It’s not a surprise to hear stories these days about the middle-class shrinking. A big part of that trend has to do with the lack of sustained wage growth for decades. Families were essentially standing still financially while the tide of inflation continued to rise. The tide came in and many families are underwater. However, stagnant wages and inflation are not the full story and may not even be the most important part.
During this time of relatively flat wage growth, one would think that personal spending would go down. Typically people spend less when prices go up. For example, when gas prices go up, people tend to drive less. However, over the years, the complete opposite happened, while wage growth has been flat for the past 30 years, consumer spending has shot through the roof!
How do you explain that? One word. Credit.
Misuse of Credit Kills Wealth
We’re not looking to bore you with the history of credit, but as consumers, the only way to spend what you don’t have is to borrow. Over the past 40 years, banks have made credit such a regular part of everyday life, that today, you likely may not know an adult that doesn’t own at least 1 credit card. Imagine before credit cards, where you had to walk into a bank and fill out all kinds of paperwork to get a personal loan. We must acknowledge, access to credit is actually a good thing when used properly. The problem comes when credit is misused or financial products are designed in such a lopsided fashion that debt problems are inevitable.
The way most people build wealth is to consistently save over an extended period of time. They use those savings to invest in the stock market, real estate, or to build/invest in businesses. Unfortunately, as credit availability grew and became mainstream, personal saving rates did the exact opposite.
Above is a chart showing the outstanding credit since 1970. Keep note that credit cards really didn’t start becoming mainstream until the 80’s. You’ll notice that credit begins to skyrocket in the 80’s and hasn’t stopped since. Compare that to the chart below showing personal savings rates. People used to regularly save 12-15% of their income in the 70’s, but now it’s down to 5%. One guess on where that 10% difference went. According to a NerdWallet study in 2016, the average family with credit card debt pays $1,292 in credit card interest per year. That does not include interest paid on student loans, auto loans and mortgages.
This is not all about reckless consumer spending, there’s plenty of blame to go around. Inflation, lack of government regulation and complex, misleading terrible financial products are a large part of the problem. For example, recently auto dealers started extending 8-year auto loans. Depending on the interest rate, a borrower could pay as much in interest on that loan as the car itself. Imagine paying $50K for a $25K car and at the end of those 8 years, the car is worth less than $5K. The point is paying interest to banks is the exact opposite of building wealth. The money spent on interest payments for credit cards, auto loans, student loans, mortgages is money not saved and not invested.
It’s not about whether credit/debt is good or bad. Consumers need to be much more savvy about the cost of borrowing money. It’s not simply the monthly payment, but the amount of interest over time and what one is losing out on by paying that interest. It’s about making an active decision about which side of compound interest you want to live on. You’re either paying interest and growing the profit of banks or receiving interest by investing and growing your own wealth. Choose wisely.