Wednesday, June 22, 2011

Avoid Vanishing Along With the Rest of the Middle Class

Statistics show that the richer are getting richer while middle class incomes stagnate. Income and net worth are increasing, sometimes dramatically, for the top 1% and 10% in America, while median incomes barely keep up with inflation (or don't). Mathematically, this means that the middle class are getting poorer relative to the well-off. But most middle class people don't need to see the math--they already know from their end of the month checkbook balancing frenzy that they're getting poorer. Add the strident calls from conservatives to slash Social Security, Medicare, unemployment compensation and other elements of the social safety net, and the middle class is starting to understand how the bison felt when hunters with breech loading rifles invaded the Great Plains 140 years ago.

But people--at least those who aren't herd animals--may have a way out. Let's assume you live in a household with $50,000 in annual income, which is about the median. Put $5,000, or 10%, annually into a 401(k) account that has a 4% employer match ($2,000 per year) over 40 years of work, invest in a diversified portfolio that generates a 6% return compounded annually (a modest amount by historical standards), and you'll have $1,080,000.

If you adjust this $1,080,000 for inflation of 3% per year, you'll find that it's worth the equivalent of $320,355 in today's dollars. But you can get around the inflation problem by increasing the amount you save each year by the inflation rate. Since most people's incomes tend to keep pace with inflation--even middle class incomes, although just barely--you can bump your retirement savings up pretty much in line with inflation. (And note that salary increases would also increase the dollar amount of the 4% employer match.) By increasing your contributions for inflation, you'll end up with the inflation adjusted equivalent of about $1,000,000 after 40 years. If you have a 401(k) without an employer match, or one with a smaller match, save more in some other account to make up the difference.

If you don’t have access to a 401(k) or similar plan, then this plan for a 25-year old could consist of saving the $5000 permitted per year in an IRA account until age 50 and then the $6,000 permitted per year for older folks until age 65. Increase your savings for inflation. Assuming a 6% return compounded annually, you’d have $797,084 after 40 years (or the inflation adjusted equivalent if you increase your saving in line with inflation). The amount is smaller because there is no employer match in an IRA. But if you save a bit more each year in another account or work a few years longer, you'll probably be a millionaire.

Only some 2.5% of the U.S. population has $1,000,000 in investable assets. But at least half the population, including many middle class households, have the potential to become millionaires. You have to be scrupulous about saving, and luck is a factor. Serious illness, disability, or other medical problems, aged parents who are unprepared for retirement, divorce, and other difficulties can blow up a financial plan. But a lot of folks who have the potential to be well-off in their golden years throw that chance away on big houses, cars, and TVs, nice vacations, frequent restaurant meals, fine clothes and other lifestyle enhancements. There's nothing inherently wrong with living large now, if you understand the consequences. But if you want to escape the multitude of middle class people being driven over a cliff by economic inequality, then think for yourself, act on your own, and separate yourself from the herd.

For more on how to build wealth, see the following: (a), (b), (c), (d), and (e)

If you think you really can't save, then take a look at

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