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I've seen reports about government workers, contractors and others who, if the shutdown drags on much longer, won't be able to make their rent or mortgage payments, pay medical bills and utilities or even afford food.
This has me thinking. How did we get to the point where so many people are living from paycheck to paycheck? Whatever happened to saving accounts and other investments that people can depend on during financial emergencies?
This is not to say that the federal shutdown is fair or a good thing or that people who don't have substantial savings deserve whatever they get. But there are many unexpected events that happen in life that can stress us financially. It could be a job loss, illness, unanticipated major repair of your home or car, among other things. The fact is a large number of Americans are simply unprepared even for little emergencies, let alone the big ones.
This is hard to believe: Of the more than 12,000 people who responded to a Federal Reserve-commissioned survey (pdf) in late 2017, only half said they have enough savings to cover just three months of expenses if they lost their jobs. And only 59 percent said they could handle an unexpected expense of just $400 by paying cash, using their savings or putting the expense on a credit card that they could pay off in just one month. Most of the others said they'd be forced to charge the amount to a credit card and pay it off over time or borrow the money from friends and relatives.
So what's going on and what can be done about it?
It's important to acknowledge that for many people with low incomes, just covering basic expenses makes it difficult or impossible to put any money aside. (That's a subject for different blog post.) But for many others, it's an issue of accumulated debt. Just making their loan payments, in addition to coping with other everyday expenses, leaves nothing at the end of the month to save. Even if there is money left over, it doesn't make sense to save money at, say, one or two percent interest while paying much higher rates on the amount that's still owed. So one's bank account remains empty, and the only choice in an emergency often is to borrow even more. Yikes!
It's one thing if this was caused by a major event that's out of one's control, such as an illness that wiped out the family savings. But it's entirely different if it has been self-imposed by years of spending more than one earns or has saved.
Falling into the trap
And it's easy getting snared by this trap. When it comes to those finer things in life, companies make it hard to say no, offering many inducements for people to take on debt as a mechanism for getting want they want. Consider, for example, car leases and long-term loans, which are designed to get consumers to focus on the monthly payments instead of the overall cost. Suddenly you actually can get that new car or high-end model you thought was out of reach. Or how about merchant deferred interest offers, which let you buy today and pay tomorrow, often with no interest. With some of these deals, you don't even have to make any payments until the due date. (Just don't miss a payment or pay late. If you do, you'll suddenly find yourself owing all that deferred interest, which can accumulate at double-digit rates.)
Of course, there also are those ubiquitous credit cards, which put mostly everything in reach, even if it costs more than you can pay at one time. And, really, who wants to wait for stuff, even products and services that aren't a necessity, when you can get them now? Why shouldn't you be driving a Lexus when your brother-in-law is? Doesn't your family deserve a swimming pool as much as much the neighbors do?
That attitude is exactly what companies are counting on. Despite the touchy-feely, warmhearted impression you might get from their commercials, companies don't care about you. What they're interested in is selling as many widgets as possible to ensure that their major shareholders executives or both can afford a big white house with a helicopter landing pad. And it doesn't matter to them that you're going into debt, as long as you're able to pay, even if means cutting back on food or heat, or spending the kids' college fund.
And companies aren't the only ones responsible. The very nature of our economy makes it difficult even for those with middle-class incomes to get ahead without struggling. It's an unfortunate reality that supply and demand keeps prices generally just below the point where middle class wage earners say enough is enough. That's because if people are willing and able to pay more, the market will be all too happy to accommodate them.
Making matters worse is the emergence of dual-income households, which allows people to bid up prices even higher, to the consternation of those with only a single household income. (Earlier today, I saw a furloughed federal worker on CNN complaining about that very thing.) Beyond that is consumers' willingness to assume as much debt as they can get away with, which drives prices even higher.
As a result of all this, we're at a point where so many people feel they have to live on the edge. So when the government shuts down, workers are laid off, or any other emergency disturbs the precariously balanced normal, it's crisis time. And for those with low incomes, it's pretty much crisis time all the time.
What To Do
It's important periodically to reflect on the fact that borrowing money doesn't create wealth. Instead, you're essentially spending your future earnings today, along with having to pay interest for the privilege. If your income already is insufficient to let you live comfortably with a healthy financial nest egg, adding or increasing your future debt payments isn't going to make life easier. Of course, you might get a higher paying job or otherwise be in a better position to handle those future higher expenses. But can you really count on it, or are you just hoping?
Face it, if you're not paying your credit cards off every month, if you haven't saved at least six months of living expenses (at least a year is better), you're in a financial crisis that you must address. That means taking yourself out of that losing game that so many people are playing these days.
The first thing is to get a good idea of your income and expenses and see where you stand. And then set up a realistic budget that has you spending less than you make, allowing you to pay off your credit cards and other short-term debt and, once you've done that, accumulate savings. It's not as complicated or tedious as it may sound.
Despite what you may have seen elsewhere, you don't need to create a granular budget that focuses on things like pet supplies, entertainment, and dining out. You just need to make sure that you can cover your recurring and essential expenses, pay off your debt or add to your savings, and, hopefully, have enough left over to have fun. I'll be providing a simple approach to budgeting in another blog soon. But given that it's January, now is the perfect time to get started. All you need is a simple spreadsheet program such as Microsoft Excel or the Calc application in the wonderful and free Apache OpenOffice suite.
Also, be careful about long-term debt commitments. They can leave you vulnerable during financial emergencies, not to mention sticking you with high finance charges.
Of course, you'll likely need a mortgage if you're buying a home. But must you really go for the highest amount the bank will lend you? If you can't otherwise afford the kind of house you really want, perhaps a better approach would be to wait while you save for a higher down payment or increase your income. And when you take on that mortgage, be sure you have enough to cover the payments for the next six months to a year if you lose your household income because of a layoff or other emergency.
Car loans and leases also are tricky. Preferably, you'll have enough savings to buy a car with cash. (Yes, I really said that!) Unless you're getting zero percent or super low-interest financing, it makes no sense to borrow money for a car while you're keeping savings at one or two percent or in risky investments. If you must borrow, follow the old 20/4/10 rule. That means putting at least 20 percent down, keeping the loan term to no more than four years and making sure your vehicles expenses – including the loan payments – are less than ten percent of your monthly gross income.
The problem with car leasing is that it's deceptively expensive. It's true that the monthly payments are much lower than they would be for an equivalent loan. But you'll pay for that benefit with the hidden interest charges, which typically are much higher, especially now that interest rates are rising. And leasing puts you on track to get a new vehicle every three years or so. That sounds great. But given that new car and trucks lose their value much more quickly than older ones, repeatedly leasing has you constantly paying exorbitant new-car depreciation. And while those payments might comfortably fit into your budget, you'll end up with what amounts to life-long car payments. And just try to get out of that lease if you lose your job or have any other financial emergency or even if you die! It likely will be very expensive. I'll reveal more about the hidden dangers of leasing in a future blog.
In summary, you and your family should do everything possible to avoid living on a financial cliff, as difficult as that may be. If you're already there, now is the time to figure out how to fix it. It takes planning and self-control. But once you're debt-free and have a fat savings or investment account that both insulates you from life's little emergencies and leaves enough for the finer things, you'll feel great. And when you decide it's time to buy that new car or take that big family vacation, you'll be able to do it without having to worry or feel guilt – and with no risk.
Good luck and stay tuned.
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