Most Americans will end up at 55 where they were at 35—not in vigor or short-term memory, sadly, but in earnings.
Recently researchers at the Federal Reserve Bank of New York announced some grim news: An impressive study of 200 million Social Security records going back to 1978 revealed that working Americans’ earnings plateau in their 40s.
This may seem fine—what would be bad about bringing in that same peak salary every subsequent year?—until one accounts for the eroding effect of inflation. For example, say a 45-year-old whose annual earnings peak at $60,000 in 1995 still makes in the neighborhood of $60,000 a year in 2015; by then, at age 65, $60,000 will only buy what about $38,000 bought in 1995. In terms of buying power, it’s like receiving a pay cut of more than $20,000, even though the salary figure stayed more or less the same. Not getting raises to match inflation is probably the biggest reason why 50-year-olds lose buying power after their 40s.
And that’s if earnings stay steady, which, as the Fed report notes, is by no means a guarantee. Americans who work in their 50s and 60s are vulnerable to a lot of risks. Risk, of course, is relative, but participating in the U.S. labor market in middle age and not being in the top 10 percent of the income distribution is fairly risky, the Fed found.
The reason it’s risky is that workers in this age group have a higher chance of experiencing what economists call a “negative income shock”—a way of saying something lousy happened to one’s salary, such as getting fired and having to take on another job that pays less. The AARP reports that on average, older workers see a more than 20 percent wage decrease when they get a new job.
The exception to these trends of mounting risks and diminished buying power are the workers at the very top of the income distribution, who for the most part enjoy continuous and large increases in earnings until they retire.
But, armed with this information, what is someone not on the flusher end of the spectrum to do? Most personal-finance experts will emphasize changes in personal decisions, not in trying to change any bigger-picture systems. The most common advice is to not overspend, and it’s not bad advice. It can be tempting to try to keep up with the consumption habits of a peer group, but since, as the Fed report shows, some in their 50s are paid surprisingly well, keeping up would be damaging in many cases. (Thorstein Veblen, a 20th-century sociologist wrote all about this temptation in his book The Theory of the Leisure Class, in which he explained that even in pre-capitalist societies, people were buying visibly expensive goods to signal their wealth; today, those goods are nice cars, fancy watches, or posh homes.)
However, as is so often the case in personal finance, pinning the responsibility solely on the individual would be a mistake. There are regulatory changes that would make this situation different. As of now, for instance, when someone agrees to take on a loan—be it a mortgage, a car loan, or something else—that loan is based on current income. When most people take on debt like this, they assume that their earnings will increase, or at least stay steady. In reality, though, their buying power will most likely diminish, so debt should be sold with a warning indicating as much. Rosy, false assumptions about rising earnings only benefit banks and mortgage brokers.
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