Don't Go Broke 'Gradually, Then Suddenly'
NEW YORK (BankingMyWay) -- In Ernest Hemingway's 1920s novel "The Sun Also Rises," the character Mike is asked how he went bankrupt. "Two ways," he answers, "Gradually and then suddenly."
If things keep going as they have been, that could happen to a lot of Americans over the next few years.
Two current news items make Hemingway's 1920s relevant today. First, the Census Bureau reported Wednesday that the typical American household's income has fallen to the lowest level since the late 1990s, continuing a four-year decline. Adjusted for inflation, average income is about $50,000 a year, nearly 9% less than in 1999.
In the second item, the Labor Department reported that in August wholesale prices had the largest one-month gain in more than three years, suggesting that higher inflation could be on the way.Both trends would seem to be gradual, with the damage mounting slowly over the years. But the effects can snowball quickly. To understand that, turn to another bestseller, Malcolm Gladwell's "The Tipping Point: How Little Things Can Make a Big Difference." Many changes, says Gladwell, happen gradually, then suddenly. A pot of water on the stove gradually gets hotter, then suddenly leaps into a boil. A virus gradually moves through a city, then suddenly becomes an epidemic. The same thing can happen with savings and investments. As wages gradually decline, people put less aside. And as costs rise, the money they save is worth less and less. As a result, more people retire with inadequate nest eggs. So, instead of spending their early retirement years living off their annual investment income, they must start spending principal, the nest egg that should produce those earnings and which, ideally, should be untouched for the first 10 or 15 years of retirement. As the principal gets smaller, the earnings shrink, forcing the retirees to take more from principal in the years that follow. The vicious cycle speeds up, until all the money is gone -- years ahead of schedule. The BankingMyWay Retirement Income Calculator shows the problem. If a 45-year old had $250,000 in savings earning 8% a year, put $10,000 aside every year, while inflation averaged 3%, she could retire at 65 with $4,603 in monthly income from her nest egg, which would last for 30 years. But if she started with the same $250,000, faced inflation of 5% and, because of a falling income, could save only $8,000 a year, she'd end up with just $2,947 a month. Of course, if she dug into her principal in order to spend $4,600 a month, she'd run out of money very quickly. In fact, if inflation were 5% instead of 3% in the 20 years before retirement, she'd have to spend even more than $4,600 a month to maintain her standard of living. Hopefully, things will not turn out this badly. If the economy strengthens, wages may start to rise. And, despite many dire predictions, inflation has been very modest for years -- in fact, in launching a third round of quantitative easing on Thursday, the Fed defended its policy in part by noting the lack of inflation resulting from previous QE programs, despite widespread criticism by Fed watchers in the past that QE policy would drive inflation too high. Still, the possibility of losing money "gradually and then suddenly" should not be taken lightly. The key to minimizing the damage is to spend less in order to save more, to avoid long-term financial traps like an overly large mortgage, and to preserve the option of working longer. Then, if your wages rise and inflation doesn't, you'll be ahead of the game -- perhaps able to retire early or live better after you do. --By Jeff Brown More on the American economy:
One-in-four Americans say they are poor
Not meeting your money goals? Might be your fault
Motif Investing: Can it Save Your Retirement? Follow TheStreet on Twitter and become a fan on Facebook.
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