The United States may have been built on the hard work of the middle class, but the middle class we once knew simply is no more -- at least according to a recently released Pew Research Center report.
It's time to say goodbye to the middle class we once knew
In 1971, there were 80 million middle-income American households -- middle-income is defined as those with an income ranging between 67% and 200% of overall median household income after being adjusted for household size -- and a combined 51.6 million upper-income and lower-income households. Furthermore, the middle class held more than three-fifths (62%) of all household income (based on data from 1970).
Fast-forward to 2015 and the number of middle-income American households has grown by more than 50% to 120.8 million. However, we've witnessed far faster growth of upper- and lower-income households, which now combine to total 121.3 million households. The simple conclusion is that middle-class America is no longer in the majority.
Additionally, U.S. aggregate household income as of 2014 shifted dramatically in favor of upper-income households. As you can see below, middle-income household income has plunged, while lower-income household income hasn't really gone anywhere.
This serves as a quick overview of Pew's findings, but there were plenty of other nuggets of interest within its report. Let's briefly examine a few.
The wealth gap is growing, but it's not all bad
Perhaps the most intriguing find is one that's generally been well-accepted for years: the wealth gap between upper-income individuals and the lower- and middle-class is growing.
According to Pew, we've seen household income growth across the board based on 2014 constant dollars. But the fact remains that upper-income households have witnessed their median incomes rise by 47% in constant dollars compared to just 34% growth in middle-income households and even slower growth of 28% in lower-income households. Having more money gives upper-income households greater access to secondary and tertiary income streams, such as rental properties and dividend income from an investment portfolio, which could help explain some of the growing difference in wealth.
But the so-called income gap isn't all bad news for America. The number of people living in the highest-income households (defined as three or more times median household income) has more than doubled from just 4% in 1971 to 9% in 2015. This figure might get lower-income households in an uproar, but the fact that the middle class is shrinking and the upper-middle class percentage is pretty much static over the last 44 years suggests that economic opportunities, either job- or investment-based, are allowing Americans to improve their socioeconomic status. It should be noted, in all fairness, that the percentage of lower-income households has increased, too, from 16% to 20% over the same time span, so clearly not everyone has found their way up the economic ladder. But the indication is that the American dream is within grasp, potentially regardless of your current socioeconomic status.
Housing plays a big role in the growing wealth gap
One of the real standouts in Pew's research report was just how big a role housing played in defining the wealth gap between upper-income and lower/middle-income individuals.
As a percentage of median net worth, home values play a much bigger role for lower- and middle-income Americans than they do for upper-income individuals. Therefore, when the Great Recession hit between 2007 and 2009, middle-income and low-income Americans really took it on the chin as home prices drastically deflated. The end result is that median wealth for upper-income households has pretty much doubled since 1983, in constant 2014 dollars, whereas for middle-income households the Great Recession essentially wiped out the entirety of their two-plus decade advance. Lower-income families have actually seen their median net worth decline in constant dollars over the prior three decades.
Pew's report is an excellent reminder to be wary of one of investing's greatest myths: that your home is a good investment. The reality is that home prices typically appreciate in value on a step-by-step basis with the rate of inflation. Robert Shiller, author of Irrational Exuberance, notes that home prices outpaced the rate of inflation by a meager 0.21% between 1890 and 1990, and the return was even paltrier between 1950 and 1997, where it clocked in at 0.08% over the rate of inflation per year.
The lesson here is simple: your primary residence is a place to live and shouldn't be counted on as a vital asset for your retirement.
Education is another primary defining factor
Another big separator of wealth is education. This probably comes as no surprise, but the more schooling you undertake beyond high school, the more likely you are to be able to climb the socioeconomic ladder.
Decades ago, going to college was considered an exception to the rule, not the expectation. In today's job market not having a college degree is akin to having two 800-pound concrete blocks attached to your ankles as you attempt to climb the socioeconomic ladder. Between 1971 and 2015, college graduates with a bachelor's degree or higher had a net gain of 1.3 percentage points in their income status (a measurement that quantifies the change in upper-income individuals minus lower-income individuals). By comparison, high school graduates, less than high school graduates, and some college/two-year degree individuals saw their income status decline by 21.9%, 18.1%, and 16.1%, respectively.
The important lesson here is that your education is critical to landing a job that allows you to earn a good wage and offers opportunities to advance. This doesn't mean that you need to go to Harvard or become a surgeon for that matter. However, a four-year degree in a field that interests you and is also in high demand is likely to result in a good starting wage and room for advancement.
Furthermore, wisely choosing what college to attend can be an important step. Student loan debt can be crippling, with the Institute for College Access and Success noting that 69% of students graduating in 2014 had some form of student loan debt. The average debt per borrower worked out to $28,950. As a prospective college student, you want to maximize your return on investment, which sometimes means avoiding costly private colleges in favor of less expensive in-state four-year schools. Each situation will be different, but you'll want to weigh all available options when deciding where to attend college.
One last defining point
Lastly, even though Pew's report strictly focuses on comparing data taken from the U.S. Census Bureau and Federal Reserve Board of Governors, and doesn't get into too many specifics behind why we're seeing a widening of the wealth gap, the writing on the wall suggests that the ability to invest is likely one of the biggest wealth-separating factors.
We've witnessed a solid expansion in stock and bond assets as a percentage of household wealth among all three income classes. Lower-income families had 7% of their assets in stocks and bonds in 2013, compared to just 2% in 1983. Middle-income families witnessed their stock and bond holdings jump to 21% of their household assets in 2013, up from just 6% in 1983. Finally, for upper-income families, stocks and bonds comprise 26% of their assets today.
As a whole, upper-income individuals are better diversified with their assets, but they also understand the importance of investing for their future with stocks. Pew's report is a testament to stop waiting and start investing for your future. Buying high-quality stocks and holding them over the long term has been shown, more times than not, to be an effective strategy to build wealth over time while outpacing inflation. Whether you're starting with $100 or $100,000, the longer you wait, the more time opportunity you'll lose to compound your nest egg.