[Financial Planning for the 100-Year Life] How Should Household Financial Assets Be Allocated?

According to the Bank of Korea's 2023 flow of funds data, households (including non-profit organizations) held financial assets worth 5,234 trillion won last year. Households manage their financial assets by dividing them into cash and deposits, stocks, bonds, insurance, and pensions. At the end of 2023, the proportion of deposits among household financial assets increased significantly to 46.3%, up from 43.4% in 2021. This was due to a substantial rise in interest rates, with bank deposit rates exceeding 5% at one point.

In contrast, the share of stocks decreased from 23.0% to 21.8% during the same period. The bond share slightly increased from 2.4% to 3.2%, but it remains low compared to 6.2% in 2014. Considering the future economic conditions of Korea, it seems desirable to reduce the proportion of deposits and increase the shares of bonds or stocks.

Interest rates are likely to decline in the medium to long term. The most important factor determining interest rates, the economic growth rate, is expected to decrease. The potential gross domestic product (GDP) growth rate, which currently indicates Korea's economic growth capacity, is estimated to be around 2%. The potential growth rate will likely decline further as labor decreases and companies, which have already accumulated substantial capital stock, are unlikely to significantly increase investments. Additionally, total factor productivity, another factor determining potential growth, is unlikely to improve significantly in the short term.

The inflation rate, which caused interest rate increases over the past two years, is also gradually decreasing. The consumer price inflation rate reached 5.2% in 2022, the highest since the 7.5% recorded during the 1998 foreign exchange crisis. However, it fell to 3.6% last year, and the Bank of Korea projected consumer price inflation rates of 2.6% and 2.1% for this year and next year, respectively, in its February economic outlook.

There is a persistent surplus of funds in the Korean economy. Since the 1997 foreign exchange crisis, the domestic gross investment rate has been lower than the total savings rate. In fact, the average annual investment rate from 1998 to 2023 was 31.6%, lower than the savings rate of 34.8%. This trend is expected to continue for several more years. This means that the supply of money (savings) exceeds demand (investment), which could lead to a decline in interest rates.

As corporate demand for funds decreases, banks will likely purchase bonds. At the end of last year, Korean companies held cash-equivalent assets worth 916 trillion won. Since companies (mainly large corporations) hold such large amounts of cash, their demand for funds is expected to decrease. Given that household debt exceeds 100% of GDP, households are also unlikely to continue borrowing extensively.

With a relative decrease in loans in fund management, financial institutions will have no choice but to increase investments in securities. In particular, banks emphasize stability over profitability in asset management, so they invest more assets in bonds than in stocks. As of December last year, the bond share in banks' asset management was 15.4%, up from 14.9% a year earlier.

Stocks are also considered undervalued. Over the long term, the KOSPI has risen more than the nominal GDP growth rate. For example, from 2000 to 2023, the KOSPI's average annual growth rate was 6.9%, 1.2 percentage points higher than the nominal GDP growth rate of 5.7%. If nominal GDP grows by 4% this year (real GDP by 2.1%), the appropriate KOSPI level would be around 3,170. The KOSPI market capitalization is also undervalued by more than 10% compared to broad money (M2). The economic variable most correlated with the KOSPI is daily average exports. In April 2021, the KOSPI overestimated daily average exports by 40%, but as stock prices adjusted and exports increased, the overvaluation was resolved.

At the end of last year, U.S. households allocated their financial assets as 12.0% in cash and deposits, 52.6% in stocks, and 5.9% in bonds (the remainder in insurance and pensions). While Korean households do not need to increase their stock share as much as in the U.S., increasing the shares of stocks and bonds to some extent could improve the returns on financial asset management.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University