Congratulations. You are rich!
Australia is now home to 2.2 million millionaires, according to a new study. Half of all Australians in 2021 had more than $400,000 in wealth. This means we have the highest median wealth of any country surveyed.
Yet a financial stress index gives us a score of 40 out of 100 to be able to raise $2,000 in an emergency. We are more concerned about the cost of living than global warming.
What is the problem?
It is entirely possible to be asset rich and cash poor.
Wealth is a stock – a static pool to which we add or draw as we need. In Australia, it’s mostly our homes and our retirement accounts. A great nest egg for the long haul, but far from an ideal way to pay for dinner.
Income and expenses, on the other hand, are flows. A glance at your trading account will be enough to convince you that money is seemingly constantly flowing in and (more often than not) going out. The problem lies in the flow.
Over the past year, salaries have increased by 2.6%. That’s average – not everyone got a raise.
At the same time, gasoline prices rose by 32%. Fruit and vegetable prices are up 7%. The cash rate is more than 25 times higher today than it was last year.
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So it’s understandable that even millionaires (on paper) feel the pinch.
But the financial pain is more pronounced for those with low incomes. Rising costs hurt low-income people the most.
It’s not because low-income people are spendthrifts. The lowest earning 20% of households in Australia spend more than they earn. Yet, although research is dated, it appears that most of their spending is on essential goods and services.
It’s because life is more expensive when you earn less. Whether you call it the poverty bonus or the poverty penalty, the effect is the same. The poor pay more.
There are three components to the premium. First, low-income people often have to pay for things that others don’t – “special costs”. Second, low-income people often have to pay more for the same goods and services – “increased costs”. Third, low-income people may be forced to buy products that are more expensive in the long run because they do not have access to cheaper products – the “access costs”.
Special costs may take the form of additional fees and charges. For example, some bank accounts charge fees if an account is overdrawn or a payment is rejected. Both are more likely to happen when someone is on a low income, as they may have limited funds in their account.
They may also be essential services for low-income people, but less common for high-income people. For example, only 20% of the poorest 25% of workers are entitled to paid parental leave, compared to more than 50% of those earning $1,200 or more per week. Those who are not entitled to paid parental leave may thus be forced to pay more for the care of their children.
The best example of increased costs comes from buying in bulk. If you buy five kilograms of potatoes, you will pay about $1.40 per kilogram. If you buy potatoes one by one, the price per kilogram doubles. So why would anyone buy smaller packs? Well, because a potato costs 70 cents and 5 kg costs $7. If you only have the last few dollars left in your bank account, 70c is what you can afford.
It’s not just about buying in bulk. A more efficient refrigerator can save you $1,000 over 10 years. Still, a higher upfront cost – even if it’s $100 – can be a deal breaker.
The increased costs are also easy to see in utilities. Chances are your electricity or gas supplier will offer a discount if you pay on time. These discounts can be worth up to 30% of the invoice. Which is a lot if you can afford to pay early. If you live paycheck to paycheck, however, getting those discounts is a pipe dream.
Finally, access fees. You’re much better off paying interest on a credit card than on a payday loan. Still, if you have a low income and a bad credit history, it can be difficult to get a credit card approved, forcing you to buy the most expensive product.
So while we’re all feeling tense, it’s those who were already struggling who are feeling the most pressure. Once you start facing poverty premiums, the already high costs become even higher, creating a vicious cycle.
With inflation still rampant and wages taking a long time to catch up, we need to think about how to reduce poverty premiums. It would be a small relief for people who could use the most.