5 Money Habits That Can Keep the Middle Class Poor Forever

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The middle class may seem to have it made financially, with enough income to survive comfortably and purchase homes, vacations and retire well, but even they aren’t immune to poverty.

Robert R. Johnson, CFA and professor of finance in the Heider College of Business at Creighton University, explained five money habits that can keep the middle class poor forever.

1. They Succumb To Lifestyle Creep

The most common mistake people make is letting their spending increase commensurate with their new salary, known as lifestyle creep, Johnson said.

“For instance, people move into a bigger apartment or buy a more expensive car or home to reward themselves for receiving the raise.” While you temporarily improve how your life feels, you can’t get financially ahead, and may even fall behind, especially if you’re taking out loans to finance any of these.

Instead, Johnson urged people to “effectively invest any money from a raise” and to “act as if you didn’t receive the raise.”

Johnson laid out the math: If you received a $5,000 annual raise and you invested that $5,000 annually into an investment account growing at a 10% annual rate, you would have accumulated over $822,000 in 30 years based on a single raise.

“And, lest you believe that a 10% average annual return is unrealistic, according to Ibbotson Associates, since 1926 the average annual return on a large capitalization stock index is 10.4%, while investments in long-term government have on average grown annually by only 5.0%,” he explained.

2. They Become House Poor

Another mistake some middle-class folks make is spending too much on a home, which Johnson said is a form of “crowding out” other investment opportunities. He cited Nobel Laureate economist Robert Shiller who claimed that housing is traditionally not a great investment because it takes maintenance, it depreciates and it goes out of style.

“Many people mistakenly believe that real estate is a good and safe investment. They fall prey to stories of real estate values rising dramatically over long periods of time,” he said.

This doesn’t mean don’t buy a home, but it does mean don’t put more money into one than you need to, and not in favor of other investment opportunities like stocks and bonds.

3. They Take Too Little Risk

While it’s wise to be aware of risks, Johnson finds that people can be too risk averse in their investments.

“Financial mistakes begin early in life and the biggest financial mistake people make is taking too little risk, not too much risk. Unfortunately, many people allocate retirement savings to money market accounts or low-risk bonds.”

The surest way to build wealth over long time horizons is to invest in a diversified portfolio of common stocks, he said. Those who have a long time horizon have more time to take bigger risks.  

“Early in their working lives, people should begin investing in a low-fee, diversified equity index fund and continue to invest consistently whether the market is up, down or sideways.” Known as “dollar-cost averaging,” putting this money consistently into an index mutual fund or ETF “is a terrific lifelong strategy,” he said.

4. They Try To Outsmart the Market

Many people think that they can avoid market declines by moving their money in and out of the market at key moments, Johnson said. He said this is near impossible, or at least, it’s rare for anybody to do it successfully and consistently.

Once again, he said, the best way to counteract this tendency is to practice dollar-cost averaging in a broad-based stock market mutual fund or ETF, such as one that tracks the S&P 500.

5. They Over-Focus on Paying Down Debt

While getting out of debt is important, Johnson said it’s possible “to place too high a priority on paying down debt,” especially if it gets in the way of other investing opportunities.

One such opportunity he’s seen people forego in favor of paying down debt is “the decision to participate in an employer sponsored retirement plan. Perhaps the worst financial mistake anyone can make is turning down free money. If one does not contribute enough in a 401(k) plan that has a company match to earn that match, one is basically turning down free money.”

The quote “all things in moderation,” certainly applies to prepaying mortgages and other debt.

To Johnson’s way of thinking, any strategy that doesn’t prioritize solid, smart and consistent investing is moving in the wrong direction.

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