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.
Off-topic: Scientists hail synthetic chromosome advance
Well done, and a big “bleep you” to the Creationists.
You are right. We make almost double what they considered wealthy in that study, and we generally only keep about 3 months of cash reserves. That’s based on the assumption that if something happened to my (currently the only) household income, I would be able to find another job in an average of 6-8 weeks. That’s a decent average, but in tough economic times, it would mean dipping into our less than liquid funds for at least a short term.
My wife and I, since we bought our first home, generally figured out about what we qualified for, then would aim to purchase something in the 1/2 to 2/3 of that range. We know way too many of our friends and family who are what we called ‘house poor’. That would be like those in the study, with a nice house, but barely living paycheck to paycheck. Unfortunately, that is the model that bankers and society in general pushes, which is one of the reasons the housing bubble hit so many people so hard.
I read The Two Income Trap and thought it was based on a lot of false assumptions. For example, when it preaches to women to stop working, it assumes that a middle-class wage-earner can blithely step out of the job market for 20 years and not have a problem finding equal work when the children are grown.
When we had kids, we knew it would be a short-term sacrifice. Daycare is expensive, but then the kids are in school all day and when we did the finances, it just seemed stupid to give up a good-paying job when daycare is only needed for a couple of years. Instead, we bought a smaller house in a middle-class neighborhood, chose not to purchase behemoth vehicles that get horrific gas mileage, and not to buy a lot of highly-processed and take-out foods.
@AnotherAnonymouse,
We followed pretty much your strategy. Despite having two incomes, we bought a more modest home (and that we still live in twenty five years later) and lived more frugally than we needed to. So even if one of us lost our job, we would have needed to make only modest changes. It eases stress enormously.
Plus even if you’re fairly responsible, in this economy the hits just keep coming. We were fairly OK a couple of years ago, but we’ve had to move twice and my wife has changed jobs a few times, and we’re having to move AGAIN. Once you slip, there’s very little that keeps you from continuing to spiral.
I think the idea of a house that you live in as an asset is highly problematic. Owning a house in a high-inflation environment is good if you plan on staying in it a long time, because your mortgage payment generally stays flat as rents rise, but houses come with high maintenance costs and they are not very liquid. Plus, you are in danger of rising property taxes eating you alive.
A problem not mentioned here is the increase in house sizes and the prices that comes with them. People don’t have a choice about buying expensive homes because there are no affordable homes anymore. Bigger houses cost more to build and buy, and inflated mortgages come with that too. If people with middle class incomes had $100-150,000 homes instead of $300-400,000, and mortgage payments in the hundreds per month instead of thousands, they likely wouldn’t be having financial problems.
Around 1950, the average US home was a thousand square feet. Today it’s nearly 2500, thanks to lobbying by the construction industry and corrupt politicians (again) who write zoning laws for their benefit. In many areas, it is actually illegal to build a home under certain sizes (minimum square feet for rooms and the entire house).
http://stephencolley.com/trends-since-1950/
People involved in the small house movement are well aware of such issues. I’m saving (and can afford) to build one when I eventually return to Canada, no mortgage needed. These blogs include quite a few stories of families who lost everything when the mortgage bubble burst, then live i a tiny home for a few years and get back in the black financially.
http://en.wikipedia.org/wiki/Small_house_movement
http://thetinylife.com/what-is-the-tiny-house-movement/
http://tinyhouseblog.com/