The Average American Case Study Series will show you what the Average American looks like in certain scenarios and discusses how we can all be less ‘average’ and on the path to financial freedom.  Workers that are 15-20 years into their career are considered, “mid-career”, and typically fall into the age range of 35-44.  For the purposes of this case study, let’s call them 40.

Data above are per household.  The stats above are all public, utilizing sources from various reliable places, such as the Bureau of Labor Statistics.

My Observations:

Salary: At $78,385, income is pretty strong!  Although this is a pretty good starting point, we can do better.  If this is average income, we can easily get up to $100k per year through above average performance and hard work.

Spending: Spending almost $60,000 a year doesn’t seem that unreasonable.  However, spending $60k a year while making only $78k a year won’t cut it. 

Let’s check the numbers:

 

 

Big problem.  The average American at 40 years old is spending more than they make.  They are going into debt by an additional $1,558 per year.  Instead of making progress towards financial independence and early retirement, they have quite literally put themselves on a path to work until they die.  This can’t happen.

Spending must be reduced significantly, or income has to go up significantly.  Their current Spending / Take Home Pay ratio is -3%, or said another way, they are spending 3% more than they make each year.

If you truly want to reach financial independence as soon as possible, your Spending/THP ratio should be  around 50%.  If you ever see this ratio creeping around 10% or lower, there is trouble.  This means you are spending everything you make before saving a dime. 

Most finance professionals focus on debt first and foremost, but can you really focus on paying down debt when your everyday lifestyle puts you back into more debt?  Not a chance.  Our average 40 year old American needs to fix their Income/Spending problem first.

Total Debt: $209,223.  Our average 40 year old friend has too much debt.  Not all debt is bad, but this debt, and this amount, is bad…crippling, actually.

The average American at this age typically sees the below interest rates:

·         Credit Card: 14.5%
·         Mortgage: 4.75%
·         Auto Loan: 4.2%
·         Student Loan: 5%

At these rates and a $209,223 aggregate principal (total debt owed), they are paying $10,108 a year just to service the debt!  If you ever wondered how banks make money, this is how.  Our 40 year old is giving away 17% of their take home pay to the banks just for kicks.  This must change immediately.

After their THP/Spending ratio has reached positive figures, and they have additional dollars left over after living expenses, all dollars need to go towards paying off debt.

Credit Card has to go first.  At 14.5% interest, money is quite literally going up in flames each month.  Or put another way, you are sitting in your office chair for hours each day just to send interest payments to a massive corporation, still leaving the principal amount on your loan to deal with!

The other loans are less offensive to me, but I would still pay them down and get them out of the way.  Such a major part of mastering personal finance is to simplify everything in your financial life.  This means getting rid of all those debt accounts and bills.  Here is what to do:

·         Pay down that credit card first.
·         Then move on to the student loan.  Given they have had this for almost 20 years, it must feel like a ball and chain.  Pay it down, move on, and enjoy life without that rusty steel ball around your ankle.
·         Now move onto that car loan.  At 4.2%, they aren’t doing too bad, but it’s still another form of debt lingering over their shoulder.  Since it’s more than $10k, sell the car, buy something more reasonable, and enjoy not getting a bill in the mail each month.

That just leaves the mortgage.  Ill go into mortgage payments and home ownership in numerous future articles, but for now, know that I believe a mortgage payment to be an acceptable form of debt. 

I am not super excited about the concept of home ownership. It is NOT an investment but an expense. 

However, everyone needs a place to live, and if you find a reasonable place that brings joy to your life, buy it, don’t overspend, and don’t look back.

A final note on debt for our friend.  Numerous debt accounts are not good for the psychology of early retirement.  When you have so many debts stacked up against you, it can feel like there is no way out and why should you even try?  This is real.  Pay off those trivial debts ASAP, make sure your only debt is smart debt, and then you can start saving and investing.  As a rule of thumb, if you have a debt above 5% interest payments, go ahead start working to pay it off immediately.  Even if you need to get a part time job for 6-12 months, do whatever it takes to pay off those debts, simplify your finances and give yourself a ray of hope for the future.  If the debt is below 5% or a mortgage payment, think long and hard about whether you should keep working to pay it down early, or send that money towards investments.  More on this controversy later.

Savings: $4,200.  Very poor, but not a surprise.  They have been outspending their take home pay each year, so I would guess the cash in the bank is a gift from a grandparent or parent somewhere along the line.  I personally am quite conservative when it comes to cash on hand, and like to make sure that the RME family has at least $50,000 in cash on hand at any time.  If something happened and we fell on hard times, we could slash spending almost overnight and this amount could sustain us for 18-24 months.  I may miss out on some investment gains by having so much cash sitting idle, but it helps me sleep at night, and aligns with what I am comfortable with. 

A key to personal finance is to stay true to yourself and to do what is comfortable for you.

What should they do next?  Let’s fast forward a year and see where our average 40 year could be.

Now 41, our friend has boosted their income to $100,000.  They had to take a job with a new company across town, but was able to net a 28% raise!  This is not unreasonable for a hard worker with strong performance.  People will pay for top talent.  Make sure you are top talent.  New take home pay is just under $71k per year.

They took this opportunity to sell their house, move closer to the new job, and downsize a bit.  They had too much house anyway.  Those extra rooms were sitting full of junk, and when family visits, they now have a high quality 30’’ tall inflatable mattress with a memory foam topper, all for $150.  Mortgage debt was reduced by $68,000 due to the downsize and average yearly house payments fell by just over $5,000 per year!

Other spend was also dramatically improved.  They cut down on commute and driving time, reducing transportation cost.  They cooked at home much more and threw parties at their house instead of going out to fancy restaurants and bars each week. They packed their lunch each day, dropped cable, found a better internet provider, found a better phone plan, and began to manage utilities much more efficiently around the house.  All in, spending was reduced to $35,000 a year, a reduction of $23,784 from previous spending.

When you put the new Take Home Pay rate of $71k and the new spending rate of $35k, you have a Spendig/THP ratio of +50.3%!  What a transformation!  This means they only spend 50% of what they make, and can save and invest the other 50%.

Over that first year, they have $35,537 left over from earnings to put towards debt.  Credit card debt is wiped out in the first 45 days.  The auto loan was reduced by $8k by selling their old car, and buying a more reasonable used sedan, like a Honda Accord or a Toyota Camry.  New remaining auto debt of $10k was paid off in 4 months time.  Student loans were tackled next.  By year end, all student loans were paid off as well.  All in, $2,227 in credit card debt, $10,000 in auto debt (reduced from $18,615 by selling current car and buying used) and $20,219 in student loans was all eliminated in 1 years’ time.  Total consumer debt was reduced by $41,111 through lifestyle changes and dedication.  Oh yeah, since they relocated and bought a smaller house, mortgage debt dropped by $68,000 as well.  Total debt reduction in 1 years’ time?  $109,223 IN DEBT GONE.  POOF!! The only debt that remains is the mortgage at $100,000 and 4.75% over 30 years.  Not too bad.

But wait, there’s more!  Even after all that debt reduction, given the new higher salary and reduced spend, our friend managed to GROW savings by $3,051.  Savings at end of year sits at $7,251.  What a transformational year. 

From here on out, things just start to compound.  Assuming their salary and spending stays the same (which is conservative, and they would likely gain additional promotions and raises over time), and $35,547 in discretionary cash (money remaining after spending is paid for) each year goes towards reaching financial independence, here is what their future looks like (assuming a 9% return on investment).

After 13 years of additional work, they are free to retire.  At age 54, they have amassed $911,500 in personal wealth. More than 25x their annual spend of $35k per year. 

 

Through hard work and dedication, your average American at age 40, with debt up to their eyeballs (>$200k), going deeper into debt each day, and effectively zero in savings ($4.2k), has been able to retire at age 54, significantly earlier than the average American. 

It really doesn’t take much to break the mold and do something extraordinary.  Commit yourself now and start making progress today.

Key Takeaways

·         Drive your income as high as possible as soon as possible

·         Moderate your spending and ensure your Spending/THP ratio is near 50%

·         Pay off all consumer debt ASAP and simplify your personal finances

Your Next Steps

·         Evaluate your income.  Is it where you want to be? Are you at or above fair market rate?

·         Where is your Spending/THP ratio?  Is it close to 50%?  If not, moderate spending or go make more money!

·         Do you have consumer debt?  Pay it down now, simplify your finances.

·         Commit yourself to the next decade of making progress and you will be well on your way.

Data

1.       https://www.bls.gov/opub/btn/volume-4/consumer-expenditures-vary-by-age.htm

2.       2. https://www.cnbc.com/2017/04/07/how-much-the-average-family-has-saved-for-retirement-at-every-age.html

3.       https://www.urban.org/sites/default/files/publication/72976/2000514-Americans-Debt-Styles-by-Age-and-over-Time.pd

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This Post Has 2 Comments

  1. The Average American is in big trouble. That saving rate is dismal. You’re right. They need to grow their income and cut expense.
    Doing the same thing won’t improve their finance. At 40, you really need to think about retirement.

    1. Spot on! The average American is indeed in trouble. In reality, most people make enough money, they just don’t save enough!

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