In the last article I discussed what it takes to move from poverty into the middle class. The biggest thing needed was a change of attitude. Most people who are poor and remain in poverty are poor in spirit – they feel powerless and defeated, so they continue to make bad decisions under the guise of “what difference does it make.” It’s like a person stuck in a pit that just keeps digging deeper rather than looking for a way to climb out.
People who stay in the middle class also have an attitude that keeps them there. It is true that people in the middle class live a good life with nice homes, cars, and luxuries like vacations and meals out. The capability to manufacture and distribute goods at much lower prices means that even someone in the middle class can have things that only those who were wealthy would have had sixty years ago.
The trouble with settling for the standard middle class financial position is that it leaves you and your family in a very precarious position where anything that upsets your income can quickly drop you into poverty. Most people who are out there driving the shiny new cars and sipping on lattes at Starbucks are one paycheck away from missing their mortgage payment. They also are not saving for retirement, just hoping that things will somehow work out when they can’t work anymore.
The attitude that keeps people in the middle class is also a defeatist attitude. Instead of thinking they cannot sustain themselves, as people in poverty do, people in the middle class think that they cannot do without debt and cannot save and grow their net worth. Just as someone who is living in the ghetto thinks that there is no way they could get a higher paying job because of where they come from or because of their race, people living in the suburban McMansions think there is no way they could ever be without a car payment, no way that they could send their kids to college without student loans, and no way that they could have a few million dollars when they retire. This keeps them making bad financial decisions like putting dinners on credit cards and then paying them off over 15 years and raiding their 401k accounts in their fifties to start a new career or just pay down debt.
The way to move out of the middle class and get to a place where you have financial security is to change your attitude about debt and what you can afford so that you can stop wasting your hard work to make interest payments and instead put some money aside to earn interest and supplement your income. There is no reason you need to buy a new car. There is no reason you need to go to a college you cannot afford. There is no reason you need to take on a house payment that extends longer than 15 years.
If you are a young adult who is just starting out, you have the opportunity to not get yourself in the hole that most middle class families find themselves in the first place. Instead of going to the dealer and buying a new car with eight years’ worth of payments, save up a couple of thousand dollars up and buy a quality used car with a hundred thousand miles on it. Today’s cars easily get a couple of hundred thousand miles and you’ll be spending maybe $500 a year in repairs, if that, which is less than a car payment or two. If the transmission goes or you have some other critical failure, just junk the car and get another $2,000 replacement. After a year you’ll have $4,000 more than you would have with a car payment.
When looking at colleges, go somewhere you can afford. If you don’t have a half million dollars in cash-on-hand and can’t get a huge scholarship, look at the in-state public colleges where you can spend only 25%-50% of what you would spend at a private college. Also see if you can get scholarships based on your place in your graduating class or your GPA. In addition to going the public route, instead of going right to the university and taking remedial English and math classes, think about spending a year or two at a community college. The professors will be better (you won’t be stuck with a graduate student teacher for these classes), you’ll be able to live at home and save on dorm and food expenses, you’ll have another year or two of Mom and Dad’s watchful eye to keep you on track, and you’ll pay a quarter off what you’ll pay at even the public university. Even if you go straight to a university, see if you can take classes at the community college during summers to get out faster and reduce the cost of your education.
When you are looking to buy a home, don’t do it until you have enough for a 20% down payment. This means either waiting longer or buying a starter home with a couple of bedrooms and then moving up in a few years. By putting in a 20% down payment, you’ll eliminate the need to pay for mortgage insurance, which will save you money each month. You should also only buy what you can afford with a 15-year mortgage, which means that your payments are less than 25% of your take-home pay. This will allow you to pay off the mortgage before the kids are ready for college and leave you with enough money to fund retirement and save up money to pay cash for things.
When you start working, start putting 15% of your paycheck into your 401k, invested in three or four low-cost mutual funds. Favor passive, low-cost index funds over expensive managed funds. Keep fund fees to under 0.50% if you can. Also, get $300 per month direct deposited into an index mutual fund right from the start. If you get in the habit of investing part of your paycheck instead of spending it all, you’ll never miss the money. It is much more difficult to start investing when you have payments for cars, cable, and cell phones.
Finally, look for ways to save up and create investment accounts to pay for things instead of paying cash, and certainly never put things on credit cards that you can’t pay cash for right now. Instead of going on a lavish vacation the first few years, put the money away in a vacation fund (again, put it into an index mutual fund or two) and then take a maximum of 10% of the fund out for a vacation in later years. The fund will pay for the vacations for you. Do the same thing for gifts. Finally, learn to cook and cook well so that you can avoid the high-priced meals out. All of these things will give you the money needed for investing, which is how you grow wealthy. Have your cake and eat it too. Let your investments pay for your luxuries.
Anyone with a middle class income can retire financially independent. It is just a matter of what you do with the money you make. Start acting like a rich person and handling your money like they do and you will become rich one day not that far in the future.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.