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A Day in the Life of "Mr. and Mrs. Median"

Tue, Jun 16 2009, 12:28 GMT
by Nilus Mattive

Money and Markets

I often use a lot of market history and economic data to support the arguments I make here in Money & Markets. That's because I believe crunching numbers, comparing the past to the present, and using a healthy dose of common sense is the best way to figure out what's happening in the investment world, and where things might be headed next.

Today I want to follow that same approach with a slightly different spin. We're going to put faces on some of the seemingly abstract numbers that are floating around out there. In doing so, we'll get a telling look into what regular ol' U.S. citizens are experiencing right now. Let's call them "Mr. and Mrs. Median."

What I think will become painfully obvious is that housing remains largely overpriced ... people remain tremendously unprepared for personal hardships ... and the road to substantial economic recovery will likely be long and arduous.

More on that — and what to do about it — in a moment. First, let's start with a simple baseline...

How Much Do Mr. And Mrs. Median Earn?

If we want to get a sense of where people stand in their personal finances, I think a good place to start is with their cash flows.

And here's what the 2007 U.S. Census Consumer Income report, issued in August 2008, says:

• Real median household income in the U.S. is $50,233. In other words, half of the households in this country make more and half make less.
• Households headed by married couples have a median income of $72,785.
• And the top 20% of households in the U.S. earn more than $100,000, with the top 5% of households earning more than $177,000.

Remember, these numbers are for households, not individuals. The numbers for individuals would be much lower.

Still, on the surface, it doesn't seem too bad, right? Mr. and Mrs. Median — an ordinary, upwardly mobile, middle class couple — are bringing in about $72,000 a year.

Well once you start looking at their day-to-day lives and expenses, you'll get a completely different picture. Let's start with Mr. and Mrs. Median's biggest expense, and the most notable one in today's environment ...

How Much Would Mr. and Mrs. Median Pay for Housing Today?

According to that same Census report, about 80% of higher-earning households own their house ... though the term "rent from the bank" is probably more accurate in most cases.

And this is where we run into our first head-scratcher ...

According to the National Association of Realtors, the median price of a single-family home in the U.S. fell 14% to $169,000 in the first quarter of 2009.

If we take that number and divide it by the median household income of $50,233 we get a ratio of 3.36.

In other words, it would take the middle-of-the-pay scale American household nearly 3.5 times their annual income to buy the middle-priced house.

From a historical perspective, that's getting back to normal — in the 1990s, the ratio hovered right in that general area.

However, we have not factored in things that have happened since that 2007 Census report, including mounting job losses, evaporating 401(k)s, and the tightening of credit.

In other words, we are using top-of-the-cycle incomes and on-the-decline housing prices with more than a year's difference in the data points.

More importantly, the bigger problem is this ...

A Regular Family's Actual Monthly Budget Makes Housing Affordability Much More Complicated!

Since our hypothetical couple does far better than the straight median household income — $72,000 vs. $50,233 — today's median-priced home should be all that much more affordable for them then, right?

If you look at the price-to-income ratio, yes. It's a reasonable 2.35.

However, once you start tracking our couple's actual monthly expenditures (something that practically nobody does anymore!), you'll see just how unaffordable even today's moderately-priced house is for an upwardly mobile family.

We'll start with another generous assumption: Mr. and Mrs. Median are actually going to put down 20% on this new house. Crazy talk, I know.

With today's 5.75% 30-year fixed mortgage, their $135,200 loan is going to cost them about $788.99 a month.

Hey, with $6,000 a month coming in, that should be no problem, right?

Wrong.

First off, there's that little thing called taxes. Let's assume their employers cover half of their Social Security and Medicare taxes. That means they lose 7.65% of the $72,000, or $5,508.

Then, Uncle Sam will want his "regular" cut. For a couple making $72,000 that would come out to about 20% according to the IRS. Say goodbye to another $14,400!

State taxes are anybody's guess ... they could be zero in Florida or 5.3% in Massachusetts. We'll split the difference and say they pay 3%, including state and local. That's $2,160 out the window.

Already, our favorite imaginary couple is now clearing just $49,932, or $4,161 a month.

Of course, they probably have health insurance, which costs something like $500 a month through their employers ...

Their cars and associated insurance bills suck out another $500 or $1,000 (the average car payment in the U.S. is about $380) ...

Gas could be $100, $200 or more ...

Groceries — not of the organic variety — might run a cost-conscious family of three or four about $600 a month ...

And cell phone, cable, and Internet would be $150. (Boy, am I being nice there!)

As you can see, their monthly bills are already running into the $2,000 range, which means they're now left with $2,161 a month.

Deduct that mortgage payment of $788.99 and they'll have about $1,372 a month left in their bank account each month.

Still doable, right?

Well, we didn't mention the costs directly related to their new house yet. Even if we assume a relatively low property tax rate of 1%, they're shelling out $1,690. Insurance would tack on another $1,000. And utilities might average $300 a month throughout the year. The grand total for these costs is easily $500 a month.

End result: Mr. and Mrs. Median are left with $872 a month in so-called disposable income.

That money will have to be used to pay for every other single thing they buy throughout the year — including vacations, clothes, regular maintenance of the house and cars, unexpected emergencies, etc.

If they have kids — and I think it's safe to assume that this imaginary couple does or soon will — they could also be shelling out a boatload for child care, toys, etc.

Sure, they'll probably scrape by.

But ask yourself this: Given all those other expenses that we have not yet accounted for, is there any way that this couple can possibly be saving and investing for their retirement or their kids' educations?

No way!

They certainly wouldn't be able to contribute the $5,000 maximum to even one Roth IRA. And even with the tax savings afforded 401(k) plans, they'd be lucky to put away a couple grand a year each.

In fact, that jibes completely with the actual statistics — according to the Employee Benefit Research Institute, the average worker contributes about 7.5 percent to their company retirement plan. That means Mr. and Mrs. Median are saving $5,400 a year toward their combined retirement.

Other real-world numbers back this up. At the end of last year, the median balance of a 401(k) plan was $18,942.

The average balance was a significantly higher $65,454. But that's because a minority of people (19 percent) have built up 401(k) balances worth $100,000 or more. A full 39 percent had less than $10,000 socked away.

If Regular U.S. Citizens Want Real Prosperity, Something Has to Give Here ...

Look, I realize I'm just tossing around numbers. And you might think my assumptions are crazy — on either side of the spectrum.

But from my personal conversations with friends, family, and readers all across the country, this little exercise is grossly underestimating the situation for many Americans.

Heck, how many upwardly mobile middle class couples do you know who recently paid $169,000 for their homes in major metropolitan areas? Not many I suspect.

And for those who bought in the last few years, not only does everything I just said hold true, but they are also underwater ... they could have mortgage resets ahead ... and on and on.

The only way many people are holding their finances together is with the glue of credit. Because based on the incomes in this country, there's no way so many people can be driving $40,000 cars and living in $400,000 houses.

Or more accurately, there's no way that these higher-priced cars and houses can sell at current prices going forward. The math just doesn't add up, and the credit is long gone.

Think about it. For a household to afford one of the many $500,000 homes I see for sale everywhere I look, they'd need to pull in $142,000 a year. And that's at the 3.5 ratio, which as I've shown you is far too optimistic once you look at actual family budgets.

According to the Census, only 7% or 8% of households make more than $142,000 a year to begin with. How much of the housing inventory in your area is at the higher end of the market?

Bottom line ...

The Great Unwinding of Credit Will Continue, So Make Absolutely Sure You're Prepared!

I hate to be a downer here. It'd certainly be nice if everyone could just go on with their happy lives, expensive cars and houses, and endless credit-fueled buying binges.

But it ain't gonna happen.

In the very best case, with a solid economic recovery, I expect housing prices to stagnate for many years. If mortgage rates continue to jump or the recession lingers, look out below.

Meanwhile, the days of conspicuous consumption will quietly fade. You can already see this happening with the recent uptick in the U.S. saving rate.

Is it a doomsday scenario? Not in my opinion. The overall quality of life in this country can keep improving. But it feels like a cultural shift is starting to take place, that it simply must take place.

That means slower growth for some time to come.

Plenty of U.S. citizens are simply going to scrape by, barely making ends meet because of the unwise decisions they made in the last decade. They're going to have to re-evaluate their household budgets just to survive. They're going to realize that the lifestyle they've become accustomed to is no longer attainable.

They are absolutely not going to accumulate wealth at a rapid clip.

Fortunately, since you read Money & Markets, I'm sure you find yourself in better financial shape than Mr. and Mrs. Median. Yet I don't want you to rest on your laurels.

And even if you find yourself crunched in this tough environment, I want you to know that there are still plenty of steps you can take now to become better prepared for the future ...

First, continue living well within your means and saving religiously. There is no free lunch, and the only way to build wealth is by spending less than you earn.

Second, make sure your portfolio is prepared for a long economic slog. I favor economically-insensitive dividend stocks, carefully-selected bonds, and other conservative income investments. But I also recognize the importance of inflation and dollar hedges, inverse ETFs, and a healthy dose of cash. Diversification remains a valid concept, in my opinion. Our team of experts here at Money & Markets is giving you all the tools you need to put together a portfolio that's right for you.

Third, ignore the hype about a quick recovery, massive gains just waiting around the corner, and all the other feel-good talk that's out there. Sure, you can continue raking in solid returns every year if you make the right moves. But the idea that this 10- or 20-year credit party is going to get worked off in a year doesn't pass a "common sense test" and it certainly isn't supported by the numbers. We all have to adjust our expectations accordingly.

Published on  Tue, Jun 16 2009, 12:28 GMT

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