Interpreting the Household Finance Data June 12, 2009Posted by shaferfinancial in Finance, Uncategorized.
Tags: Financial Strategies succeeding or failing?, Interpreting the household finance data
The previous post I presented the latest houshold finance data from the Federal Reserve. Now I would like to put my spin on what it means.
1st and foremost it means that we, as a group, are not going to be prepared adequately for retirement. We simply don’t save enough, don’t use effective strategies for building wealth, and are dependent upon others [social security, defined pensions, etc.] for our retirement income.
What are these strategies that are failing? The save/invest in mutual funds [whether index funds or not] and the pay off our mortgage as soon as possible strategy. Here is an interesting point, for those who save in annuity type vehicles they have more value than those who save in mutual funds [70K for annuities versus 56K in mutual funds] even though mutual funds are almost 10 times more popular. Now why might this be? Two reasons; first, annuities actively discourage folks from selling or canceling the annuities with penalties, while mutual funds don’t generally have penalties to sell and second, annuities never go negative. So in a sense, annuities protect people from their own counter-productive behavior! Now most regular readers know I don’t encourage deferred annuity ownership, instead preferring the life insurance products, but there is a lesson that can be taken from the above fact. Of course this dovetails into the studies that point out that mutual fund investors do quite a bit worse than the actual funds they invest in whether they have a financial adviser or not! When you look at the overall amount in retirement plans and pooled investments in general, you start to see a pattern not of people not applying the basic strategy, but of people not able to negotiate the stock market’s ups and downs. It is really that simple. And the next survey in three years will demonstrate this dramatically I bet!
The other strategy of buying a personal residence and building up equity is a successful strategy. It is successful because people use leverage to buy a house and leverage small $$ into large $$$ over time. However, it is problematic because it becomes difficult to liberate that wealth from your house as your equity moves up. In short, it is the most successful investment most people make, yet remains out of the reach of people to use until it is refinanced out or the home is sold.
In short, people are generally failing at investing in stock mutual funds. They are successful at using leverage in building home equity over the long haul. But many eliminate that leverage as soon as possible leaving them with much of their net worth [45%] unavailable to them. The fact that these are failing strategies is only going to be more apparent as more and more folks retire without a defined benefit retirement in place.
Of interest are the generational changes that have been made. Two generations ago, most people did not invest in stocks either directly or indirectly. There was a real reason for this as those folks remembered or lived through the stock market crash of 1929-1935. Individual stock ownership was considered akin to gambling, hardly a platform for responsible financial behavior. Even the professional pension manager kept only a small percentage of the investments in stocks. Among the most successful money managers were insurance companies who invested very conservatively, mostly in bonds. So we have gone from there to a spot where everyone is expected to be able to invest in stocks for themselves in their 401Ks! Quite the change in attitudes.
We have also seen a change in attitude about home ownership with home ownership patterns changing dramatically. Home ownership, once a minority behavior has become a must-have for folks peaking at 69% ownership for adults. But other changes include serial home ownership, where we have starter homes and build up from there. When we move where we live, the first thing most people think about doing is buying into the new area. Great for Realtors, but is it really working for folks? I think any serious look at this issue might point out that this has increased the financial risk significantly for people and has led to the greatest rates of bankruptcy and foreclosure in the history of our country.
Finally, it appears the older ways of saving money, through life insurance, annuities, and savings accounts, etc. that were swept aside for mutual funds might have some important characteristics not realized by the so called “experts.” What all these financial instruments have in common is principal protection, lower variability and moderate rates of return. In our rush for better theoretical returns have we thrown the baby out with the bath water? I leave that as an open question for folks, but hope that folks give it a little thought.
Now regular readers hopefully will not misunderstand what I am saying. I am still a big believer in active investing, both stock and real estate. I am only pointing out that it might make great sense to build a financial base with the older, proven savings vehicles before you “bet the farm” on mutual funds or hopefully gain experience in more active investment strategies.