ELLEVEST INSIGHTS

Last month, my family and I spent two weeks at Cape Cod … an annual tradition we’ve had in place for over 30 years. Time there is spent searching for seashells, kayaking through rivers, and eating more food than necessary. Most of our family gatherings center around food, which is usually great news because our house is within walking distance of one of the area’s beloved ice cream shops. The not so great news is that this year, my sundae cost $15(!). We usually drop in a few times each trip but, at nearly $100 for a family dessert, we only went once. 

There’s no doubt life has become expensive, but the real story is how unevenly people are feeling the squeeze.

Wall Street loves coining catchy terms for economic trends, and one that has gained traction is the “K-shaped economy.” It describes an economy split on two divergent paths. The upper arm of the letter K represents high-income households and asset owners who remain resilient and benefit from compounding wealth. The lower arm represents lower- and middle-income households who face financial stress and an erosion of purchasing power.

Why Americans are facing such divergent paths

Although headlines may give the impression that the economy and consumers are in great shape, the day-to-day experiences of many Americans tell a different story. This divergence of consumer health has been building for decades but more distinctly emerged in the wake of the Covid pandemic after many of the pandemic-era subsidies for low- and middle-income households expired. 

To understand just how different these realities are you simply need to look at the fact that the top 20% of households by income hold 71% of total household wealth while the bottom 20% hold just 3%.

Equity market returns are key to understanding why higher-income households hold such an advantage. Despite volatility, the S&P 500 has climbed 8% so far this year, building on a streak of three straight years of double digit returns. Even without liquidating holdings, this balance sheet growth gives affluent consumers the confidence to maintain discretionary spending. Moody’s Analytics estimates that the top 10% of earners account for nearly half of US consumer spending in 2025 (the highest on record).

While inflation touches everything from grocery runs to routine haircuts, its impact is sharply felt in energy prices. Since the start of the year, Brent crude is up nearly 50%. While energy sector equities have reaped the benefits, the price pressure felt at the gas pump is not felt evenly. While high earning professionals often enjoy hybrid or remote flexibility, in-person service employees have no choice but to absorb the extra cost of commuting to work.

Interest rate effects ripple through numerous sectors of the economy. As the 10-year Treasury yield continues to hover between 4% and 5%, higher rates present a double-edged sword: while they offer attractive yields on cash investments for those with excess liquidity, they create severe headwinds for those who use debt as a purchasing tool. During the pandemic homebuying boom, many buyers locked in historic sub-3% mortgage rates. While today’s prospective buyers wrestle with 6% mortgage rates and steep monthly costs, existing owners are in a sweet spot: they’re enjoying low mortgage payments paired with rising property values. Beyond eroding housing affordability, high rates hit lower income households harder. These households rely more heavily on debt to finance purchases, and these financing options are often structured with variable rates. Not only are they facing surging prices on daily necessities but their rising financing costs become harder to pay off as their paychecks get squeezed tighter.

Why these opposing paths could continue

It’s unclear when or how these paths will converge but there are several factors at play that could lead to continued uneven growth in the years ahead:

Sticky inflation: While markets have grown somewhat desensitized to headlines around the Iran conflict, new escalations could still spark a negative reaction. Ongoing disruptions in the Strait of Hormuz threaten to raise energy prices. Meanwhile, President Trump’s sweeping new round of tariffs threaten to pass higher costs onto consumers.

Interest rate horizon: Borrowing costs could remain elevated as markets adapt to new Federal Reserve leadership and broader geopolitical uncertainties. The market is now pricing in the potential for future rate increases.

AI adoption: The full extent of AI adoption remains to be seen but has the potential to exacerbate the divide within the labor market. While high-earning knowledge workers use AI tools to amplify productivity and income potential, lower-skilled and administrative roles face heightened risks of wage suppression or job displacement.

Helping close the gaps

For many investors, the K-shaped economy presents an opportunity to facilitate change. At Ellevest, we help clients align their portfolio strategy with these economic realities. Through select private investments, investors have directed capital to help reduce these inequalities across these examples: 

1. Affordable housing: Investing in private real estate funds dedicated to developing and preserving workforce and affordable housing.
2. Construction technology: Allocating capital to innovations that lower building costs and make homeownership more accessible.
3. Litigation finance: Funding legal cases involving small businesses that lack the deep pockets needed to pay for legal fees and access to the justice system.

Seeing the economy through a K-shaped lens can help explain why headline news may feel so out of touch with daily life. Navigating this economy requires moving past broad headlines and focusing on what you can control like your financial plan. You may not be able to influence interest rates or the price of an ice cream sundae, but a financial plan and diversified portfolio can help ensure your long-term wealth stays on the right path.