This is one of my favorite topics. About five years ago, a couple went viral on Twitter claiming that they were living “paycheck-to-paycheck” in New York City despite having a $500,000 income. This recent article from Bloomberg makes a similar claim: “One-Third of Americans Making Over $250,000 per year Live Paycheck-To-Paycheck.”
This is one of the rare articles where the facts are far worse than the title makes them appear. The baby boomer generation, who have already accumulated significant assets, are skewing the data to make it look better than it is. As Bloomberg shows, over 55% of millennials (late 20s to early 40s) making more than $250,000 per year report living paycheck-to-paycheck.
What Is “Paycheck-to-Paycheck?”
As we dive in, it’s important to note that these people (especially the $500k viral NYC couple) still make significant contributions to qualified retirement plans. So, as long as they avoid divorce, they will likely build enduring wealth.
Paycheck-to-paycheck is an exaggeration. Maybe a more fair description of these people is that they are not saving additional amounts into non-retirement investments. If they had a $30,000 emergency fund 3-4 years ago, they probably do not have much more than that today.
So, What is the Problem?
You can make a fine case that there is no problem. Spending most of your salary is probably ok if 20%+ of your income is being saved in qualified retirement plans (including employer matching contributions).
Another way to say it (coined by Jared in our podcast): Good financial planning means you will be living paycheck-to-paycheck. Not because you’re broke, but because every dollar in your life will have a purpose. Every dollar in your budget will have a job–you’re putting it to work.
But it’s still a fascinating topic–why does a family with a $350,000 income not have the ability to save additional amounts outside of retirement accounts? And it is important. Qualified retirement plans have restrictions on when you can access them. If you want to reach financial independence at a young age, you likely need to have a savings rate above and beyond qualified retirement plans.
Whether you make $400,000 or $800,000 per year, giving every dollar a job will get you to financial freedom faster–and it also frees you up to spend on things without guilt. If you could accelerate your retirement plans by 5-10 years, would you do it? You must be very intentional, even with a very high income, to ensure your dollars work to their highest and best use.
Are These People Just Terrible With Money?
In short, no. I emphatically believe most of these people are pretty good with money. Remember how I said the Bloomberg article is rare in that the facts are worse than the title makes it sound? I think the facts (which look bad) don’t tell half the story of how bad it really is.
Bloomberg is reporting on a survey that shows that over 55% of millennials making over $250k/yr are living paycheck-to-paycheck. But not all millennials (late 20’s to early ’40s) are created equal. From my anecdotal experience, detailed in the next section, I’m confident that 90% of millennials would be categorized as paycheck-to-paycheck if the survey added these parameters:
- Millennials with two or more kids
- Millennials over $250,000 but under $400,000 in annual income
- Millennials who do not receive annual gifts (usually $16,000-$32,000) from their parents
If you sorted out anyone who does not fit these added parameters, I’m confident 90% of these millennials are spending nearly all their take-home pay. From our experience, most families do not start consistently saving $1,000s/month in brokerage accounts (in addition to retirement funds) until their income gets closer to $600,000 per year.
My Anecdotal Experience
Let’s take a brief look at Brownlee Wealth Management. Most of our clients work for (or retired from) publicly traded Energy companies. About 75% of our clients are either retired or close to retirement. About 25% of our clients are still accumulating (with a median age of around 40).
If you’re not in the wealth management world, you probably read that and think we are very tilted toward retirees. But not really–the vast majority of Investment Advisory firms like ours are 95%+ retirees. I think we have a chunk of younger people around age 40 because our content appeals to them, and we have a fee structure that can work with assets tied up in their employer’s plans.
Because of this, I have some anecdotal experience to compare to Bloomberg’s story. I have probably talked to ~40 families like this:
- Household incomes from $200,000 to $3,000,000 per year
- Bell curve: most of them were between $350,000 and $700,000
- Ages 30 to 48
- Median monthly expenses were $20,000 per month
Here are my conclusions:
- No one starts saving serious after-tax/non-retirement money in an automated way until household income passes $550,000 per year.
- More color on this: Yes, a family at $400,000 can come up with a serious chunk of money for a renovation project or something else. But systematically saving a few thousand dollars monthly in a brokerage account does not happen until you reach an ultra-high income–at least not consistently for several years.
- Nearly all of the individuals/families I talked to needed more than $15,000/month to continue living the exact life they were living when we met. Again, the median and average came in at about $20,000/mo.
- These monthly expenses go up until kids are out of college.
- The most expensive years of your life are the last 4-6 years before kids get off your payroll.
- I am fairly sure I’ve only talked to two people spending $12,000/month or less.
- On this point, I think it’s all tied to how long you can keep your “starter” purchases. The longer you can live in your starter home and drive your current car, the more you can successfully avoid lifestyle creep.
My Personal Budget Explosion
I enjoy being as transparent as possible with my own finances. If you’ve consumed our articles/videos/podcasts, you’ve heard me talk about how much we took from our “normal investments” (ETFs/index funds) to start Brownlee Wealth Management. You’ve also heard me discuss how we decided for my wife, Lauren, to attend law school at Texas A&M.
I’ll take you under the hood for this budget discussion. It absolutely rings true. We had a $1,600/mo mortgage with our starter home. But we sold our starter home because of our law school plans. Because of that, our rent is now $3,300/mo. Almost all of our expenses have doubled from the $7,000/mo we were spending three years ago. When my wife finishes law school and we move back to Houston, they will likely increase in a big way again (thanks to the housing dynamic I mention below).
When kids are young, you can jerry-rig your budget. But as kids get older, you start to succumb to my next point, the “private equitization” of every industry. You can stay in your starter home. You can continue driving your 6-year-old car. But as kids arrive and grow past the toddler stage: you get smoked out.
Why People Are Spending Most of Their (High) Income
As we start this section, it’s worth noting that take-home pay is significantly less than gross pay. Let’s pretend you make $400,000 per year.
- FICA Payroll Taxes-4%*
- Income Tax-20%**
- 401(k) Contributions-10%***
- Health Insurance Premiums-3%
- HSA Contributions-2%
- Other Benefits (life/disability insurance, legal, etc.)-1%
*Fica is 7.65%, but SS stops after $147,000 in income. So, a little less than 4% of the total income goes to FICA.
**after FICA, pre-tax 401k & HSA contributions, and other pre-tax deductions, 20% is almost the exact average tax rate someone would pay with this income.
***401k: 10% pre-tax (this maxes out your elective deferrals) and 10% after-tax to be converted to Roth
In this example, your take-home pay is 60% of your gross. This leaves you with $20,000/month. Remember my anecdotal data? That was the median monthly expense number. But let’s get to the point. The real reason it’s easy to spend way more than you thought you would is this:
The “Private Equitization” of Every Industry and Service in Our Economy
Owning an RIA (Registered Investment Advisor) during this decade has been fascinating. Like many industries, private equity firms have been buying up investment firms left and right.
They’re doing the same thing with investment firms that they’re doing with any other industry/business:
- Purchase the business
- Find a way to charge significantly more and/or:
- Drive internal costs down through scale
If you can buy a business operating somewhat inefficiently and make them drastically more efficient while increasing prices, you can sell it for much more than your purchase price.
A tangent but similar shift is industries or services going away from the Walmart/Amazon model (provide everyone access to everything at a low price).
Instead, much of what we buy today comes from the Seth Godin philosophy: Do not market yourself to everybody. Instead, target a smaller market–the green below–with a very premium offering. Businesses are not trying to make everyone their customer. Instead, they want to find enough customers to pay a 10x price for a premium offering.
Many companies have simply removed their lower-priced offerings to aid in this endeavor. They’re all targeting the top 10%-20% of Americans (green box)…and then they’re using debt financing to make the sale for the next 50% of Americans (orange box).
This affects the home you live in, the car you drive, the vacations you take, the sports your children play, and the college they attend. The end consequence is the departure of your discretionary dollars. If you’re not intentional, spending far more than you imagined is easy as your family grows–every company and service you use wants more of your “walletshare.”
Real estate is not cheap. Part of this is because of the increase in land value over the last several decades. But there is another dynamic at play.
Family size has gone down. The size of houses has gone up. The square feet per person has gone WAY up.
This gets even more extreme in desirable areas with good schools. Memorial Villages in Houston is an excellent example of this. Two generations ago, it was a few neighborhoods surrounded by small farms. Yes, land values in Houston have gone up as the city has boomed.
But another dynamic took home prices to a very different level. One generation ago, you could find plenty of 2,000-3,000 sq ft. homes. As Houston’s organic growth increased, this provided an opportunity for developers.
If a 2,500 sq. ft. house on a half-acre lot comes on the market, there will be dozens of interested buyers. Most of those buyers are not families looking for a home in a good school district. They are developers looking to tear down the house and build something 2-4x larger.
If you’re in this business, your goal is not to provide affordable housing to the 7+ million people in Houston. Your goal is to create a premium house with a multi-million dollar price.
This dynamic has been happening for decades now. The free market created a plethora of real estate developers and investors that have drastically changed the market in Memorial Villages. So, two things have happened:
- The price of Houston land (in general) has increased.
- Most of the “affordable” options simply stopped getting built.
The first dynamic is obvious and expected. And to be clear, it played a material role in the area’s price increases. But the second factor is why there are so many homes over $2M in the six Memorial Villages. Twenty years ago, there were lots of 2,500 sq. ft. homes. Today, it is really hard to find one. And if you do, good luck winning the bid over a developer who will pay cash and close in seven days.
The market simply stopped making affordable options. As I mentioned above in bold–the dozens of home builders, developers, investors, etc., are not trying to make every homebuyer in Houston their customer. Instead, they have created a premium offering at a premium price. And their target is to get enough customers.
While this is an extreme example of one of Houston’s pricier areas, the same dynamic has happened with new homes in the suburbs. The large corporations building new neighborhoods all over Houston have done a similar thing.
Real estate is priced per square foot. So, if DR Horton (or any other builder) wants to maximize their profit per house, the answer is straightforward: Just stop building 1,500 sq. ft. homes! And they have. Even though today’s family size is smaller (and a three-person household could comfortably live in a smaller home), homebuilders are trying to build as efficient of a business as possible. So, the houses are bigger.
This one is maybe my favorite example. Automakers used to make a lot of cars. And by cars, I mean sedans—small vehicles with two or four doors.
Today, automakers have nearly eliminated sedans from production. They want a greater share of your wallet.
In the 1990’s, sedans dominated production. Trucks & SUVs were a small portion of what was made. By the early 2010s, trucks and SUVs reached 50% of the vehicles sold. Earlier this year, trucks and SUVs reached 80% of vehicles sold.
The most famous carmaker in the world, Ford, famously decided to stop making sedans a few years ago!
Let’s go back to this image. Companies are making products tailored to the top income earners in America. Then, they use debt to make these premium products available to the masses.
The average new car payment in America reached $714/month in May.
In 1975, a member of Beta Theta Pi fraternity decided he needed some extra income. He also wanted to find a wife. One job in the world allowed him to kill two birds with one stone: became a houseboy at Kappa Kappa Gamma sorority across the street.
This is my origin story. My dad met my mom as a student at Kansas State University in Manhattan. They married a few years later and had four kids. All of us followed in their footsteps and graduated from Kansas State. We also attended over 100 college football games, witnessing the greatest turnaround in college football history.
But let’s get back to the point! In 1975, one year of tuition at Kansas State was less than $1,000, with housing at a similar price.
If college continues to grow at 8% per year, the cost for my children to attend a public university in Texas will surpass $60,000 per year.
This is almost entirely due to the debt structure of college education. If you file for bankruptcy, you can eliminate most of your debts. But you cannot discharge student loan debt through bankruptcy.
When you buy a car or a house, you must prove your financial ability to make these debt payments. And most of the people doing this are adults with decades of earnings. When a person borrows $200,000 for a college education, they do not have to prove anything, and they may not have reached the age of majority in their state when they’re approved for a loan.
As long as this debt structure is protected, paying for your children’s education will continue to get pricier. This is also the dilemma with any government stimulus aimed at student debt. If taxpayers forgive the debt, that bolsters the debt protection student loans have–and allows universities to charge even higher prices.
Youth Sports & Summer Camps
When I was a child, the cost of the youth basketball league I played in was $75. As you all know, the McKinsey consultants have influenced youth sports just as much as these other areas.
Once your child hits ten years old, it’s easy to spend five figures per year on gear, club fees, private practice sessions, and travel.
This has created a secondary effect for wealthy Texas families: private schools. My wife and I are heavily leaning toward sending our kids to private school as they get closer to high school. One of the primary reasons is that we want our kids to have the experience and learn the lessons that go along with playing organized sports.
But I am adamantly opposed to sacrificing every family dinner, weekend, and family vacation in pursuit of making my 8-year-old a McDonald’s All-American. I really don’t want my kids too caught up in sports. I don’t want them to play college sports. But I want them to learn discipline, teamwork, and perseverance from these sports.
Solution: pay for drastically smaller class sizes.
There is not a right or wrong answer here. But just like the other industries we’re profiling, it’s easy for an ultra-high income family to spend vast amounts of discretionary income between kids’ activities and summer camps.
We just took our family to Disney World (my and my kids’ first time). We absolutely loved it. I was not looking forward to it before we left. Now, I am planning on going back at some point in the next couple of years.
But this trip would have been miserable had we not spent the extra money to stay on property and pay for all of the FastPasses (or whatever they call them now). Right after we returned from vacation, Disney announced another substantial price hike to their FastPass system (that allows you to skip lines that often have an hour+ wait).
A few years ago, this feature was included in your base ticket. And while this may be overly dramatic, I really think I would have hated DisneyWorld had we not spent more money to stay on property, pay for character meals, and pay for every FastPass we could. The result: it would not be hard (at all) to spend $15,000 to take a family of five to DisneyWorld for a week.
If you do DisneyWorld or 30A, a ski trip, a weekend getaway for your anniversary, and trips to see family for holidays, you can easily spend $50,000.
You can have great experiences for far less. I’m not saying the average American family spends anywhere near that much on vacations. But if you’re making $700,000/year, you can probably afford this. And if your 20-year-old self heard how much you spend on vacations, you probably envisioned private jets to Ibiza. That’s not the case–it’s pretty easy to spend way more than you imagined on decent, above-average family vacations.
This is one of the more subtle examples. The car price explosion (even pre-pandemic) was regularly covered by bloggers like Ben Carlson and major outlets like the Wall Street Journal. Housing price surges have also been well documented. Live entertainment events haven’t been talked about as much.
But the transition of professional sports team offering an ultra-premium product in the past two decades has been significant.
Both my wife and I grew up in families that had season tickets to their local baseball team. My parents had four season tickets to Royals games (although we traded these for Kansas State football season tickets when I was seven). My wife’s family had four season tickets to the Texas Rangers. Our family’s tickets were both between home plate and first base, about 15 rows up.
Lauren and I checked Texas Rangers season tickets in their new stadium for fun. If we wanted four season tickets in the same area our family had tickets decades ago–it would cost us $75,000 per year! Our families were not paying anything close to that price.
But the tickets we grew up with and the tickets they sell now are not an apples-to-apples comparison. Stadiums today are built to maximize premium seating. The first two decks are almost entirely premium seats with private clubs. You can enjoy sitting several hundred feet away from the action if you want normal seats.
The NFL has done the same thing. Season tickets with good seats are priced for businesses, not regular families. They are not trying to cater to the masses. Instead, they have built a premium offering and can sell it to a select few at a 10x price.
These changes spill their way over to single games as well. I have taken my family to two Rangers games this summer. We spent $800 on those two games for good-not-great seats, parking, and concessions.
As I wrote in the beginning, it’s easy for a high-income family to watch months and years go by without saving material non-retirement dollars. Companies, colleges, and services have become very good at taking your discretionary dollars to pay for their premium services.
And some of this is fine! I plan to spend much more on sporting events and vacations in future years. My wife and I are house people–we’re probably not going cheap for our next house.
My application for you is not “live as cheaply as possible so you can invest everything.”
But you must be very intentional to live the life you want and pursue financial independence at the pace you want. YOU need to give every dollar a job.
If you do not allocate your discretionary income with purpose, dozens of products and services are ready to take it from you. Whether you make $400,000/year or $800,000+/year, you will find ways to spend it–and make your journey to financial freedom longer than it needs to be–if you don’t have a plan.