The Middle Class Isn’t Disappearing — It’s Splitting in Half
There's one thing rending the middle class in two.
A new study from the American Enterprise Institute (AEI) shows that the middle class isn’t shrinking in the traditional sense so much as it is splitting into two distinct classes. That means people earning similar incomes are finding themselves in dramatically different financial situations.
What does it mean for the average person’s finances? And how can you stay on the right side of the divide? Experts offer some tips.
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Why the Middle Class Is Splitting Into Two Financial Realities
A splitting middle class, according to Pedro Ribeiro, CEO and portfolio manager at Marnoa Private Wealth Counsel Ltd., looks like “same income on paper, completely different financial life."
While one group is getting wealthier every month through investing, the other is working harder just to stay in the same spot, he said.
Housing Is the Biggest Wealth Divider Right Now
Housing has become the clearest line separating those moving ahead from those falling behind.
“A locked-in low mortgage versus market-rate rent is probably the biggest accidental wealth divider of our lifetime,” Ribeiro said.
A homeowner who secured a 3% mortgage, for example, might be paying $1,800 a month and earning equity, while a neighbor renting a comparable place is paying $2,600 with no equity to show for it, he said.
“Over 10 years, that’s roughly a hundred thousand dollars going in two different directions.”
Asset Ownership and Debt Are Pulling People Apart
Beyond housing, access to assets and the cost of debt are compounding the divide over time. Small differences early on can lead to major gaps years later.
“Housing affordability is a major factor, but debt levels and retirement plan participation matter just as much,” said Mindy Yu, senior director of investing at Betterment at Work.
She pointed out that carrying high-interest balances or skipping 401(k) contributions creates “a compounding drag” that becomes very significant over years. Or as Ribeiro put it:
“If you weren’t in the market during the last five years, you didn’t just miss gains, you fell behind the people who were.”
Debt pulls people further behind, too. Ribeiro noted.
“Credit card rates over 20% do permanent damage to a family’s balance sheet that’s very hard to undo," he said.
Data from National Debt Relief highlights how widespread these pressures are: 51% of Americans have debt, while 33% report using credit cards to pay bills.
Small Financial Habits Are Creating Big Long-Term Gaps
Some of the fissures between the middle class have to do with small habits. Households that automate retirement contributions “tend to build wealth steadily,” Yu said. “Those waiting for leftover money to save rarely get there.”
The folks pulling ahead also tend to “grab the full employer match” on their 401(k) plans and… “keep credit card balances at zero,” Ribeiro said.
Inflation and Interest Rates Made the Gap Worse
Recent economic shifts have further exacerbated this gap, particularly high inflation. People with investments that earned interest that outpaced inflation “came out ahead” Ribeiro said, while, “If your main asset was your paycheck, you got squeezed.”
Additionally, higher interest rates have actually benefited people who already have assets that earn money, while making things financially tougher for people who don’t, according to Yu.
“That widens the gap further,” she said.
Warning Signs You Might Be Falling Behind
Falling behind doesn’t usually happen overnight. Ribeiro and Yu described several red flags that this could be happening to you:
You’re carrying a credit card balance.
Your have no emergency fund.
Your raises are being absorbed by fixed costs.
You’re avoiding looking at your accounts.
Your income goes up but your savings stay flat.
How To Stay on the Stronger Side of the Divide
While you can’t control economic factors, small intentional moves can help shift your trajectory over time.
Ribeiro suggested you clarify your assets, use your catch-up contributions to get ahead in retirement savings and “get rid of high-interest debt before it gets rid of your retirement.”
Yu advised automating your savings, to create regular growth.
“Small, consistent actions tend to matter more than occasional big moves,” she said.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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