans who park all their savings at the bank may be unaware of the financial hardship awaiting them. That’s why pension tracking systems that provide individuals with a single, clear overview of payments due from public and private pensions in retirement are so important.

The first step in overcoming addiction is realising you have a problem. Europe’s cash habit is a big one.

Chris Bryant is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg