In February, SaveUp compiled its first U.S. Consumer Savings and Debt Report titled "Gen X and Y Lead US Trend as a Nation of Debtors." I found the report interesting and insightful. I'll examine it from a personal financial planning perspective.
My Take on the Report's Findings
The report states, "Over 60 percent of Gen Xer's debt comes from mortgage and student loans, considered "good" debt, that helps build assets and job opportunities. Gen Yers however have close to half of their obligations, 48.4 percent, in non-asset building loans, mostly considered 'bad debt.'"
Low or inconsistent income can create a cycle of taking on debt (particularly "bad" debt) to make ends meet. And unfortunately, the recent economic crisis has affected those in Gen Y dramatically. According to a Bloomberg L.P. article, "Average incomes for individuals ages 25 to 34 have fallen 8 percent, double the adult population's total drop, since the recession began in December 2007." This population hasn't benefited as much from the recovery either. Perhaps, due to less job experience, they face additional challenges entering the workforce and finding a job that meets their qualifications.
Stats on the placement of savings also have interesting implications. The report states, "Gen X and Y divide their savings fairly equally in three ways. Over one third (34.6 percent) of their total savings is set aside towards retirement. Another 32.5 percent is placed in taxable investment plans, while the remaining 32.9 percent is allocated to low interest bearing savings accounts (CDs, savings, money market, etc)." My speculation (and hope) is that these "buckets" line up with specific short, mid and long-term goals. It seems these savers are striking a balance between multiple goals. Establishing goals and making purposeful decisions with one's resources is what I strive to help clients do. I presented a webinar on SaveUp titled, "Personal Financial Organization and Goal Setting." You can view it in its entirety by logging into SaveUp and clicking "Webinars" under "Education" on the left.
Debt Ratios
The types of debt mentioned above made me think about whether or not the debt is affordable. Given falling incomes, can these individuals pay off the debt they have? Debt ratios can give you a starting place to assess whether or not the amount of debt you have is affordable. I presented another webinar titled, "Getting Out of Credit Card Debt." However, the techniques outlined can be applied to tackle any type of debt. You might not be able to afford the debt you have if your total debt to income ratio is over 30 percent (If your total debt ÷ income = more than 30 percent).
Additionally, a ratio of unsecured debt (such as credit card debt) to income of more than 15 percent is to be avoided (If your total unsecured debt ÷ income = more than 15 percent).
According to finaid.org it's best not to have a monthly student loan payment higher than 10-15 percent of your salary monthly. They provide a calculator for those assessing the affordability of various educational programs which can be found here.
Debt is not necessarily a bad thing. However, it needs to be understood, managed wisely and considered in the context of one's goals and overall financial plan. The type of debt makes a difference. You could be paying interest (and principal) each month and be building equity in your house or your could be paying a credit card company. In other words, not all debt is created equal. Additionally, no matter what generation you're in, you want to make sure you have an emergency account as well as a financial plan that is revisited and adjusted to your changing needs.
This post was written by SaveUp's personal finance contributing writer, Catherine Hawley, CFP.