By Michael Lynch CFP®
We Americans, as a collective, underperform in our financial lives. Don’t get me wrong, I’m not saying we’re bums.
Quite the contrary. We’ve created the world’s most dynamic economy; we produce life-enhancing innovations at a pace that has never been matched.
We work hard, we work smart, we work creatively, and we are, in general, well rewarded for it.
In 2022, on average, Americans over the age of 15 earned just under $60,000 annually, according to the U.S. Census Bureau. Those who worked all year, full-time, pulled in just under $85,000. (U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements, 2022).
It’s Not What You Earn, It’s What You Keep
Yet I can’t help wondering why, for all the wealth produced, for all the income that flows through our checking accounts, why isn’t more retained by the average American household?
In 2022, half of American households had net worths under $193,000, according to the Federal Reserve Board’s 2022 Survey of Consumer Finances. The Fed’s survey also documents that at age 65, half of Americans have less than $200,000 invested in retirement plans. So, after a lifetime of working, half of us manage to squirrel away less than four years of income.
Money Misconceptions
I am convinced that our under-accumulation of wealth stems from a fundamental confusion about what constitutes sound financial management, a confusion of good business finance with good personal finance.
We’ve all heard the phrase, it takes money to make money. In business and investment this is certainly the case. We must spend money before any will come back to us.
The basic paradigm is the agricultural model, which provided humans with our first movement into stable, self-sustaining societies. In order to earn money farming, a person must acquire money, either through savings or loans, purchase land and seed, then work the land, rely on a bit of luck that no aberrant weather or other catastrophe wipes out the crop, then work to harvest, sell the produce, and pay off the loans. It is only then that the farmer earns a profit and starts the cycle again.
The bottom line: in business, we must spend money before we can have it to spend. Failure to spend will doom any business to stagnation and ultimate failure. Being too cheap will end an enterprise.
Our Households Aren’t Farms
The fundamentals of personal finance, however, are the opposite. In personal finance we should wait until we have the money to spend it. We must earn, set aside 10 to 20 percent, and let the pile grow. It is only after the pile has grown that the prudent person indulges in spending to upgrade one’s lifestyle.
This pay yourself first rule is not new and certainly not revolutionary. It was first put to print in 1926 by George S. Clason in his classic parable, “The Richest Man in Babylon.” Yet far too few Americans accept Clason’s advice.
Instead, we tend to justify today’s consumption with expectations of future earning increases. Many of us actually use the business paradigm to rationalize spending on the personal side. We categorize personal consumption as an investment in business.
Can Old Cars Lead to Riches?
I may, for example, have a Toyota Camry that, while a decade old, is paid off, running fine and inexpensive to maintain. Not having a car payment of $500 enables me to invest an equivalent amount in a taxable account or far more in a retirement account, as I don’t have to pay taxes.
I want a Lexus. I don’t have the money saved. I will have to take a loan. No problem. I tell myself it is important for me to have a nice car for business appearances. Just as a dentist must have teeth, a financial advisor must drive an upper-end automobile.
I’ve rationalized personal consumption as a business expense and diminished my future net worth--my ability to achieve real financial freedom--in the process. I could do the same with any number of nice-to-have lifestyle items, including a larger house, a vacation home, a country club membership, a boat, season tickets for the Yankees and Red Sox (I have clients who are fans of both teams,) private schools for the children, and expensive suits, just to name a few.
It’s Always a Judgment Call
Now some of these expenditures may in fact improve my bottom line. Dentists do need teeth and I can’t live in a tent and ride a bicycle to appointments with clients in second-hand blue jeans. Some purchases, such as vacation homes, may be a great investment in family time. But each dollar must come from somewhere and I can justify almost any purchase as an investment, when, in fact, many will simply be lifestyle-enhancing consumption.
Ultimately, there is no objective measure that can neatly pinpoint the optimal spot between the bicycle and the Rolls Royce or the second-hand jeans and the five-figure suit where I should place my marker. The principles, however, are useful. They provide a gut check as well as the ability for us to understand our spending habits, our choices, and the consequences of these choices. Most important, they allow us to be honest with ourselves and make smart money choices.
Michael Lynch CFP is a financial planner with the Barnum Financial Group in Ft Myers, FL, where he focuses on his clients’ finances so they can focus on their lives. He teaches consumer-oriented financial education courses for leading organizations. He is a member of Ed Slott’s Elite IRA Advisor Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020, and It’s All About the Income: A Simple System For a Big Retirement, May 2022. You can find more articles and videos at www.simpleandbig.com. He can be reached at mlynch@barnumfg.com or 203-513-6032.
Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484. Tel: 203-513-6000
Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. CRN202706-6735304