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The Fallacy of the Middle-Class: Overcoming Social Resentment (X). Debt… as ACOT (A Cherry On Top).

Hi to everyone. This is such the beginning of the weekend, and I am challenged to finish this publication with one of the most “sempiternel” ideas of my whole life. I will try to be brief, and direct to the point.

“Beach Awaits”, an aquarelle exercise that I did to learn how to paint sand. Many of the miniature paintings are my studies on how to paint this or that. Size: 5 inches x 7 inches. Handmade with love on paper Fabriano 5 300 gsm.

In my last post, we learned about the expenditures and the budget 50-30-20 of one typical Salvadoran low-middle class family that is composed of 5 members (2 adults and three children). I also was specific in terms of showing you that any monthly family budget is simply a mirror of how to spend the resources or its sources of funds gathered, and once we analyze the way each family distributes its budget in needs expenses, wants expenses, and savings, we can also understand the “real vs intended” life-style of the middle-class families. We started with the example of a low-middle class family which earns US$28,800 dollars (gross per year), simply because it coincides with the median low-class family earning scheme of the United States of America (before the COVID19 pandemic).

The life-style of a family is restricted either by budget-resources, time, and available options. We studied this case in detail over the slides. We also acknowledged how important was that each of my readers can exercise their own budget 50/30/20. What did you discover? I am sure you found out many things about your lifestyle (good and bad decisions). We also wished to state that each family is free to choose or select its expenses priorities. We cannot impose any lifestyle on any member of society, because in a free-country, each family can do with their money what they want to do, and spend it how they want…. but if your priorities are to support your children to be integral individuals in the future, it is wise and advisable to help them to be integral and educated, beyond what they get at school. We also illustrated this concept in one of the slides provided.

How does the middle class live? – Sources of Funds. Today is all about the sources of funds for the middle class. Not just the low-middle class families, but all the middle-class (those who live with US$ 28,800 dollars/year up to US$150,000 dollars/year). According to Brookings, OCDE, World Bank, Ernst & Young, and Bank of America, the annual income for a middle-class household starts at US$14,600, but for our consulting house Eleonora Escalante Strategy, one of the variables to define the middle-class in terms of income revenues, must be to review the lower limit bracket, because we consider it should be at least US$28,800/year, regardless the country. Otherwise, if it is below US$28.8K/year; families are simply still in the low-class, and sharing many of the multidimensional poverty or deprivation dimensions that we will share in our next theme for next week.

The sources of funds from the middle class are as follow:

  1. Full-Time Employment Salaries or wages: The family of five of our example, only has one economic provider (mom) who earns a gross salary of US$2,400/month. But it could be the case, for example of another family in which both of the couple (husband and wife) work and each earns US$1,000/month. Additionally, the eldest of the children, who studies at the university, is also working and earning US$500 at a Call-Center. If you sum the three monthly income wages, this family is able to be considered a low-middle class family, only by the variable income.
  2. Family Remittances or International Support from relatives: El Salvador has more than 2 million Salvadorans living outside its territory, and they send between US$ 250 to US$ 500 dollars a month to their families residing in the country. Many low or mid-middle-class families couldn’t bear to live as a middle-class, without that monthly support.
  3. Second work activities or an adjacent entrepreneurial informal income flows: For example, a marketing manager who works 40 hours per week at a mobile-phone company, may have a second source of revenue streams, which come from a petit business led by his wife (who sells bijoux jewels or clothing or tacos, or has a distribution of bakery inputs all over San Salvador).
  4. Real Estate Assets: If the family has inherited assets or has invested in real-estate, any income that may come from the renting or leasing of those assets is added. For example one of the adult members of the family has inherited a couple of houses from her parents, and she rents these properties, that provide a fixed secure cash-inflow month by month.
  5. Financial Income: Some high-end middle class families invest in financial portfolios (fixed income, equity shares or stocks, etc) in the local and American financial markets. This portfolio investments may provide some financial cushion or earnings year over year. For example: Ten years ago, a financial manager of a bank, received a bonus of US$ 15,000 at the end of the first year of work, and he decided to invest it totally by buying shares and fixed income securities through Fidelity Investments. At the end of the first year, he was able to grow the initial US$15,000 into US$16,500. Year over year, this financial manager was investing all his bonuses, and he has been lucky to keep growing his financial earnings. Nowadays after 10 years, he holds more than US$250,000 in financial investments that he can cash out whenever he wishes to do it.
  6. Debt: Banks and financial services or credit card companies are always hunting for the middle-class. VISA offers financial products to those household members who earn more or at least US$80 dollars per day. Banks are offering short-term debt instruments to anyone who has a capacity to pay in installments, but little is promoted into anything else than consumption of wants and needs.

Many families of the Middle-Class are trapped in debt as a way of living. But what happens when your revenue streams are not available (let’s say that your spouse has lost his job, or your kids are still too little and can´t help economically or your restaurant business has been hit by the pandemic, and you are desperate and helpless to keep your workforce, and decided to ask for debt?). The worst sin of the middle-class is to believe that just because they have had secure revenue streams, they can get indebted for whatever they wish to buy. The lack of financial education in the Middle-Class is abundant. No one teaches us to do household budgets when we are children. No one teaches us that debt is only for those who are able to pay it, and no one has expressed boldly that the utilization of debt is a terrible way to grow our consumption and lifestyle patterns.

The utilization of debt must be only when a middle-class company or a middle-class person doesn´t need it and it is able to pay for it. And that means, strictly when your cash on hand named Free Cash Flows (defined as EBIT + Depreciation – Capital Expenditures – Increases in net working capital) is positive, robust and it is growing year over year. Debt is not to fix what you don´t have, is to catapult your economic growth, knowing that you are able to pay all your obligations without any type of trouble.

For example, let’s consider an entrepreneur who sells grains (he is a grains-retailer): his entrepreneurship endeavor is to sell rice, corn, beans, chocolate, coffee, etc. His sales per month are $6,500.00; and the amount of Earnings before Income Taxes, Depreciation, and Amortization (EBITDA) of $2,500.00/month. This business entrepreneur is always saving between $1,000 to $1.200 dollars per month. On top of that, the entrepreneur has cash-flows not only from operating activities of his grains company, but he also has cash flows from investing activities (of his savings). In total, this entrepreneur has enough cash, reflected in positive and growing free-cash-flows (remember that a free-cash-flow is the total cash available for distribution to owners and creditors after funding all worthwhile investment activities). His financial results have been awesome over the last three years. In consequence, the financial health of this company is perfect, it is strong and it is promising for the future, to begin to think into consideration to get indebted.

Debt should be considered only as a cherry on top. A “cherry on top” means metaphorically that something small and special is added to something else that is also very nice to make it just that much more enriched and prettier (but is not really needed). Don´t get me wrong please. Debt is not to demonize it either. But debt can be used only when we don’t need it. In simple terms, if you wish to use debt (short term or obligations of one year max duration), you have to ask yourself first the following question: Can I survive and cover all my wants and needs without revenue streams (salary wage or income from my business) for at least one year? If you are not able to do this, you can´t get indebted neither ask for a credit card or short term loans. Even during the current pandemic recovery, debt has to be used wisely (with extended grace periods, lower interest rates and petit payments per month). Remember a post pandemic financial product in debt is for recovery, and it requires to be accompanied of a rescue grant or other gifts/donations (government recovery packages).

Debt only as ACOT. ACOT is the acronym of “a cherry on top”.

But what happens when families do not have a business, do not have real estate assets, do not have savings neither investments, do not have remittances flows from relatives in foreign lands,  but only an average salary per year of US$28,800. What happens when this family decides to use credit cards to begin to pay certain indulgences above its monthly budget, specifically for certain wants and needs month over month? What happens when this family is also not saving anything at all?… And on top of that, this family has been affected by the pandemic, to a point in which the employer decided to send the economic provider to WFH (work from home) and reduced her salary by 30%? To be continued…

Next week we will explore all the consequences of the wrong usage of debt by the middle-class? And the fallacy began…

Sources of Reference will be provided next Tuesday 17th.
Disclaimer: Illustrations in Watercolor are painted by Eleonora Escalante. Other types of illustrations or videos (which are not mine) are used for educational purposes ONLY.  Nevertheless, the majority of the pictures, images, or videos shown on this blog are not mine.  I do not own any of the lovely photos or images posted unless otherwise stated.

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