Laura’s note: A version of this column ran in USA Today on Tuesday. Yes, Friday is usually round-up day, but I just got off the red-eye from LAX and this is all I got right now.
Grads, Pursue a Realistic Dream
by Laura Vanderkam
The big headline during recent graduation seasons has been what percentage of mortarboard-sporters will move back home with mom and dad. One widely quoted poll claimed the “boomeranging” rate was 85%. While that estimate is undoubtedly high, we do know that the rate of new household formation — people striking out on their own — plunged during the Great Recession. About 400,000 new households formed annually during its depths, compared with a long-term average closer to 1.3 million.
As the economy recovers, though, the new household formation rate is coming back up. That’s good news for the economy (and stores like Ikea) but it’s a more nuanced matter for those entering the real world this spring. Because when it comes to finances, young people have been on to something. Finding cheap housing is the best thing you can do to improve your balance sheet — freeing up far more cash than cutting out those lattes. The trick for young grads is to keep that same mindset through life, as the huge house that will eat up a third of your income starts beckoning. Rethink what’s sold as the American Dream— ownership of a house you have to stretch to afford — and you might discover the real American Dream. That is, the freedom to pursue happiness.
Housing one-third of spending
According to the Bureau of Labor Statistics’ Consumer Expenditure Survey, housing accounted for one-third of American households’ spending in 2010. (Realtors and online calculators sometimes say you can spend a third of your gross take.) When many people do the same thing, it shapes expectations of normal behavior. To be sure, if you have a low income, you’ll need to spend big just to afford somewhere safe. But what’s interesting is that Americans higher up the income scale consider it normal to stretch, too. People earning $50,000 a year hunt for $150,000-$200,000 houses; families earning $200,000 often eye $800,000 homes, not $500,000 ones.
The usual argument for stretching, on the ownership side at least, is that housing is an asset — a way to build wealth. Alas, it’s also a quick way to lose wealth, as Americans with underwater mortgages can attest. But even if you’re buying low (or are renting), here are practical reasons to rethink the more-is-more mindset as your income climbs.
First, spending less on what is most people’s biggest expenditure gives you the flexibility to change your life that cutting coupons just can’t. Kristen Hagopian’s family went from earning $100,000 a year to $50,000 when she decided to stay home with her kids for a few years. While this Philadelphia-area mom knows her way around a thrift store — and shares tips on her Brilliant Frugal Living radio show on Philadelphia’s 1180AM WFYL station — all the discount shopping in the world wouldn’t have helped if the family had a $400,000 mortgage.
A better option
Fortunately, they didn’t. “Do yourselves, your sanity, and your bank account a huge favor, and go for a home you can easily afford on one income,” Hagopian advises. That requires careful shopping and perhaps repairs, but “the work you put into finding such a home will be richly rewarded down the road with a much clearer, much faster path to financial freedom than just about anyone else you know.” You could change careers. You could retire early — not a bad trade-off for a smaller yard.
Second, happiness research finds that spending on experiences makes us happier than spending on things. We anticipate our fun beforehand and savor the memory afterward — something hard to do with a sofa. Spending less on housing means you can afford a lot of vacation. That’s what Danny and Jillian Tobias discovered. They landed good jobs in the Washington, D.C., area after college, but rather than spend a third of their income renting (or buying) a swanky apartment, the couple rented a “very, very cheap” one, Danny reports, that cost about 15% of their combined income. The payoff? In five years they saved $80,000, which they used to travel the world. Over the course of two years, they climbed Mount Kilimanjaro, they saw the mountain gorillas in Uganda, they followed the old Silk Road overland from Turkey to China. “We’ll have our memories for the rest of our lives,” Danny says. “In a way, it was an investment in ourselves.”
This strikes me as the real American dream — investing in a great life, not just great granite countertops. Obviously, you can’t live in Mom’s basement forever. But as young graduates start the household formation process, it helps to remember that money spent on one thing is money not spent on something else.
Once you start earning good money, it’s tempting to look for a place that will impress the Joneses. But “Americans tend to easily get swept up in the idea that we need to create the perfect home as soon as possible, and we can end up bankrupting ourselves in the process,” says Kimberly Palmer, author of Generation Earn: The Young Professional’s Guide to Spending, Investing and Giving Back. “Sometimes you have to consciously fight back against that cultural pressure to overspend on a home, whether the pressure is coming from parents, friends or HGTV.”
Spending 20%-25% of your income on housing, rather than 34%, leaves 9%-14% for building a life. That can make you so happy, you won’t care what the Joneses think.
Laura Vanderkam, author of the new book All the Money in the World, is a member of USA TODAY’s Board of Contributors.
Photo courtesy flickr user turkeymom4bacon