So lets say you have a 401(k) and are adding to it regularly, you own your house, you have no credit card debts, you are paying off your car loan and overall your financial house is in fairly good order. Still you keep hearing the news about credit crisis, mortgage meltdown, dollar depreciation… It is enough to make you nervous but what should you do?
Frankly very little in the macro economy has much impact on what is a smart long term strategy. Should you move your retirement money into a money market fund, because of the risks of stocks now? No. If you are good enough to time the market you are already amazingly rich (or will be soon). But either no one is able to do this or next to no one is. Occasionally you might get lucky and time things right but being able to consistently do so over 40 years is just not something that happens.
So what you should do now is what you should always do. Have cash savings. Pay off your mortgage (don’t over-leverage yourself – don’t take out equity just because you have some). Save for retirement. Have health insurance. Don’t take on credit card debt (or most other debt). Keep up your employment skills (learn new skills…). Diversify your investments (stocks, international stocks, real estate, cash…).
People often get careless when the overall economy is good. And so maybe you failed to do what you should have been doing then. But the right thing to do today is essentially the right thing to do always. For example, Americans are drowning in debt. They were also drowning in debt 3 years ago. That problem is the same. If you have too much debt you should fix that. Not because of all the fear today, but because to much debt is always bad. You should not take out too much debt in the first place and if you have to much you should fix it whether the economy is strong or weak.
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How bad is the mortgage crisis going to get?
This interview of Paul Krugman is worth reading. And it does seem to me the magnitude of the mortgage crisis is very large and likely will result in national declines in home prices of over 15% from the peak. Which is a very large decline. And in local markets declines of 35% seem likely.
Related: Home Price Declines Exceeding 10% Seen for 20% of Housing Markets (Sep 2007) – Home Values and Rental Rates – Real Estate Median Prices Down 1.5% in the Last Year (Aug 2007) – Real Estate articles
Ok the title is a bit of an misstatement but I am getting so tired of massive government transfers to the rich. Basically here is what has happened. People with tens and hundreds of millions of dollars didn’t want to be subject to pesky regulations just because capitalism requires it. So they paid their politicians to not regulate their investment activities. They paid their lawyers to evade the legal requirements that they couldn’t get their political friends to remove.
Largely what they did was take huge amounts for taking positions that risk the economy for personal gain. The investments have huge leverage and massive negative externalities to the economy. Any capitalist would know this is exactly what the government is suppose to protect the economy from. Unfortunately our politicians think capitalism is that whoever has the gold, therefore should make the rules. A sad state but not a surprise.
So then, the negative externalities begin taking effect and the government now seems to think that massive government intervention is a great thing. What a sad state of affairs.
What should happen now. That is hard to say.
But certainly with the amount of huge financial bailout the government has engaged in recently certainly they need to plan for this far in advance (it is obvious their preferred method of letting their friends take huge risks with the economy and pay themselves well while the risks work out requires huge bailouts very frequently).
You could, I suppose, decide everyone should pay to support a few thousand people being allowed take positions that have huge negative externalities (in risks to the economy) and pay themselves millions before those externalities become obvious and then bail them out when it doesn’t but that doesn’t seem like the best strategy to me. Though it is obviously the one we have chosen. This is one very non-partisan issue. They pretty much all support letting those that pay the politicians well, do whatever they want. And then support bailing them out if there are problems.
What should the government do in economic matters. Not at all hard to say. Politicians shouldn’t auction off the health of the economy to those that pay them the most money. Politicians should not allow companies to subvert the legal and tax system and be rewarded (just because those companies pay the politicians well and fly them to nice vacations…). The government should regulate negative externalities as capitalism requires to function properly.
But most of all the voters need to vote for those actions. As long as voters elect those that believe in corporate welfare this is the natural result.
Related: Why Pay Taxes or be Honest – Politicians Give Lobbyists Tax Breaks for Billion Dollar Private Equities Deals (not the politicians are given the deal makers cash loans) – Estate Tax Repeal (payoff to the rich) – Politicians Again Raising Taxes On Your Children
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The next shoe to drop in housing
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Fannie and Freddie are demanding higher credit scores and charging higher rates for those who don’t have them. Until recently, a borrower with a 620 score might pay the same as one with a 680 score, said Victoria Bingham, chief executive with Pacific Rim Mortgage in Tigard, Ore.
But now that person might have to pay a half percentage point more. With today’s rates, that translates into 6.75% for a 30-year fixed-rate mortgage instead of 6.25%, or $74 more a month on a $225,000 loan, typical for her client base.
Borrowers must also put more money down, especially if they don’t have stellar credit. For instance, those with down payments of less than 5% need a credit score of at least 680, said Steven Plaisance, executive vice president of Arvest Mortgage Co. in Tulsa, Ok. Previously, he could make loans to people without big down payments if they had other strong points, such as stable employment.
Related: Federal Funds Rate and 30 Year Fixed Mortgage Rate – Mortgage Payments by Credit Score (Aug 2007) – learn about mortgage terms – Beginning of the End of Housing Bubble? – How Not to Convert Equity
Central bank intervention … unprecedented in scale and scope by Brad Setser
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As around $900b, the fed’s balance sheet is something like 6-7% of US GDP. With $1600b in foreign assets, the PBoC’s external balance sheet alone is more like 50% of China’s GDP.
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But with Martin Wolf now arguing that scenarios with more than a trillion in credit market losses cannot be ruled out – even more unprecedented central bank — and government — action cannot be entirely ruled out. The scale of the “great unwind” has been stunning. The pace of change in the policy debate only slightly less so.
Related: Fed takes leap towards the unthinkable – Goldman Sachs Rakes In Profit in Credit Crisis – Misuse of Statistics: Mania in Financial Markets – Why do we Have a Federal Reserve Board?
Some people think all financial info is boring. I actually find a good deal of it interesting but this tip is pretty boring. Building a cash safety net is an important part of your personal finances. We have explained previously the very simple idea that you don’t buy what you can’t pay for. If you can’t pay for it this month, don’t buy it.
But that leaves out one thing. Even if you do have the cash you should be building up a cash reserve before buying luxuries. The typical advice is to build up 6 months of expenses in cash (rent or mortgage, food bills, utilities, health care, etc.). Now actually building up to that level can take awhile and forgoing all non-mandatory expenses until you have that saved is not usually reasonable. But as part of your personal finances building up an cash reserve is important (even if it is boring).
A significant portion of downward spirals in personal finances are started when people have emergency expenses and have to borrow that money (since they don’t have cash reserves). If you are over say 26 and don’t have a cash reserve yet saving for it should be part of your monthly budget. How quickly you build that up is a personal decision but I would say a 1% of the target amount (so if you are aiming for a cash reserve of $20,000 then $200/month).
If your finances don’t allow that, then do what you can. But realize that is one of the weaknesses in your personal finances and try to fix that as soon as possible.
Very important personal financial allocations for you to put first include: current needs (food, car payment, rent/mortgage, utilities…), insurance, creating a cash reserve, retirement savings, saving for future purchases. Then there are luxuries and treats, such as: eating out, vacations, cable TV… Many people put current needs, luxuries and treats fist and then say they don’t have the ability to do what is responsible. That is not often true for those that actually have an internet connection to read this blog.
Related: Buy less stuff – Saving for Retirement – How to Use Your Credit Card Responsibly – Trying to Keep up with the Jones
More photos from my visit to Rocky Gap State Park, Maryland. Photos by John Hunter.
Related: Nature Recreation Declining – travel lodging options
More travel photo essays: Shenandoah National Park, Virginia – Rocky Mountain National Park – Monocacy Aqueduct, Maryland
For those that don’t find picking stocks fun it is nice to know that just investing in indexes is likely the best option for almost everyone. I have much of my retirement assets invested in index funds. I still think I can beat the market (though the results of the last few months have not been kind) but the amount I invest in individual stocks is not a huge percentage of my portfolio. I still like Google, for example, and in fact might well be buying more this week (it is down over 10% since I added to my position a couple weeks ago). Can You Beat the Market? It’s a $100 Billion Question
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From 1986 to 2006, according to his calculations, the proportion of the aggregate market cap that is invested in index funds more than doubled, to 17.9 percent. As a result, the negative-sum game played by active investors has grown ever more negative.
The bottom line is this: The best course for the average investor is to buy and hold an index fund for the long term. Even if you think you have compelling reasons to believe a particular trade could beat the market, the odds are still probably against you.
Interesting. I am surprised by the rapid increase in the total expense of trying to beat the market. I guess all those wall street bonuses add up. In my opinion the article does not provide adequate support the claims made, but I think overall the claim are sensible (based on numerous studies of results). The odds of beating the market yourself are very low. And the odds of paying the right people to beat the market for you are likely not worth the cost (in the market today).
Related: Advice from Warren Buffett – Stop Picking Stocks? – 12 Stocks for 10 Years Update – Feb 2008
1,000 True Fans by Kevin Kelly
But the long tail is a decidedly mixed blessing for creators. Individual artists, producers, inventors and makers are overlooked in the equation. The long tail does not raise the sales of creators much, but it does add massive competition and endless downward pressure on prices.
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Assume conservatively that your True Fans will each spend one day’s wages per year in support of what you do. That “one-day-wage” is an average, because of course your truest fans will spend a lot more than that. Let’s peg that per diem each True Fan spends at $100 per year. If you have 1,000 fans that sums up to $100,000 per year, which minus some modest expenses, is a living for most folks.
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I am suggesting there is a home for creatives in between poverty and stardom. Somewhere lower than stratospheric bestsellerdom, but higher than the obscurity of the long tail.
Another interesting idea from Kevin Kelly. I like real life examples of applying economic and financial thinking, which I think his post does well. We have more options that just working for some organization. I have a bit of work to do to gain myself 1,000 fans and quite a bit more to get to 1,000 true fans. But I am making some progress in that direction.
Related: Who Influences Your Thinking – Street Use with Kevin Kelly – Signs You Have a Great Job… or Not – Curious Cat Investing Search
Bill Gates Issues Call For Kinder Capitalism:
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Among the fixes he plans to call for: Companies should create businesses that focus on building products and services for the poor. “Such a system would have a twin mission: making profits and also improving lives for those who don’t fully benefit from market forces,” he plans to say.
Related: Appropriate Technology – Using Capitalism to Make the World Better – Data Visualization Example (Hans Rosling) – Design for the Unwealthiest 90 Percent