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Monday, August 05, 2013

Overestimating The Distance Your Income Can Buy You

Every few months a thread similar to this goes up at imamother.  A family has broken the 6 figure income mark (combined), feels they are making good money, and wonders what in the world is going wrong.  They are living month to month, have some debt, and are not able save, and can't make heads or tails of why not.

Granted, not every stage in life is one where you will be able to get ahead.  There will be times in the Circle of [Financial] Life where everything that comes in, goes out.  However, I do think it is problematic if that time is when your children are not yet even elementary school age.  Not to be a party pooper, but I am absolutely certain that the norm is that children get more expensive, not less.   And, that is regardless of the price that can be fanagled with the future day school/yeshiva.  I really should write more about the Circle of [Financial] Life because it is good to understand what the trends are in terms of increasing and decreasing expenses.

Sadly, six figures earned between two income earners, paying full time daycare (and in this instance, tremendous health care costs), is not "we both have we well-paying jobs" but rather, baruch Hashem we are employed.  It is really wonderful to see people pleased with their lot, but their lot simply can't justify a $1,600 mortgage payment + associated utilities, $1,500 in monthly babysitting costs (which I always deduct from the lower income taxed at the marginal rate), car payments, $1,600 monthly mortgage, and 10% maaser (G-d bless them).  And it is duly noted that these type of budgets that leave the family hand-to-mouth generally lack other costs that many (myself included) would deem fairly necessary including life insurance.  This scenario is a change from what I see on the other side of the spectrum where a couple making a combined $200,000 feels the are not well-paid, feels unfortunate in their incredible lot, and also lives hand-to-mouth.

We have to be realistic about what our earning power, debt, and any amassed savings mean in terms of realistic spending for our own situation.  So many people overestimate their buying power, thinking their earnings are sufficient, but they really don't have a handle on what their earnings mean both in the present and in the future.    I am still of the opinion that a realistic spending plan (not including costs that are tied to a second income or are actually optional, even if seemingly socially obligated) should fit comfortably within the single, higher income.  Where that is not the case, some changes should be made to accommodate the reality.  Naturally, it is impossible to advise based on a post that does not even include an income breakdown or without knowing enough about the couple.

Lest anyone think that overestimating spending power is limited to people with average or slightly about average incomes, (hashgacha pratit) is the next post on imamother in the finances section.  This couple has 13K left per month for savings and is trying to buy a home where they need a 400K downpayment.  They are currently renting a home as they don't like their old neighborhood and their own home is overleveraged and is currently rented out.  They considered a loan modification, but they can't get one (well, of course not, there is no equity and now it is rented) and she worries if they are undersaving for retirement at 2K per month (yes if you are double income with a 2 million dollar home!).  Goodness, my head is spinning.  If you have 13K a month left over after paying your expenses, you are in a fantastic position, but there is a lot to consider.  My own rule of thumb is that your mortgage payment should be easy to support at the income level you can expect over a lifetime.  When buying an insanely expensive home, your home, by definition, is generally not a liquid asset in the least.  It also will not generally increase in value over time, leaving you with equity, as a more average home.  These are just the facts on the ground.  You must be able to pay the mortgage payment easily with the income you can easily expect not just today, but tomorrow.  Most high paid athletes eventually blow out their knee, and I believe people who hit the jackpot wealth wise will often blow out their figurative knee so to speak eventually.  If you are in the financial sector, you also need to consider that overleveraging yourself endangers your own career and your earning ability.

I have no real problem with wealthy people buying very pricey homes, but I do think they are better off paid for or mostly paid for.  Start smaller and trade up, rolling the savings along the way and the proceeds into the next property.  Or, if you choose a massive mortgage, have a lot of that in cash to tide you over in a rought spot.  If you are talking about saving for the downpayment on that type of home while renting yourself (and renting out an overleveraged property), you just aren't there yet.  With $156,000 to play with annually, you can get there. . . but come back in 10 years!

Well, now we've seen that you can be both very average and have quite tremendous earning power and be out of touch with the distance your income can buy you.

(Typing fast, please excuse any errors.  I can make corrections later).

19 comments:

Mr. Cohen said...

I humbly suggest that Orthodox Jews spend less on:

* eating out in kosher restaurants (even pizza costs a lot)

* soon-forgotten bar mitzvah and bat mitzvah celebrations

* pre-wedding vorts (1990s Rabbis tried to eliminate vorts)

* soon-forgotten flowers at weddings

queenbee said...

I know you are reluctant to offer advice to the first imamother poster, but I'm curious to hear what your hunches are about where this family should begin to cut back, and what your opinion is of the other imamothers' suggestions.

Orthonomics said...

queenbee, I'm game. Which suggestions are you most interested in my opinion on?

Rachel Stern said...

I actually think that people need to learn to live more modestly in general. I lived in Teaneck, NJ and the majority of our friends were exorbitantly wealthy. Most lived in large homes, nearly every one at least once, renovated their kitchens, and did so using only top of the line materials. These people have "set the bar" very high. Bar and Bar Mitzvah celebrations that rival weddings, Shabbat meals that are fancy huge spreads of food enough to feed an army, two cars are fine, but must they be the most expensive cars that money can buy? When I lived in Teaneck, I FELT the pressure of all the gashmius. It made me feel badly that I could not provide our children with the same things: fancy clothing, fine jewelry, fancy family vacations, club memberships, fancy cars, a larger house (and of course every child MUST have his/her own bedroom, his/her own computer/TV/phone/cellphone/ipod etc. Summer camp, trips to Israel, and one must afford all this on top of the very unreal Yeshiva tuitions (the last year I had anyone in Yeshiva it cost 25k per year per student -- and discounts for multiple children are minimal at best). I once heard someone comment, "In order to live as a religious Jew, one MUST earn at least 250K USD per year!!! And I have NO IDEA how anyone who does not earn that much manages!" Well, I wonder how much people who earn in EXCESS of that actually help people who do NOT earn that much. Because someone earning ONLY 150K per year is surely not eligible for "charity" or any contributions from "social services". But suddenly, in the eyes of many less than a quarter of a million dollars a year is "poor". What a shanda. Essentially, though, American Orthodox Jews have been SEDUCED. SEDUCED by America, the land of plenty, SEDUCED by the materialism, the conveniences, and the assimilation. They have assimilated and absorbed values that are NOT JEWISH VALUES. The CORE value, that seems forgotten: ZIONISM -- which at ITS essence is the drive to LEAVE Ch"L and all its negative influences and to go to Israel -- to LIVE, not to visit, not to send your children there for summers.

tesyaa said...

The best advice given to #2 (the wealthy family) was that the family invest in a real financial advisor, instead of soliciting advice from a bunch of anonymous women.

tesyaa said...

And I've said this for years, but subtracting the cost of day care from the second salary ignores many realities. First of all, if the husband is earning less, he may still be unwilling or incapable of doing all the childcare. He may also torpedo his career by doing so. As for the mother, she may be cut a little more slack by a future employer for being a SAHM, but she is losing years of career seniority and earning power by staying home. Even if her net earnings after childcare are minimal (or even zero), she may be investing in a great deal of future earnings. Naturally, this depends on the opportunities available and her chosen field of work.

met said...

What does that mean, "subtracting the cost of day care from the second salary"?

tesyaa said...

From the original post:

but their lot simply can't justify a $1,600 mortgage payment + associated utilities, $1,500 in monthly babysitting costs (which I always deduct from the lower income taxed at the marginal rate), car payments, $1,600 monthly mortgage, and 10% maaser (G-d bless them).

The implication is that the smaller salary is only worth what's left over after daycare. My argument is that there are many, many intangible benefits associated with the second job, even if they can't be measured in salary. Of course, this is more applicable when the second salary is a career path job. But even someone working in a field that seems to have little future potential is gaining workplace experience and possibly skills that can be used in a future career.

tesyaa said...

I know there are also intangible benefits to being a stay-at-home parent. Of course, in many cases, the children do benefit. In terms of cash flow, some SAHPs will save a lot of money by being frugal, while others will overspend out of boredom. My point is I wouldn't ALWAYS (OP's word) treat the second salary as merely the dollars left over after childcare. It depends on the job and the family.

Orthonomics said...

tesyaa, I'm loathe, especially in this economy, to say to any parent to leave. However, income split is important because it opens up the family to understanding what they are really earning. If the split is 50/50, $18,000 for childcare might be what it is. If the income split is 75/25, the wife is break even and their spending has to be based on a 75K income. If the split is 80/20, the wife is losing money which really doesn't work well when debt is starting to accumulate.

Leaving a job isn't the only option. There are sometimes opportunities for alternate schedules, but it depends on the field. Daycare is a huge cost and it makes sense to minimize it. That might mean a different schedule. It might mean a different daycare arrangement. Perhaps it could even mean paying your own parents if they are open to providing care but need income themselves. I have a non-Jewish friend who paid her own mother for care.

Anonymous said...

I'm a loyal reader with a PhD in economics, and I just came across the following article that fits right in with what you write: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2237640

To summarize: the wealthier the wealthy people in a US state, the more their middle-income neighbors spend and the less they save. And it's not because these middle-income neighbors expect to be wealthy soon: it's because they think they "need" more.

JS said...

In terms of the first person, my first advice would be to stop giving maaser. Maybe that's controversial. But, I don't see how you give 10% of your income away in a process that makes you very likely to be the recipient of someone else's tzedakah. In fact, I don't think anyone should be giving tzedakah unless they're financially secure and adequately saving for their own future. What's the point of giving 10% now when in a few years you'll need to dip into the till yourself? You give 10% now and then take tuition scholarships (or give and take at the same time!) or you give 10% now and then rely on your children since you never saved for retirement or you give 10% now and your kids are saddled with student loan debts. It seems woefully short-sighted and a case of mitzvah ha'ba b'aveira - a good deed accomplished through a bad one.

In terms of the first family, I think at some point you need to realize things are simply not going to get better and are likely to get worse. Maybe there are small tweaks they can make, but there's no doubt continuing on their path will lead to a lifetime of struggling and overwhelming debt - especially if that path includes yeshiva tuition (which I'm sure it does). So, you either live with it as part of the sacrifice for the lifestyle you want or you make a radical change - move somewhere, home school, give up yeshiva, train for a new job, etc. Radical change is hard, but it's the only option when you've so thoroughly messed things up.

And, unfortunately, most people do seem to mess things up though maybe it's worse for Orthodox Jews who are strongly encouraged to mess things up earlier in life by getting married early, having kids early, and often not having proper job skills. And are then essentially forced into expensive private schooling.

Of course you also have social pressure to spend. The second family may be foolish, but they will likely end up okay. But, the real issue is someone who likely makes in the $400k-$500k range and is considering a $2M home is seeking advice from people making $40k-$50k living in a $200k home. And, worst of all, they probably go to the same shuls and meet up at the same bar mitzvahs and weddings. That makes the poorer people insanely jealous (consciously or not) and leads them to make really stupid decisions. A rich family can afford to spend an extra 10% to get the high-end trim package on their new luxury car - even if it is incredibly vain and foolish, it's not going to break them. The poor family can't afford to spend that 10% even if it is just $500. And that's the problem. When you're living at the margins, the small foolish overspending is devastating especially when it's justified by looking at your neighbor's insanely expensive new car.

Miami said...

If you want to make a good real estate investment, buy the cheapest house in an expensive neighborhood, they tend to appreciate more than the more expensive houses.

If you want to be happy with your lot in life, live in a community dramatically below your means and be the richest person in your circle of friends. You'll always feel good about the situation, as long as you avoid embarrassing your friends who lack the ability to spend like you.

A rich man is NOT a man with a lot of money, a rich man is someone content with their lot in life...

I'm sure some of you will get that reference.

queenbee said...

Hi, sorry, I left your blog for a few days.
I guess I'm most interested in your comments about ways to save on health care, since that seems to be one of their biggest monthly expenses. Do you think it pays to look for a new job with cheaper healthcare, or do you agree with the mother who said you will just end up taking a lower salary? What about the idea of having the healthy family members on cheaper private insurance?

I'm also curious about your take on the creative accounting suggested on the 5:06 post: legit or not?

Overall I think it's an interest post. The woman doesn't mention any obvious ridiculous splurges that can be easily dismissed. I worry about people like her when they have to cope with tuition too.

queenbee said...

As for the second imamother post, I agree with tesyaa that the best advice she got is to get real financial advice. But overall, the ladies did okay IMO. They told her to max out her retirement savings instead of saving to buy a 1.6 million dollar house. It sounds like she's heard that before but doesn't want to listen. The thread goes on and the OP comments that she feels the way to build wealth is through entrepreneurship rather than having a job, and she's a big believer in taking financial risks. What do you think?

Miami said...

For someone not funding retirement and college savings but focused on a multi-million dollar house... and is consulting the impoverished posters on imamother for financial advice...

Nouveaux Riche...

Anonymous said...

We make $235 and we literally live paycheck to paycheck - if that. We have been working for 3 years and after student loans, tuition etc. we have zero savings and still have a lot of loans. We have no way to buy a house. And I eat sandwiches for lunch every day, I never go out to eat. Any ideas what to do? When people have kids but have good lifestyles - a house, a car, etc - it seems it is financed by parents paying for education, down payments etc. It hurts especially because no one admits it.

JS said...

There definitely seems to be a lot of people with parental/grandparental support. That and running up the credit cards and not saving a penny. It's tough to count someone else's money and not worth trying.

If you want advice, you can try posting more details.

tesyaa said...

If they've been working 3 years and also have tuition expenses, they must have had kids while still in school? Student loans and tuition at the same time are a killer.

BTW, $235K for a couple 3 years out of school is pretty great. If one or both is a lawyer, the pay is good, but the time commitment is huge.