financial skills

Avoiding the Poverty Tax

Philip Brewer — Fri, 07 Oct 2011 10:24:24 +0000

There's a lot of money in poverty. Not for the poor folks, of course. (See also: Too Broke to be Frugal)

The money in poverty is for the rich folks who sell things to the poor. You'd think that that there'd be more money in selling to the wealthy, but the wealthy tend to be difficult customers. The poor, on the other hand, are sharply constrained in ways that make them a very profitable market segment.

Rich folks — even middle-class folks — get a whole bunch of stuff for free, starting with free checking. They also get stuff cheap — in particular, they get low rates when they borrow. Most important, they can take advantage of deals that are unavailable to poor folks. (For example, they can get huge tax-free investment returns by stocking up and they can afford to drop collision coverage on their car insurance.)

Poor folks end up dealing with check-cashing stores, payday lenders, rent-to-own stores, pawn shops, and all the other businesses that cater to poor customers — and end up paying a lot more.

You'd think that the shops that cater to rich folks would charge more, but that's often not true. The stores that charge the most are the small shops in poor neighborhoods with a captive market of people whose work schedules and transportation options make it impossible for them to shop elsewhere.

Gary Rivlin, in a new book on the topic called Broke, USA, suggests that poverty ends up adding something like 10% to the cost of living for a poor person — it's like an extra 10% tax just for being poor.

But (and this is the whole reason it's worth writing a post about) it's only like a tax. It's more accurate to analyze it as a fee — a fee charged, not on poverty itself, but on people who lack a set of skills related to running their household economy.

Most of us here at Wise Bread have these skills. We learned them from our parents, from our parents' friends, from our peers, from books, from websites like Wise Bread, and maybe even in school. We know how to balance a check register, which means we don't pay overdraft fees and we don't end up bouncing so many checks that banks won't take our business. We know how to create a budget, so deciding to go into debt is a decision, rather than something that just happens while you're not looking. We know how to read the literature the bank sends with the rules for the various kinds of accounts.

The fundamental skill for avoiding the poverty tax is the ability to calculate the all-in cost of a particular set of choices.

For example, we can take the bank's list of account types and figure out which kind of account will give us the services we need for the lowest cost.

Avoiding the poverty tax is simply a matter of applying that skill to the larger questions of your household economy.

When your grocery budget is tiny, it's tough to stock up on stuff that's on sale — but it's not impossible. Start with one can of tomato paste on sale. The following week you can use that one, freeing up enough cash to buy two of something else that's on sale.

Long before your emergency fund grows to the recommended six months' spending, it's large enough to save you a fortune in late fees and finance charges. (And once it's a little bigger than that, it can provide the security you need to save even more money with higher insurance deductibles.)

The trade-offs involved in deciding to buy a car are hugely complex — balancing all the costs (financing, registration, insurance, maintenance, fuel, parking) against the savings and income made possible by the increased mobility. But identifying the key variables and their approximate magnitudes is enough to make useful comparisons. You can, for example, figure out that you come out ahead by living within walking distance of work, even if your rent is much higher.

Of course, just having the skill is not enough. You also have to use those insights to guide your actions. This is also made tougher by poverty. If your finances are already in desperate straits, it's easy to imagine that any particular error or indulgence won't make any difference.

That's just another example of how the poverty tax ends up hitting poor folks while the wealthy don't even notice. But really, avoiding the poverty tax isn't a matter of wealth. It's a matter of skill.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Learn good financial habits from your parents. Or not.

Philip Brewer — Tue, 08 Sep 2009 13:00:02 +0000

One of the big advantages that children of the middle-class and wealthy have is that they grow up in a household where a huge amount of financial knowledge is embedded in its day-to-day functioning. Parents teach it, but it's also just there for the child to pick up, almost for free, like language and basic social skills. If you don't get this basic financial knowledge at home, it's possible to learn it other ways--but don't underestimate how much you need to pick up.

I talked a few days ago about getting your banking services for free. This is something that's routine for any household that's middle-class or higher, but hard for poor folks for several reasons--one of which is just that they don't know how to go about it. But that's just one example. There are so many ordinary good financial habits (like balancing your checkbook, checking your credit card statements, paying your bills on time, having an emergency fund, being careful with debt, challenging vendors who try to overcharge you, having a budget, tracking your spending, saving, investing, and living within your means) that middle-class folks pass on to their kids more or less automatically. It's hard for people who grow up in poor families to catch up.

Obviously I'm using "poor family" as shorthand. Many poor families have great household management skills to pass on to their kids. (After all, a poor family needs great household management skills lots more than a rich family does.) And there are plenty of other things besides poverty that produce the kind of generational ignorance that I'm lumping under the category of "poor family."

For example, immigrants from countries where the banking system is underdeveloped or unsound not only lack basic skills in how to use banks, they often don't even know that those skills are of value--and they're prone to pass those attitudes on to their children. Immigrants also may not speak the local language--and even people who do speak it may not read it well enough to make skillful use of things like bank fee-disclosure documents.

Still, a lot of it is just poverty--people who don't have enough money to meet the minimum balance to get free checking, people who live in poor neighborhoods where there aren't any banks (but are plenty of check-cashing and payday loan places), people who have no financial cushion against small glitches turning into major financial catastrophes. Growing up in such a household makes it tough to learn ordinary good financial habits.

In a middle-class household, the basics of middle-class financial life are being taught all the time in many different ways:

Conscious instruction

Some things are specifically taught. For example, when I was about twelve my grandfather (who was a banker) took me to the bank to make my first deposit. He showed me how to fill out a deposit slip, pointed out what the different lines were for, showed me where to sign the check on the back to endorse it--and explained what endorsing it meant.

Really affluent parents tend to do more of this conscious instruction--teaching their children the proper relationship between family members and the bankers, brokers, and trust officers who deal with their finances. But middle-class parents can and should teach their kids their basics, from how to write a check to how to know when you're being cheated.

Modeling correct behavior

Some things are not so much taught as demonstrated. My parents used debt carefully. I remember that they had a car loan when I was small. When I was a bit older they got a mortgage to build a house on some land they owned, and I remember my parents holding firm when the deal almost fell through over a quarter of a percentage point.

My dad was a college professor and only drew his salary nine months out of the year. During those nine months, he made sure to save enough money (saved out of each paycheck at the credit union) to support us over the summer when he wasn't getting paychecks.

My mom balanced the checkbook every month. It wasn't her favorite household chore, but she did it every month anyway--a habit which I continued until I got married. (Now my wife balances the checkbook.)

Everything parents do while their kids are around demonstrates their values--how much they tip, whether they decide to wait until payday to make a purchase, what they do when a clerk makes an error, which expenses stay in the budget when money gets tight and which get cut.

Letting kids help

I'm old enough that when I was a kid bank statements didn't come with your transactions all sorted by check number. They did, though, come with your canceled checks. So, step one of balancing your checkbook was taking the stack of canceled checks and sorting them into numerical order so that you could mark them off in your check register. When I was about middle-school age, I remember helping my mom by sorting the checks for her. (I remember it vividly, although I probably only did it a few times.)

When I was a bit older I remember paying the household bills a few times--I went through the stack of bills and wrote all the checks and gave them to my dad to sign.

As a small child I'd go grocery shopping with my mom and learned about things like comparing unit prices. I don't know that I was a lot of help, but I was there--not just watching, but participating.

Letting kids manage their own money

Small children will tend to make poor financial decisions for lots of reasons. Their arithmetic skills are still developing and they're still learning things like how to defer gratification. If they have some money of their own, they have a chance to learn this stuff when the consequences of poor decisions are reasonably small--no money for a comic book because they spent it on candy or vice versa.

It's hard to know how much to "help" children make the right choice. Part of the point is for children to feel the pangs of a foolish choice when both the sums and the stakes are small, so it's important to let them make their own mistakes. On the other hand, encouraging a child to save up a chunk of money to be spent on a something the child will enjoy for a long time can go a long way toward developing a life-time habit of thrift.

Casual conversation

Even when there's no actual instruction and when children aren't included by helping, they're still learning all the time. (Learning all the time is what children do. You can't stop it. All you can do is have modest influence on what they learn.)

If the parents are in basic accord, the children will tend to pick up their habits (modified to the extent that they thought things could have been done better). If the parents argue about money, their children still learn a bunch of stuff--that money is important enough to argue about, for one thing. But they also learn from the specific content of the argument. Are they arguing about luxuries versus necessities? Are they arguing about a higher standard of living versus saving? They learn something about each parent's perspective. And, since they have to live with the results, the lesson gets well and truly driven home.

Kids also learn from their friends, their friends' parents, older siblings, their neighbors, and anyone around who has money. They learn from watching and seeing what happens, but they learn in particular from what their parents say about what's happening. Casual comments about this neighbor's failed business or that neighbor having to depend on money from the in-laws make an impression. The kids will also soak up a certain amount of cause and effect from the sequence of events--when the family across the street loses its house in foreclosure, the kids will remember if it's the family that could somehow afford a new pool when no one else could and used to go on two fancy vacations every year.

Teaching yourself

There are lots of ways parents can do a poor job, from failing to do the actual instruction parts to modeling foolish or destructive behavior.

If your parents did a poor job, it falls to you to correct the errors and to fill the gaps. After all, you're the one who has to get by with whatever you know.

Yes, it's a daunting task to pick all this stuff up on your own--especially as an adult, where every mistake can have serious consequences for your family. The fact that it's going to be tough doesn't mean you should skip it, though. It just means that you need to apply yourself to learning all that stuff that luckier people learned when they were growing up.

If your parents did a good job, I hope you'll cut some slack for those whose parents didn't. And, even if your parents did a great job, there's always more stuff to learn about managing your finances.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: