And inflation isn’t the problem. I saw this article come up which references a study done by Pyments.com and LendingClub. It describes how 1/3 of households making $250k claim to be living paycheck to paycheck and of that a whopping 55% of millennials making this much claim they are living paycheck to paycheck.
Many would ask how this could be. I will tell you how: poor choices. People may try to come up with all types of excuses why this amount isn’t enough for them but I doubt that any of it would stand up to close inspection.
Many of the people making these types of salaries live in expensive coastal cities. Places where homes can easily be in the millions and private schools can cost $24,000 a year. These tend to be what really eat up high incomes: mortgages, child care and school.
It’s best to see this through an example. Let’s say you live in a city close to me like Jersey City NJ, and your household consists of 2 working professionals with 2 small children. Let’s say they are a lawyer and a banker. The lawyer makes $100k a year while the banker makes $230k a year. This isn’t inconceivable in the New York City job market.
At New Jersey tax rates and assuming each person maxes out their 401(k) contributions of $19,500 each, after tax income will be $196,041.
The median home value in Jersey City is approximately $600,000 but a quick search on Zillow for homes with at least 3 bedrooms yields this $1.29 million townhome near the commuter hub of Journal Square which at today’s interest rates will cost approximately $7,880 a month in mortgage, taxes and insurance. This takes a bite of $94,560 out of your income or approximately 48% of your combined take home pay.
Not ones to deign sending their children to public school, these parents then choose to send their children to St. Peter’s Prep, one of the elite private schools of Jersey City with an annual tuition of about $20,000 per year. Taking $40,000 from their take home income now leaves the couple with about $61,481 to cover all other expenses.
If we then assume electricity of $200 a month, food costs of $2,000 a month including eating out, water costs of approximately $300 a month, a car payment including insurance of $550 a month, we are left with $24,881.
Add the cost of a family vacation which costs $8,000 and anything else you could put away for college, let’s assume $500 per child per month, and you are left with $4,881 for new clothes, toys etc. which they may not think too much of and end up putting on a credit card. This is how a couple making $330k, more than the $250k in the headline, could end up living paycheck to paycheck.
Some Alternatives
We all need somewhere to live. Yet in my experience, people with high incomes would have you believe that their options are very limited as to where they can live. It’s almost always a neighborhood that is extremely expensive and a home that is priced like those in that expensive neighborhood. They cough up a huge down payment and ensure the burden of an expensive mortgage which eats up thousands in after tax income each month.
Why couldn’t they just move somewhere cheaper you ask? My anecdotal evidence points to the idea that many people feel a sense of entitlement when they have a high income. A sense that somehow they are different and because they make more, they and their kids deserve the best. You can’t set yourself a class apart by living in a regular neighborhood, you have to be with other elites like you, nothing less will suffice. Others may have demanding careers and simply want the convenience. The thought of an hour long commute to work a stressful and high demanding job is too much given the sacrifices they are already making.
This circular logic traps many high earners into spending more. Many aren’t even conscious they are doing it. They simply may assume it is just what one does when they have the means. Yet the outcome of these decisions often lead to people living paycheck to paycheck.
Besides living in a different neighborhood, another thing that can be done is to just live in a smaller home. I recently visited Sweden to meet my brother and one of the things I noticed was that almost all of the homes in his suburban neighborhood were much smaller than you would expect if you were touring a suburban neighborhood in the US. At around 1500 square feet, his home seemed to have more than enough room for my brother, his wife and 3 kids. His wife even exclaimed she though it was too big for all of them. Yet, we can’t seem to get over wanting more here in the US.
One of the reasons homes themselves are so expensive is because the size of homes has been increasing since the 70’s and in 2018 was almost 50% larger than the median home in 1980.
The other high cost item which are up a lot of disposable income was the private schooling. Personally I don’t see the reason for private schooling if you already live in a good neighborhood. In the US, the school districts are funded by local taxes so consequently the richest neighborhoods have the best public schools (with some exceptions). Yet there are many cases where parents still choose to send their kids to private school in spite of being in a good district.
As is becoming more well known through economics studies and media focus, the socioeconomic ladder is more sticky than many would like to believe in the US. It is often easier for someone poor or lower class to become upper middle class or rich in countries in Western Europe or Canada than it is in the US. This means that private school or no, the children of the wealthy usually become wealthy themselves. One study even found that when you control for socioeconomic factors, public school versus private school makes no difference on income later in life. Yet parents will almost always endeavor to make sure their kids have a leg up or get the best so I don’t expect one study to settle the debate among parent, I just know from my own personal experience I wouldn’t mind sending my children to public school.
More Anecdotal Evidence
I have notes in past posts that the media often focuses on the wrong things when it comes to being rich versus being poor. Income is often cited as the measuring stick for gauging who is rich and who is poor but as the $250k study shows, who makes a high income and who is wealthy are often different things completely.
While the gap between the bottom 50% of incomes, ie those making less than $67,521 and the 1%, those making $597,815 is about 8.85 times, the difference between the median household wealth in the US is much more vast.
The median household wealth in the US is $121,760 in 2019 while the starting net worth to get you into the top 1% by worth is $11.1 million or about 90 times greater than those at the median net worth. While wage earners bust their hump and think they’ve made it by making around $600k a year, this represents just 5.4% of a starter 1 per center by net worth. In fact, if we go by the 4% withdrawal rule for sustainable wealth, the 1% by net worth can make around $450k just doing nothing and due to tax rules, likely see take home pay comparable to a wage earner making the 1% income without even lifting a figure.
The reason I say this is to not give you the impression that making a high income is pointless or that working people will never catch the rich. The point is to demonstrate that if one earns a high wage and spends it like they are already wealthy, they pretty much ensure the status quo that their household will never actually become truly wealthy.
I posed this conundrum to a divorce attorney I know who often deals with wealthy and middle class clients. She exclaimed that she was regularly shocked at the amount couples make versus the low net worth they have.
Divorce attorneys in the US have a special window into net worth because the net worth of the household has to be tallied during the divorce in what’s called a statement of net worth. Clients can lie but their bank, job or advisors may face subpoena from a judge if they try to hide assets so it’s usually a somewhat reliable tally of their actual assets. This attorney relayed to me that 80% to 90% of her middle class and wealthy clients only had retirement accounts and their primary home to show for all their hard work. The rest is often frittered away on expenses like those private schools I mentioned, a second home or extravagant cars and vacations.
The historically low interest rate environment since the financial crisis has allowed many of these households to not only see their main assets rise in value (their homes) but also to leverage these further and cash out. She explained that when the information is summarized and presented to either side in the divorce, many are often shocked at how little they actually have to split between them.
How Did We Get Here?
This really begs the question of how and why we got where we are as a society? Even after breaking down a $330k household income as I did above, it still baffles me as to why people freely choose to make so much and live paycheck to paycheck. In part 2 to this post, I would like to not only look at how saving and investing differ across the world but why Americans in particular just can’t seem to break the spending habits and save. It also makes me wonder if we even should try to save given that the economy is so dependent on services and the consumer. So be on the lookout for the next post where I explore these topics further.
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