There are two primary ways that anyone can use to live above their means, meaning they are spending more money than their income can sustain without creating a financial crisis. The first way, the invisible way, is to spend the money that should be set aside in savings to maintain and replace physical items. When you cannot afford to maintain or replace the items you use then disrepair will inevitably result in a drop in your lifestyle from where it is today. The second way to spend beyond your means is to access and spend credit. There are many ways to access credit, such as a pawnshop, payday loan, or car loan. However, for the average person to consistently spend above their means and imperil their finances, there have been 3 giant trends. Each of these trends leaves the borrower poorer with interest charges, tax penalties, and a weaker financial foundation.
Version 1.0 – Credit Cards
Although credit has been around for thousands of years, the ease of access to credit for Americans didn’t expand until Visa and Mastercard were formed in the late 1960’s. Prior to that, you pretty much had to pay cash for everything but a home or possibly a car.
Version 2.0 – Home Equity
Anytime that real estate prices take off, such as the late 1970’s or early 2000’s, homeowners extract their equity to spend by taking out home equity loans or second mortgages. One mortgage broker joked to me in 2007, “I have a lot of clients who refinance twice a year to extract more money. But there is one client who is always borrowed to the maximum but would still borrow an additional $20 every time his home would go up in value, if I’d let him.
Version 3.0 – Raiding Retirement Accounts
According to the IRS, $60 billion was withdrawn early from retirement accounts in the last 12 months. Be aware that these early withdrawals triggered tax penalties of 10% of the amount taken out. Raiding retirement accounts early began with the Great Recession of 2008 but since then it has only increased over the last 7 years. Families that were struggling financially looked around for spending money and saw no savings, no home equity, and no credit, so they targeted the one asset they had left, retirement accounts. Unfortunately, U.S. underemployment hasn’t improved since 2008 so the average American continues to struggle financially. Perhaps this is why Fidelity Investments just reported that the average 401(k) balance for someone over age 55 is only $65,300 – a woefully inadequate amount to support any kind of comfortable retirement.
Each of these living-above-your-means versions are for the financially illiterate who haven’t mapped out their financial life and create bigger problems than they solve.