A model for economic mobility

This is a continuation of this threads discussion of a model for wealth accumulation:

http://boards.straightdope.com/sdmb/showthread.php?threadid=106675&pagenumber=1

The goal in this thread is to present a realistic economic model for the amount of wealth an underachieving yet frugal working class couple can accumulate. I’d like to examine the net worth at ages 50, 60(retirement) and 88(death.)

I’d like to suggest the following scenario. Any interested in the analysis are free to chime in with any differences.

  1. A young married couple, Sam and Sally Sample, ages 18 have assets of $3,000, a serviceable if older car, and another $1,000 worth of real property.

  2. They are both menially employed earning $8.00 an hour, working 40 hour weeks, 50 weeks a year.

  3. They receive no benefits.

  4. All necessary living expenses are paid out of income, but we assume that they are frugal and savings oriented rather than spending oriented.

  5. Within the next 7 years they will buy a starter home valued at $50,000.

  6. Within the next 5 years they will buy a 2 year old economy car, and drive it for eight years before they purchase another. They may or may not finance.

  7. At age 25 and 27 they will have a child (Suki, and Stan,) raise it, and send it to an average state college.

  8. Also at age 25 Sally will stop working, and Sam will have been promoted to a position where he earns $25,000 a year with decent life, health, and disability benefits, and a 3% matching 401k plan that he will contribute the max to.

  9. From age 25 to 50 Sam’s real income will increase $1,000/year, topping out at 50K, as he moves up in his company to the level of Shift Supervisor at Asphalt Solutions.

  10. He would like to retire at age 60, but can work until age 65.

  11. They will keep a $3,000 safety net in ready cash when they can. Excess above that will be invested in an S&P 500 fund where it will return exactly 8% in real terms, as will Sam’s 401k. At age 50 and above they will adopt a more conservative philosophy and earn 5%.

  12. Depending on their financial circumstances at age 38 they may buy a new house and rent the old one out. We will assume real growth on real estate will be 4%.

If those terms aren’t ok, let’s discuss an modify them until they are.

If they are we will need to devise a budget for the couple for the following periods: age 18-25, 25-50, 50-retirement, and retirement through death, then run the analysis.

Let’s discuss all financial items in real terms with today’s dollars.

Let’s start with the 18-25 budgetary recquirements and see if we can’t reach a consensus, but first are there any objections or suggestions to the 12 items?

If you are going to a do a lifetime analysis like this you may want to include income shocks, both positive and negative; i.e. an inheritance (postive), or a costly hostpital stay for one of the children (negative) as a kind of stress test.

tretiak:

I’ve thought of that, but how do you model it?

Ideally, I’d just assume that they cancel each other out.

Maybe it would be best to throw in another look at their financial picture, say at age 32, and that would give us an idea of how able they might be to weather such a storm.

Where do Sally and Sam live. Cause it ain’t the Twin Cities:

I sold my 100 year old, needs a new roof and new wiring, 600 sq foot 1 bath, 2 bdrm, in a bad neighborhood home 4 years ago for $78,000. Same home is now worth $112,000.

You cannot rent a studio apartment for less than $400 a month (OK, there was one in the paper last weekend for $380, but it was in a really scary part of town).

I have every respect for this thread and have every hope that it will bring enlightenment. However, I shall not participate.

This kind of stuff is exactly why I spend so much time at SDMB, instead of doing my real work. :frowning:

Well, back to putting numbers in boxes…

Dangerosa:

Good question. We’ll need to assign a state for the samples for tax purposes. Let’s put them in my State, PA, and not in a prime city like Philly, or Pittsburgh. How about we start them off in a trailer park in Cumberland County for $225/month plus utilities (actual cost of renting near me,) or if that’s just too horrible we could put them up in half a duplex near town for $375/month.

The historical average appreciation on a home in America is about 5% (as I recall from my research, being a recent home buyer); it outpaces inflation, but not by a great deal unless you buy the right house in the right area (and I’m guessing a place with 50k homes suitable for a family is not the sort to be likely to experience a rapid influx of homebuyers…you gotta be way out in the boonies 'round here for that). It tends to be lower for condos as opposed to SFH, and generally depreciates for mobile homes. It depends greatly on where the home is, and if they are buying a dperessed area, the house may not appreciate much at all, and may even go down. I think your projected 4% real return is unrealistic, much though I’d like to believe otherwise. :wink: If you have a source that says otherwise, I’d like to see it; I’ve found a search link to a Fannie Mae .pdf that said 4.6% over the past 40 years, but it kept crashing my browser so I can’t check the context.

(If they have less than a 20% down payment, they will have to pay private mortgage insurance until the equity in their home reaches 20%, or do an 80-10-10 loan where the 10% loan is a home equity loan (usually at a higher rate))

Gaudere:

The problem with real estate is that it’s not a continuous liquid. Some areas are going to do much better, others not. Our house for example (and I’ll email you a link if you want to see pictures for it is about to sell for 2 1/2 times what we paid for it 7 years ago.) Just five miles away though, a landfill went in and those houses near it have lost value.

Most of the indexes out there like the Wilshire, the barns and NCRIEF are geared more towards commercial real estate or timberland, so it’s tough to get good numbers. TIAA-Cref says 8% is the recquired return for a mixed bag of real estate in a portfolio to keep it efficient according to Modern Portfolio Theory, in a report I have in my posession. Spiritus found a link that said they got 8.25% over the last 5 years, so they probably arrived at their 8% through the rear view mirror.

I suppose that trying to guess the average return of an individual house is as foolhardy as trying to guess the average return of a specific stock by looking at the S&P 500, yet what’s the alternative.

Is that 4.6% of yours an inflation adjusted return? I find it difficult to beleive the real return on retail housing properties is only 1% or so.

Not knowing Pennsylvania (I saw it from Jersey once), is Cumberland County the kind of place where if Stan were to get laid off because the factory shuts down, he will be able to find a comparable job? Or is it like the small towns I used to help close plants in where we were basically telling people to pack it in when we “obsoleted” the plant?

If its the first, you don’t need a risk assessment for a possible (probable in Stan’s line of work) layoff. In the second, you definately need to figure it in.

Also, is their public transportation available there, or will their one beater be sufficient for both of them? If they work in two different places - or work different shifts, they will either need access to public transportation or a second car.

Your budget items while they rent - I pulled them last night when I saw the other thread and I was thinking “Scylla’s insane, I lived this and it didn’t work”:

Rent

Taxes

Utilities:
Gas
Water/Sewage
Electrical
Phone

Insurance:
Car
Health
Home/Renters
Life (but I would say not until Suki is born do they need life insurance)

Gas

Groceries

Clothing/Haircuts/Laundry (I assume they don’t own a washer dryer at 18 and one does not come with their rental - or if it does its coin op).

Perscription drugs (I’m assuming Sally is on B/C pills, without coverage these ran $35 a month 10 years ago)

Real Estate, particuarly housing, has been kicking ass the past 5 - 10 years (It’s what’s been keeping up from getting stuck in this recession; the low interest rates and high appreciation allow homeowners to refinance and get extra spending money, while the demand for housing keeps the economy going), so I’m not surpised at the recent spectacular rate of returns you’ve been able to find. Heck, it was over 20% last year in my 'hood for condos. I think the average of just a few points above inflation is more relatistic for the long term in areas where there is no real scarcity of land (unlike Chicago or NYC or LA), and if I remember when I get home I’ll see if I can look up the figures in the homebuying books. I remember also a general rule of thumb is to plan on owning a home for about 5 years just in order to not lose money on fees, closing costs, points, and sales commision, and it’s about about 3-7% for closing costs and about 6 - 8% for commision.

So they’re saying they need 8% for their theory, but I don’t see them saying that that’s an average return.

Also, since 1980, the 30-year fixed mortgage rate has averaged about 10.15 percent.

Dangerosa:

That’s a good list. We’ll start from that and see if anybody wants to add anything to it.

Gaudere:

You’re right about the TIAA_CREF. Needing 8% and getting it are two different things.

I’d have to get my book out on it, since I’m not a big follower of MPF, but the way it’s supposed to work it assumes a degree of efficiency in markets over time.

What that means is that for the given risk of an investment when compared with other investments, there’s a certain minimum return that is necessary otherwise nobody is willing to buy it and take the risk. If the return is too low then the price drops until it becomes attractive. If the return is too high, then the price goes up until it is no longer attractive on a risk/return basis.

The required return is kind of like your baseline, what it should be getting. Modern Portfolio thery is most valid for trying to devise a portfolio with proper weighted allocation, not for predicting returns, so I know I’m trying to use a wrench to hammer a nail when I use the TIAA-CREF’s figures this way. So, what the hell?

How about we assign real estate a 2% real growth rate?

I think it does better but I’m getting seriously outvoted.

I think inflation skews that number during that period. I’ll either find historical data or interpolate a mortgage rate based off a spread from the 30 year treasury. But, we don’t have to worry about that until we get Sam and Sally off the ground for the first few years.

Dangerosa:

Well, around here there’s a number of industries and plants. I’d just as soon assume Sam stays in the same job at the same co. or that he finds equivalent jobs and is basically continuously employed. Seems like a reasonable stance.

I suppose we could build in a one year layoff to occur randomly during his employment, but is that really going to add anything to the analysis in comparison to the trouble it’ll take?

Lets see how the years play out. We can throw some sort of curve ball at the family (maybe a layoff, maybe a health problem) later if we think its realistic. Lets just play it year by year.

In year 0. Sally’s weekly paycheck looks like this:

Gross wages $320
-13.83 Fed
-19.84 SS
-4.64 Medicare
-8.96 PA State tax

She files married with one allowance for a net weekly pay of $272.73.

Stan’s paystub is identical.

They work 50 weeks a year and are not getting any benefits, so they get $2,272.75 every month in their budget. Not too bad (and better than I was doing way back when - but then I had one $25,000 income, not two $16,000 incomes).

Dangerosa:

Cool. Thanks for working the pay. We can start devising a budget if we want (I say they live in the trailer park because Sally wants to buy a house ASAP.) I also figure Sam has an 1986 IROC Z28 that he bought in High school that he maintains himself for the time being.

But, I don’t want to actually run them through the first few years until we’ve given more time for people to question the original assumptions or add to them.

Nice work, folks. The model is shaping up. I only have a few minor points of possible contention:

dangerosa’s list of expenses mentions prescription drugs, but I think we should really have some expectation of medical interventions which then get dealt with through either insurance or direct expenditure. Young people are generally healthy, but I would think that 4-5 visits to a doctor per year between the two is fairly conservative until age 24. More as son as Sally gets pregnant, of course. And the frequency of visits per capita increases with both children and age.

It;s probably simplest to just figure on an HMO and factor a few copays and prescription fees into each year. Looking longer term, I would think that at least one year in ten when the family pays 80% of an HMO deductible is about the right ballpark. Should we factor in dental visits, too? They are not covered under most low-cost medical plans (and are a separate cost under most employee=sponsored plans).

Scylla, the only item on your “life schedule” that I find unusual would be the turning of a house over to rental income. I think it will complicate the analysis unnecessarily while also being a divergence from the “normal” blue-collar couple. (Mostly, though, I envision huge headaches in trying to decide what a realistic rate of return over the life of a rental property: liability, repairs, vacancy periods, upkeep, tax consequences upon sale, ugh!)

They also need medical insurance. At least major medical. I didn’t have it in my budget because, well, it was actually my budget ten years ago, and the company I worked for had benefits.

Also, we’ve given them start up assets, but they are going to need to spend those down for start up costs, not many 18 year olds own a vaccuum cleaner - and unlike a couch (you can always find someone who will give you their old couch) things like vaccuums are hard to “gift” into. We can assume that they got a lot of things they will need (pots and pans, dishes, towels, sheets) for their wedding - but people don’t tend to give toilet bowl cleaner as a shower gift. I see a $500 trip to WalMart in their future.

There are the set up costs in setting up a kitchen. You only buy things like baking powder or basil once every couple of years - but it needs to be bought the first time. Grocery set up costs - $300

They also need furniture. Sally would like a new couch, but being frugal, is happy to throw a slipcover over the old one that someone else was getting rid of and came free for now. However, they are using Sam’s full sized bed from his parents, and he boinked Kelly Kline in it during their sophmore year, so a new queen size bed is a must. She’d really like a new bedroom set, but, once again, she is frugal, and that $3,000 nest egg needs to be saved as much as possible. They do need a TV and and VCR (or DVD player, both can be had for $100 bucks), however - even poor people in America have a TV and a VCR.

And we are still a single car family - does that work with them both employed - are we assuming they can carpool?

I go pick up my adorable children now, and probably won’t be back until sometime tomorrow.

Oh, and wouldn’t we want a few more slices in our analysis?

18-25
-------------house + Suki + Sally @ home + Sam’s new job
26-27
-------------Stan
28-38
-------------New house
39-43
-------------Suki in college
44-45
-------------Stan in college
46-47
-------------Suki graduates
48-49
-------------Stan graduates
50-retirement
-------------The good times roll

Oh, and as I think about it I have a couple of issues with the $1k/yr raise (in todays money) from ages 25-50. One the one hand, your shorting the poor guy by stopping at 50–raises should really continue until he retires. One the other hand, 4% raises above inflation (decreasing to 2% over time) are pretty generous for an “underachieving working class guy”. On ethe third hand (hey–it’s economic modeling. The maket supplies hands to meet demand) it does make the numbers nicely symmetric and easy to figure. Perhaps the first two hands cancel each other out so we can clap with the third? Tell me, does $50K/yr for a 50-year old in your part of Pennsylvania qualify him as an “underachieving working class guy”?

Spiritus Mundi:

I just don’t see them buying health insurance early on. I didn’t, until I got at a job that supplied it. I also didn’t go to see a Dr. from 18-25 except for some stictches at the ER, and the blood test for my marriage. I’m inclined to think that Sam is young and foolish and believes himself to be immortal at age 18.

Sally on the other hand is the brains of the outfit, and while she can’t talk Sam into Insurance, she goes to the Dr. twice a year. I say she gets a diaghram, not the pill, and that she also goes to the Dentist twice a year.

We’ll let Sam pay for his foolishness and not go to the Dentist until he gets an abscessed tooth and needs a $400 root canal at age 22. Then he’ll go semiannually.

As for the rental housee ::shrug:: You’re right, it’s not typical, but let’s take a look at how they stand financially at that time and decide whether it’s reasonable for them to make some kind of investment or not.

As for Sam’s salary. It’s pretty arbitrary. There are three big manufacturing plants nearby where a shift supervisor might be in charge of a couple of hundred people and make anywhere from 75-100k, but that would be better than the life of mediocrity we’ve consigned this couple to.

I think 50k would place Sam pretty squarely in the middle of long-term blue collar workers, but we can make it more, or less.

If we wanted to try to be more accurate I would guess that he could probably get up to 40k pretty quickly (say by age 30,) but from there it would be a slower climb. It’s really going to depend on the business. Shit asphalt solutions could go public and he could make millions on the IPO, but if we want to put him in the middle of the road, I’m inclined to leave it as it is.

We’ll see what anybody else thinks, and maybe make a decision and try to put together the first few years tomorrow.

Once we get it done, it would be pretty simple to go back and run different scenarios. I.E. Sam gets up to 75k, or never gets past 30k.

After we run it through the first time, then we can also decide on some “what-if” scenarios with disasters and stuff.

Dangerosa:

Yeah, this thing is fleshing out nicely.