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Interpreting the Household Finance Data June 12, 2009

Posted by shaferfinancial in Finance, Uncategorized.
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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.



1. Joshua - June 12, 2009

LOL, haven’t you heard David? Bonds aren’t safe investments anymore either… at least not while our current congress & president are running things (into the ground).

This explains it VERY Well: http://www.youtube.com/watch?v=P2ELt2QnRY8

Secondly, I would like to request a post from you. Could you please do a post with a table format that shows the pro’s and con’s between different investment instruments when placed in a story line?

For example, Joe Average has $20k to invest but isn’t sure which route he should take. He could A) Use the money to leverage a real estate investment (we could say a 4-plex unit) B) Purchase your insurance products with cash value (EIUL) C) Purchase an index fund on the market D) Put it into a money market or CD, etc.

Then provide a table showing how he would probably do using a 10 year timeline with historical data (trying to include the huge declines for this and last year).

I think that would be as eye opening, or more-so, than the last post you did although not directly related. Thanks in advance!

2. shaferfinancial - June 12, 2009

Joshua, I will keep it in mind. There are some inherent difficulties in speculating future returns. Going to New Hampshire next week so it will take me a while to get this together.

3. shaferfinancial - June 12, 2009

Well, the government has done some things in order to protect the overall economy from collapse which does all of us good. I don’t agree with everything they do, but they are trying their best. I believe banks are the largest beneficiary along with AIG. If the unions get a bone thrown to them, well its only fair. As to the Indiana Teachers retirement plans that are suing over the bonds, well what the hell were they investing in Chrysler for????? It hasn’t made money in years. Can’t cover bond payments if you don’t have the cash flow; analysis 101!!!!

4. Joshua - June 12, 2009

New Hampshire is one of the few remaining states that truly believes in state’s rights. In fact, an entire movement has been going on there called The Free State Project (http://www.freestateproject.org/). I highly encourage you to check it out before you leave.

As for your comments about the government. You worry me a bit on where you stand. Do you not subscribe to the way BawldGuy and I do when it comes to economics? I may have misjudged you in this regard. 😉

5. shaferfinancial - June 13, 2009

Bawld guy and I do not see eye to eye on all things economics, although we have some common ground. I think most people are fearful of inflation and high interest rates as a result of the government’s actions over the last year. Where we differ is my listening to folks like Warren Buffett who feel the stimulus package and the TARP funding was a necessary evil to stabilize the economy. I note that some of the TARP funding is being paid back. However, we both agree upon the need for low capital gains taxes.

6. Joshua - June 13, 2009

The TARP funds were a joke, just as a suspected, and it has been many months in which the banks have asked to pay it back and Obama and the Congress refused to accept it!

I’m not fearful of general inflation because every since the early 1900’s when the dollar was no longer backed up by gold we’ve had MUCH inflation. What I’m worried about is the collapse of the dollar (which WILL happen it just depends how long it will take before current fiat money tactics can keep this falsehood running) and then which we’ll be seeing HYPER-inflation which will be the final nail in our coffin.

I agree with capital gains but if you agree with that then why would you agree with them using our current tax money for stoopid purposes? I think you should read a few more books on economics, particularly from Von Ludwig, Ron Paul, & listen to and watch Glenn Beck.

I’ll leave it at that because I believe, though I’m young, I might outpace you in the amount of time spent studying economics but in finance your ahead and thus I subscribe to the blog. 😉

7. Sean Carr - June 13, 2009

Greetings Dave,

I think you’ve hit the nail on the head. You had an interesting post a few months ago on the different types of investors; traders, real estate investors, etc….

As a co-owner of a small company most of our employee’s, who I would say represent a very typical population cross section, fall into none of those categories. They are better characterized as non-investors in that they have little interest in learning about economics or finance nor do they want to manage their invested savings. 401Ks take advantage of that and as you’ve pointed out they simply don’t produce. So while I’ve dismissed life insurance as an investment for myself (I’ll let you know in 30 years weather I can continue to outperform them), I’m starting to believe that for many people who, for whatever reason, don’t want to actively manage their money, an EUIL is probably a sound part of a retirement plan. Unfortunately it seems the life insurance industry has decided to be opaque about how these policies are structured which has gives the impression that they are structured to maximize fees and profits for the issuers. Cheers for bucking the trend there Dave.

I would also argue that the average American is not cut out to be a real estate investor. They simply don’t have the capitol or expertise to invest successfully. And many (most) real estate investment advisors have no formal education in finance and like fund mangers, make their money from the fees without real regard for the risk born by the investor.

One question I have is what happens if the company issuing the policy goes bankrupt? I’m not bringing this up to disparage EUIL’s, I’m just curious if there’s a government backing and if there’s a cap on the amount.

shaferfinancial - June 13, 2009


Thanks for your thoughtful post. First the question; yes there is a government insurance backing life insurance, but there is no guarantee of getting all of your cash value back just like the government pension guarantees doesn’t match your lost pension dollar for dollar.

Let me be clear, I think EIULs should only be a part of your financial plan, the conservative savings part. And yes, I believe the data points out to people doing better in an EIUL rather than their 401K in general. However, the main part of my advice is for people to become actively involved in their money and learn how to invest. I believe real estate is great because the leverage you can use will pump up the returns, but insist people learn about real estate investing before their first investment. I have a very short list of professional brokers who I send folks to, with the experience to help people get started correctly.
However, I think you can make great returns investing in stocks if you again take the time to learn what you are doing. I know I have significantly outperformed the stock indexes over the last 10 years [wasn’t really hard considering how bad they did!].

Bottom line: I have 6 months cash reserves in a money market fund, a large EIUL with six figures in cash value available to me, real estate investments [high risk/high return], several homes and some farmland, 3 stocks [concentrated investments], 2 of which pay me dividends above 9%. I am now started to think about building up my dividend/income paying portfolio. Wouldn’t it be great if I could live off of my dividend/income from my portfolio without regard for current price of my stocks! 🙂

In other words, do what you are excited about and will make your primary business to learn about. Have some low risk and some high risk investments and build up passive income with either stocks, real estate, or businesses!

Unfortunately, most folks will not think like this and will continue to invest passively, if at all. The data seems to indicate we will be dealing with a lot of retirement problems for folks going forward.

Sean, let me know if I can offer my services to your employees. They are the one’s that really need some sound advice and are the hardest to reach.

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