What is Really Making You Poor?

If you’re a regular reader of topics related to personal finance, you’re probably quite familiar with seeing statements that suggest people are poor, or at best living paycheck to paycheck because of their choice to buy coffee, watch cable television, or buy books instead of borrowing them from the library. To validate this point they will show numbers stating how much you could save each month by not spending on these things, and then run it through a compound interest calculator to show you the millions you’d have in your retirement account. Amazing!

The thing is, even though the math might be sound, this rarely works in the real world. People don’t read this advice and suddenly stop going to Starbucks and then turn around and put the twenty dollars a week they are saving into an investment account. They don’t cut out cable and then go tell the HR department at work to increase their 401k contributions by 100 dollars.

It’s not that this advice about saving money on the small things is bad. Quite the opposite. Saving a little bit here or there, over long periods of time, really does amount to significant and even staggering amounts of money. The problem is that this is largely only good on paper and when it comes to people putting this into practice, it rarely materializes. Because these are small amounts on a daily, weekly, or monthly basis, what happens is the savings usually ends up being spent somewhere else instead.

This doesn’t mean you shouldn’t try to find small ways to save money every day, but if you do, it’s important to make sure you put that savings directly into a savings account, a retirement account, or toward high-interest debt, depending on what your situation dictates. Saving fifty bucks a month by cutting out a daily habit is great, but if you don’t put that money to work it’s just going to sit in your checking account and vanish as it gets spent on something else.

But to really make a difference you want to be able to see the forest for the trees. Focusing on all of these small details can take your eye off the big picture. Instead of constantly worrying about where you can cut a few bucks out of your budget, look at the big picture and the big-ticket items. Your decisions when it comes to buying a house, a vehicle, and the next family vacation can have a far greater lifelong impact on your finances than cutting any coffee out of your budget ever could.

Things That Really Make You Poor

The small things matter, but only if you’re disciplined enough to cut out the small things and actually put that money to work, which is easier said than done. So don’t ignore the ways you can trim the fat from your budget, but don’t obsess over it, either. Instead, turn your focus to the things that are actually making you poor and the financial improvement will be both immediate and long lasting.

1. Your Home

It only makes sense to start right at the top. Without a doubt, where you live can, and often will, make you poor. It doesn’t matter if you’re renting an apartment or bought a house, but it’s almost an American tradition to live in something that’s more than you need. It sort of makes sense to want the most home you can afford because we spend so much time there and want to be comfortable, but the problem is the definition of “afford.” Ask almost anyone how much home they can afford and they will probably tell you whatever the bank pre-approves them for. Again, this is something that makes sense on paper, but in reality it’s only the tip of the iceberg.

As of 2011 data, we spend an average of 31.5 percent of our income on rent or mortgage payments. That’s a lot of money. The problem is the mortgage or rent payment is only part of the story. Your home still needs the lights on, water, keeping the heat on in the winter and so on. So we spend another 5.4 percent of our income on utilities. Chances are, your home isn’t spectacularly furnished when you move in, so as a whole we spend another 4.1 percent on furnishings and household items. We’re already at 41 percent of our income and we didn’t even factor in things like property taxes for homeowners, insurance, maintenance and repairs, and so on.

When you’re spending nearly half of your income just on a place to live, it becomes quite clear how this can be a source of financial hardship. The hidden costs associated with living in a place larger than you need are what really hurt. Sure, the bank might qualify you for a nice home to upsize to and with low interest rates the mortgage payment looks all too affordable. The catch is that with a larger and more expensive home all the other costs go up as well, which aren’t reflected in the mortgage payment. More house means higher utility bills, more furnishings, more maintenance, higher insurance premiums, and higher property taxes. Sure, you may have an affordable mortgage payment, but all the other increased expenses may put you in the poor house. Literally.

2. Your Car

I’ve pointed out the perils of owning a vehicle and how it can make you poor in the past, but this comes in as one of the biggest expenditures, and one that often puts a significant strain on your budget. On average, we spend nearly 6 percent of our income on vehicles, either new or used. And since these cars need something to make them go, you can probably guess that gasoline is another significant expense, and it is to the tune of a little over 5 percent. Then of course there are maintenance costs for things like oil changes, minor repairs, new tires, and so on, which eat up another 1.6 percent. So, this puts nearly 13 percent of our income toward owning a vehicle.

In some areas of the country, especially those where long commutes are almost necessary, these costs can skyrocket. Gas prices are still high and if you have a multi-car family it isn’t uncommon to spend more than $500 a month just on gas. Tack on a few car payments and insurance and I’ve seen people spending more on their vehicles each month than their mortgage!

3. Food

We round out the top three things making you poor with another necessity of life: food. We need food just as we need shelter, but here in America it’s often the land of excess. Between groceries and dining out, we typically spend a little over 14 percent of our income just to stay fed. Obviously, money spent on food isn’t completely wasted since we need to eat, but it’s where this money is spent that tells the story.

We’re busy people and finding time to cook at home can be a challenge. Unfortunately, this often means we opt for dining out since it’s quicker and easier. How much this decision costs can be significant. Take a family of four dining out at your typical casual restaurant chain where meals run an average of $15. A dinner out at this place will likely run between $40 and $60. But that’s just for the food. Even if you don’t order drinks, there’s tax and tip which might account for another $10-$15. So feeding your family for one night can easily end up costing upwards of $75. Now let’s say you do this just four nights a week. That’s around $1,200 a month just on food for a portion of your family’s needs. This doesn’t factor in lunch, snacks, and other meals made at home.

Obviously not everybody dines out that often, or has a large family to feed, and there are cheaper options (as well as many more expensive options) available. The point here is simply the staggering cost of dining out too frequently. It may certainly be nice to get out of the house, have somebody cook for you, serve you, and do the dishes afterward, but it does come at a cost.

Don’t Let These Things Make You Poor

The three categories above represent the average American and it shows that housing, transportation, and food account for roughly 70 to 80 percent of our income. That doesn’t leave a lot of money to spend on everything else, let alone try to build an emergency fund, save for retirement, and put the kids through college.  This is why when you try to blame the daily coffee, the cable TV, and other small expenses for making you poor or unable to save for retirement, it really isn’t the reason.

The NPR Planet Money team put this spending data together in an easy to understand chart that will help make this easier to understand:

Source: Bureau of Labor Statistics. Credit: Lam Thuy Vo / NPR

Take a look at this graphic carefully. The big ticket items related to housing, transportation, and food obviously stand out. But take a look at the small circles down at the bottom. Down here you have things like TV and cable, movies and music, books and magazines, and clothing. All of these categories are around 1 or 2 percent each.

These are just a drop in the bucket compared to the big picture, yet these are exactly the things many financial experts tell you to focus on. You are being told to focus on saving money on items that account for just one or two percent of your total spending. Do you know what that means? It means the potential upside of eliminating all of these things from your budget will at best only have a few percent boost on your bottom line. And once you cut those items out, there’s no additional upside unless you find a way to make more money or address the larger money drains.

Again, this doesn’t mean you shouldn’t try to find ways to save on the small stuff, but the point is if you only focus on the small stuff you’re missing out on the things that are really hurting your finances. You can get rid of cable or resort to only brewing your own coffee at home, but you could achieve that annual savings many times over by simply making better decisions on more important areas of your finances. When you keep your daily spending under control and then make an effort to address where most of your money really goes, you’ll be putting yourself in a position to achieve financial independence rather than worrying about money from one paycheck to the next.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.