Whether you blame it on high inflation, declining real estate values or myriad factors coming out of a global pandemic that created the perfect economic storm, there’s no denying the harsh reality that Canada’s wealth gap is widening at a rapid rate.
According to Statistics Canada, the wealth gap in Canada increased at an unprecedented rate in the first quarter of 2023, the largest on record since 2015.
Most wealth in Canada is held by relatively few households, with the wealthiest 20 per cent accounting for more than 67.7 per cent of Canada’s total net worth in the fourth quarter of 2023, and the bottom 40 per cent accounting for 2.4 per cent of Canada’s total net worth.
As Canadians grapple with the rising cost of living, they are looking for answers on how to best invest their hard-earned dollars to ensure financial stability and a prosperous financial future.
Warren Buffett, the infamous investor known as the Oracle of Omaha, often advises people to “buy low, sell high” during market downturns. Buffett’s investment philosophy is centred around long-term investment in undervalued companies. He emphasizes the importance of buying during market lows and holding strong through market volatility.
While this strategy has proven extremely successful for Buffett, it’s challenging for those without significant financial resources.
Putting Buffett’s advice into practice
While high interest rates have benefited the wealthy, average Canadians face numerous barriers that prevent them from capitalizing on market opportunities.
Our research investigates how structural financial limits impact investment strategies, particularly during and after economic downturns. Our model showed that credit limits — determined by income and collateral — vary across different economic strata.
During economic downturns, credit limits tighten significantly for average investors, making it difficult to adopt Buffett’s strategy. In contrast, wealthy individuals can increase their investments in risky assets due to their broader access to credit.
Our research began with a basic model where people borrowed money based on their future income. We then expanded the model to include borrowing against the value of their home property.
The model revealed that during recessions, the credit limits for average investors shrink, even if their income remains stable. This is due to heightened risk perceptions among creditors, which disproportionately affect those with limited financial resources. Even for homeowners, borrowing against housing collateral diminishes because of this perceived risk.
Consequently, while the wealthy can buy undervalued assets during market lows, average investors are often forced to liquidate assets or cease investing altogether.
Our findings indicate a bigger problem: systemic barriers prevent average investors from capitalizing on potentially lucrative or riskier opportunities, exacerbating their financial vulnerability.
Broader economic implications
The persistence of wealth inequality has broader implications for economic stability and policymaking. The inability of average investors to follow investment strategies, access capital during recessions to diversify their portfolios or weather financial storms due to systemic barriers will undoubtedly cause wealth inequality to grow.
This not only restricts economic mobility, but it also undermines the fundamental principles of a fair and equitable financial system. This underscores the need for policies that provide equitable access to investment opportunities. To address these challenges, we recommend several policy interventions:
1. Improving financial education: Equipping average investors with the knowledge and tools to effectively navigate financial markets is critical. This is especially important for younger investors, as they comprise 55.2 per cent of the bottom 40 per cent of net worth in Canada, despite making up 36.2 per cent of all households.
According to the World Economic Forum, young people are actively investing in capital markets, with 70 per cent of retail investors under the age of 45. However, financial literacy rates for young people globally are below 50 per cent. There is a dire need to enhance access to financial information and education.
By integrating financial literacy programming into school curriculums, young people will have a stronger foundation in financial education, empowering them to navigate economic downturns more effectively and plan more strategically for retirement.
Read more: Why financial literacy should be taught in every school
2. Supporting access to credit: To help mitigate the financial vulnerability that average investors may face, banks and policymakers should consider implementing regulations that ensure fair access to credit, particularly during economic downturns.
While it’s understandable that banks and financial lenders want to safeguard loans, there should be more consideration given to the lender’s available income, assets, credit score and credit history by taking a more long-term view of one’s financial history rather than simply looking at a short-term picture.
This will empower average investors to have a stronger borrowing cap, so they can more easily participate in the market and build their portfolios to increase their potential wealth.
3. Restructuring economic policies: Developing policies that promote equitable access to investment opportunities is fundamental. During economic downturns, average investors often face tighter credit conditions, which limit their ability to invest in undervalued assets.
To address this, policymakers should consider creating economic buffers and support mechanisms that stabilize credit availability during recessions. This could involve government-backed loan programs or incentives for financial institutions to maintain credit lines for average investors, even during economic instability.
Such measures can help mitigate the impact of economic cycles on credit availability, ensuring that average investors have the opportunity to engage in the market during downturns, similar to wealthier individuals. Additionally, revising tax policies to favour long-term investment over short-term gains could encourage more sustainable investment behaviours across all economic strata.
A more inclusive financial system
There’s no doubt that Warren Buffett will continue to be regarded as one of the savviest investors of our time. While his advice to “buy low, sell high” is sound, it can come across as tone-deaf considering the challenges the average investor faces during an economic downturn.
Our research highlights that systemic financial constraints exist for the average investor, particularly during such times. To level the playing field, it is critical to implement policy interventions to address these inequalities.
By understanding these dynamics, we can work towards creating a more inclusive financial system that allows more people to benefit from sound investment strategies. Without bold, strategic action, the adage “the rich get richer, and the poor get poorer” will only become more true — widening the wealth gap and leaving many people behind.