Many people live in a state of economic insecurity from paycheck to paycheck, where any sudden financial hit (illness, loss of job, major car or home repair) can cause serious hardship. Such people are nowhere close to meeting the rule of thumb of having at least eight month’s living expenses available in the form of liquid assets to meet such emergencies.
We tend to think of such people as being on the lower end of the income scale but a new Brookings study titled The Wealthy Hand-To-Mouth indicates that this is not the whole story and that middle class people in the suburbs also fit the profile, but for different reasons. The study found that 2/3 of the people who were living hand-to-mouth were wealthy (defined as having at least $50,000 in assets) and 1/3 were poor.
These wealthy people may have assets that are either not liquid (such as homes) or have heavy costs associated with accessing them (such retirement accounts) so that they are as heavily dependent on each month’s paycheck to meet that month’s expenses as poor people who have no assets.
The puzzle is why the wealthy, even though they have good incomes, don’t put aside at least part of their considerable monthly income as liquid reserves that can provide a buffer to deal with emergencies.
Part of the reason is that in the long term, putting money into a house or retirement account gives better returns. But another significant factor is that when you consider yourself part of the middle class by income, you tend to choose to live in areas with more expensive homes and better schools and where people have more expensive lifestyles. So people tend to buy homes up to the maximum allowed by their income and this carries with it a large mortgage, property taxes, and other recurring costs that eat up their income.
Elizabeth Warren (before she became a senator) and Amelia Tyagi wrote a book The Two-Income Trap: Why Middle-Class Mothers & Fathers Are Going Broke where they said that for middle class families, having a child is “the single best predictor” of bankruptcy. Why?
Middle-class parents are stretched thin these days. Between health care costs, child care hassles, looking for a home in a good district, and paying for college, raising a child is becoming increasingly expensive. Little wonder, then, that married couples with children are more than twice as likely to file for bankruptcy as their childless counterparts, and 75 percent more likely to have their homes foreclosed.
You can see how this can happen. If you have a two-income household, you can afford to buy a more expensive home and car and pay for the increased associated expenses. But such families, while dependent on both incomes to pay their monthly expenses, are also twice as likely to lose a job as a family with just one income earner. So paradoxically, while two income homes may live better when things are going well, they are more likely to go bankrupt than a single income home if things turn sour.