“My Two Cents”
Andy Sutton (with Guest Commentary from CJH)

12/15/2006

Although I’m sure most people would think otherwise, I do occasionally get out of the house. Over this past Thanksgiving, I had a chance to get out for some food and conversation with a friend of mine from Maryland. As usually happens, the topics shifted to the economy. He peppered me with questions about how a middle-income average person can ever hope to be in a position to save with costs rising as fast as they are. I’ve decided that the resulting email thread was worth sharing. In the December 2nd issue of The Economist, which is a very reputable publication, the rise in US costs was profound. The All Items index is up 35.4% in the last 12 months while food is up 27.2%. These numbers vary dramatically from the hedonically adjusted CPI and are frightening. The average family can never hope to keep up with these types of increases, especially if they persist for any length of time.

Andy,

I've been seeing a lot lately in the news about how the economy is doing and there really seem to be mixed reviews. Some say there is a positive consumer attitude with the holidays coming, then I hear we should wait till companies post their 4th quarter earnings. Still others say it could be looking slim over the coming months. Then that big one that seems to be getting attention over the past few days with the US dollar starting to take a major hit, and the possible repercussions from it. Quite frankly in order to get moderate understanding of the situation I feel that a person almost has to take on a "second job" so to speak to really get informed. Taking hours in the evenings or on weekends to sort over all the various sources of information, and put the pieces of this puzzle together. As you know there are many people out there who will take things at face value and just keep on going while others look to take a more thoughtful approach to things. I just find it hard to make the time, and only seem to skim the highlights, which I guess is OK since I'm not a major investor with lots of flexible income, and my staple income tends to keep breaking even most of the time.

Most of your commentary has been about being self reliant with investing, and staying informed. Well I'm trying to do just that, although I find it difficult on a number of fronts. One of your readers (I believe from Canada, and saw your column on another website) sent you feedback back in September about getting back to basics and having good solid foundations for surviving in life. It got me to thinking; if I can draw an analogy for you on the situation I think a lot of people are in.

Let's say a middle-income household is like a person tending to yard work. The person is setting out to prepare some ground for plants. They have a pile of earth that looks to be quite good with only a few stones in it, that needs to be sifted and put into place around the plants to sustain them. So they take 3 screens of varying size mesh and start sifting. The first screen takes out the largest rocks and debris, as the rest passes through. I'll call this the major expense of a household: "housing" (whether it be rent or a mortgage). The next screen takes out another large volume of gravel, call this "guaranteed monthly expenses", things such as car payments, insurances, education loan payments, utilities, groceries, and various other staple expenses. The 3rd and final screen takes out the last remaining bits, call them "miscellaneous costs", or the random unaccounted for expenses. Much to the dismay of the gardener they are left with very little suitable earth to use for their plants. This would be what they have for "savings accounts", entertainment, general spending money, and investing elsewhere. If the gardener were smart he would have pre-planned and had the necessary things on hand before starting. Having their plant food, water and extra dirt around just in case. But this isn't always the way it goes, some just dig right in and figure out what they need later. After all even if the ground (economy) isn't exactly perfect, then there is always the "fertilizer" that the news and economists keeps saying is good for growth. You know that thing called consumption. From what I hear we the consumer are the fuel driving our economy, no matter what we are buying whether it be products, food, investing in stocks or bonds, housing, etc. Things sound like they could be positive for the most part, “because they say so.” Well with that in mind let's proceed just the way things are. What's the worst that could happen? Put all the fertilizer on, add water, and see what grows. Well if anyone has ever over fed plants before then they know that it will just plain kill them, and sometimes it does so very quickly.

I mean this to be a little entertaining, but in most respects there seems to be something serious coming into play. I've talked to a few people who are co-workers and friends now and then, about living expenses and how things are generally going. For the most part they seem to be keeping a positive attitude but mention things have gotten tight from time to time. If they have made changes to spending or have gone through total cutbacks they may not be willing to face the fact that the quality of living has changed, even if it really isn’t all that noticeable.

This leads to my next thought, I saw you had a link posted on your website, to an article at Financial Sense Online, authored by Michael Hodges, entitled "Family Income Report, Families Under More Pressure". You should take the link and highlight it somehow on your webpage as a "must read" and leave it up there for a while. I read this article and it struck close to home in a lot of respects. It seems that some of the content has reflected things you've been saying in your column as well, and things I have noticed at my financial level, some of which I commented on in a past feedback I sent to you which got posted as the "lying CPI". You have asked me to follow up with this a few times, and I have been reluctant to do so, until now. So after talking with people I decided to start looking at the small picture, that being exactly how much of a percentage gets eaten up on a monthly basis, for staple spending. Now a few of the things listed could be considered extras to one degree or another, but they all seem to be the same expenses that most people carry.

I read somewhere, but offhand can't remember the source; the median income in the U.S.A. according to the census bureau is $65,093 in 2006. This seemed to be a bit targeted to me, since I’m used to seeing more rounded off numbers or that plus and minus factor that comes with polling questions. The different people I know fall into varied incomes some hit the median almost down to the dollar while others fall much shorter. Now myself I land somewhere about the middle of this mix, I want to keep this somewhat generic, but with a little thought I'm sure your readers can identify with things and chart their own percentages.

So for the illustration I'll pick the $50K even mark, it’s falling close to where I and other people I know are with their earnings.

With $50,000 annual gross pay

Deduct 30% right off the top for taxes, as we all know this is an inevitable part of life. I may be a small percentage off for the tax withdrawal. This doesn’t include the deductions for your health insurance, social security, and retirement plan deductions you may have.

So now you’re left with $35,000 as your net pay, and this the real money that counts. Real world expenses come from the money that everyone brings home in the paycheck. Also if you have a checkbook you know that things can fluctuate in price from month to month. But so as to not confuse things I want to just find an average baseline. These are definitely ballpark numbers though.

Right now you know you have 100% of your bring home earnings.

But before you do ask yourself "what do I want to put back?" Any finance person would tell you "it's financially responsible to save money, and pay yourself first, by taking some money and putting into some kind of safe haven." What that particular place may be, is up to you. Now keep that number in your head and start the deductions. Don’t figure it in just yet; wait till the end to see the result. These are approximations of how my personal expenditures break down:

So now start deducting...

27% - Housing payment (mortgage or rent)

9% - Vehicle Payment

5% - Insurance for that vehicle

4% - Gas/Electrical Utilities

2% - Water Utility

2% - Cable Television

3% - Home Telephone

7% - Credit Cards (most people have more than just 1)

19% - Commuting Costs (this expense can vary greatly depending on the situation thus making the percentage variable; a person could be taking public transportation, costs for parking, gas to drive to work, family obligations, taking kids to school, et.)

10% - Groceries (another variable expense depending on the number of people in the household, and how outside forces are impacting food prices)

1% - Cell Phones

1% - Internet services

Oops, I seem to have forgotten something, if you’re fortunate enough, or unfortunate to have a second income (depending on how you feel about your spouse working), then the percentage of end money is probably greater. Or is it? I have purposely left some things out. Aside from the cable, cell phones, and Internet the things I listed tend to be the staple basic expenses if you’re either a renter or a homeowner. There are a number of other expenses, which can come with a second income, or if you have a home with a family, thus changing the percentages. There may be a second vehicle being paid on, so there’s more car insurance, child daycare till reaching school age, life insurance, and property taxes.

Then the little variables that can have spontaneous effects on your income, we tend to not think about those as much till they arise. They can range from car repairs, doctor visits (even though you may have health insurance you still have to pay for office visits), entertainment, etc.

So now look at the situation and tell me if that 10% left over is still around or has it disappeared faster than a stone thrown into the Grand Canyon?

Editor’s Response – Some excellent points are put forth in the piece and the take home message is crystal clear: we are losing ground. And quickly. Even families who are savings minded are finding it harder and harder to set aside precious dollars for a rainy day. Wall Street pundits cheer a 4.1% rise in wage levels, but somehow forget to mention that those increases are devoured by massive increases in the cost of living as is evidenced by The Economist’s data.

For decades now, this problem has been much less apparent because we had spare labor capacity to bring off the bench. We used to only need one income. Then we needed Mom to pick up a part-time job. Then a few more years went by and Mom needed to work full-time. Now we’re at the point where Mom and Dad both need to work full-time and in many cases at least one of them has a second part-time job just to maintain the standard of living. Does anyone think for even a second that it is just a coincidence that this sudden blossoming of easy credit came to be when it did? Just when the American family was ready to cry ‘Uncle’, Uncle Sam stepped in with liquidity and plenty of it. At first it was a lure; 12 months same as cash. So people bought on credit. Once you start buying on credit though, there is little psychological difference between buying discretionary items on credit and relying on it to buy food. I once heard a joke that a one-armed bandit at a casino is more honest than the government; at least with the slot machine, you have a small chance of coming out ahead. However, this newest trick will not last forever. There is a theoretical maximum to the amount of debt that can be carried before wages will not be enough to service it. I wonder if anyone will give me odds on who gets to that theoretical maximum first; the consumer or will Sam be crying ‘Uncle’??

Andy Sutton holds an MBA in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics.

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