Personal Finance 101: How Averages Lie

personal finance 101Whenever a personal finance writer – or a writer of any kind – wants to make a bold, shocking point, they’ll often pull out an “average” of some set of numbers. That average, when read without further investigation, is often really shocking. Could that really be true? Here are some examples.

The average square footage of single-family homes under construction fell dramatically, from 2,629 in the second quarter to 2,343 in the fourth quarter. (from USA Today)

The average credit card debt per household — regardless of whether they have a credit card or not — was $8,329 at the end of 2008. (CreditCards.com statistics)

The average 401(k) fell 27% in 2008. (MSN MoneyCentral)

Those numbers seem fantastic. I grew up in a home that had about 800 square feet and currently live in a home that feels huge to me at times and is just shy of 2,000 square feet. The average home has over $8,000 in credit card debt? That’s well over $100 a month just in interest!

However, if you start teasing those numbers apart a little, a few interesting truths reveal themselves.

The Truth About Averages

The average square footage of a home

The average new home has 2,343 square feet in floor space. Well, let’s assume that one in five homes is a 7,000 square foot McMansion. That means that four out of five newly built homes are just 1,200 square feet. In other words, if you lined up all of the houses that were built in the last year side by side ranked by their size and chose the one in the middle, it would be far less than 2,400 square feet.

The average credit card debt

Again, the huge ones skew the average. If you have three homes with no credit card debt, one with $10,000 in credit card debt, and one with $30,000 in credit card debt, the average credit card debt of those homes is $8,000 even though three out of five of the homes have no debt at all. The facts back this up – the majority of American homes carry no credit card debt.

The average 401(k)

The average 401(k) fell 27% in 2008, yet the stock market (as judged by the S&P 500) dropped 37%. What does that mean? Lots of investors out there didn’t have all of their eggs in the stock market basket.

When you hear a news report or read an article where someone quotes an average, you should get your guard up because there’s a solid chance that a skewed story is being presented.

How is it skewed? Quite often, when we hear “average,” we compare our situation to that number. Yet, as we’ve seen above, the vast majority of people are often well under (or in some cases over) that average. That average is misleading, and if we compare our own situation to that average and use it as guidance for moving forward, we can often mislead ourselves.

How can you figure out the real story? One big first step is to look at the exceptional people on either end. Take the house square footage example. The biggest houses built would be over 10,000 feet, while the smallest ones would be around 1,000 square feet. Then, look at the average. The end that the average is closest to is where most of the people actually are. After all, if there are 9 people building 1,000 square foot homes and 1 person building an 11,000 square foot home, the average is a 2,000 square foot home – but none of them are actually building a 2,000 square foot home.

Good luck.

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