Financial Literacy

If the last 100 years is any guide, the election won’t have any immediate effect at all. There are cycles to interest rates, stock market ups and downs, recessions, and for the most part – the White House occupant is not the dominant driver in any of those. But is there anything we can predict for certain?

Who knows what he or she will actually accomplish once they are in office, but there are a few big policies they have consistently said they would work toward enacting.

Donald Trump:

1. Repeal and replace Obamacare. This will likely lower the costs of medicine but also reduce the revenues of those services or products were mandated by Obamacare. If out-of-pocket medical costs are reduced for consumers, this may increase consumer spending to boost the economy.
2. Enact a 45% tax tariff on Chinese imports. Since the U.S. purchases a tremendous amount of goods from China, this would increase prices for American consumers in the short-term and the long-term, as China would likely respond with their own economic retaliation.
3. Cut the budgets of the Environmental Protection Agency and the Dept. of Education. If extraneous regulations are reduced, this provides economic benefits across the country.
4. One potential stock candidate to buy: HCA Holdings that will benefit if Trump allows U.S. Veterans to go to any doctor to get medical treatment.

Hillary Clinton:

1. Pass the Trans-Pacific Partnership trade deal. This is a special-interest smorgasbord of monopolies and relinquishing sovereignty to corporations. I’d expect these newly minted monopolies to severely reduce economic growth for the many, to benefit a few companies.
2. Cut red tape and taxes on small businesses. Small businesses have not been hiring under President Obama for these very reasons, this could create a large increase in needed jobs.
3. Expand Social Security and Medicare to cover more people and increase benefits for some. Since both programs are already heading toward insolvency, this will accelerate the national debt and problems for these programs.
4. One potential stock candidate to buy: gun manufacturers of either Smith & Wessen or Sturm, Ruger & Co. Anytime a president pushes for gun control laws there is a surge in gun and ammo sales. Firearms manufacturers say President Obama has been the greatest salesman they’ve ever had (when he pushes for gun control), and a Hillary Clinton presidency will likely be similar.

Unless you perform an industry and company-specific comparison for their specific political policies, for most people any election shouldn’t influence your investing strategy that you are holding for the long term. For example, tax policy will be modified by Congress and the Senate and so the final result may not resemble anything that the presidential candidate was trying to accomplish. After every election, political compromises and realities dramatically temper campaign promises, so predicting anything specific, in my opinion, is probably not worth your time until it actually occurs.

Any location for money has risk. Even cash under your mattress is at risk for theft, flood, fire, or devaluation. Any location outside of your control adds additional risks and costs. Bank accounts are more risky these days with: bank bail-ins, IRS seizures without a warrant, and an inadequately funded FDIC insurance.

When there is high inflation, money melts in value like ice on a hot summer day. So you spend it or transfer it as quickly as possible to maintain your purchasing power. The higher inflation goes, the more worthless the currency becomes and the average person becomes more motivated to exchange it into an alternative currency. Once the inflation rate goes above 25%, exchanging your currency becomes a part-time job for everyone.

In countries experiencing high inflation, residents exchange their weak currency for the largest nearby stable currency; the Euro, the U.S. dollar, the Chinese Yuan, etc. When Zimbabwe’s currency imploded a few years ago, many store owners only accepted gold for payment. Venezuela’s currency has collapsed and as the chart indicates, an unusual currency is skyrocketing in use: Bitcoin. The more the government tries to control an economy, the greater the side-effects become, such as a worthless currency. Residents are forced into black markets and alternative currencies to store their money.

Several large hedge funds and billionaire investors are buying more gold as they expect paper currencies to fall in value; all of the major currencies together – with no safe haven. The latest is Lord Jacob Rothschild, who is also the Chairman of CIT Capital Partners. In his recent letter to shareholders, Rothschild stated that they are reducing their position in U.S. dollars for gold and other currencies.

Some of the smart money is diversifying away from the U.S. dollar. Although the U.S. hasn’t experienced moderate inflation since the early 1980s, it is common for a mismanaged economy to experience high inflation. The U.S. Federal Reserve has certainly been reckless with the U.S. dollar over the last 8 years, printing trillions in extra currency. Do you have any plan to protect your U.S. dollars from deflation or inflation?

Anything you can buy that is unaffordable is likely to become a metaphorical financial land mine that blows up your finances. For men, unaffordable spending is commonly cars, boats, and big TVs; for women, this is commonly shoes, clothing, and vacations. But, in my opinion, there is one spending weakness that tops them all – and this is the grand purchase of an unaffordable dream home. Dream-home syndrome is when you ignore financial reality and get yourself into an unaffordable, or barely affordable, dream home that ends up becoming a nightmare.

While dream-home syndrome may strike anyone, I see it most commonly in people in the real-estate professions that are in continual contact with higher-end homes. The more you visit spectacular homes, the more you become convinced that you should have one too. However it comes about, once the words “dream home” enter your vocabulary – watch out. This loaded term permits people to ignore and override affordability because, after all, this is a dream home and therefore no expense should be spared.

If you can easily afford your dream home, this is no problem. But when it comes to real estate, the sky is the limit for the price of the lot and the remodel, which can blow through even the highest budget. Some people want the prestigious zip code, street name, water view, while others just want the spectacular home itself. Dream home syndrome even applies to a small starter home – if you simply cannot afford it and your salary is not leaping upward.

A few nightmare scenarios that I am acquainted:

• Someone bought their dream home in the upscale part of town and then remodeled most of it. Even though they had no drop in income, they lost the home to foreclosure within four years. A lifetime of savings from frugality went up in smoke.
• Someone made around $1 million in capital gains by selling their home near New York City. They didn’t plan on it, but ended up spending twice that amount to purchase and remodel their dream home. Only after it was too late, did they realize that the cost to finish the project will push their retirement date back at least 5 more years.
• A couple, each earning over $250,000, built their huge customized dream home at a cost that was far more than what they could afford. But, before they could move in, they were transferred across the country and had to sell it. There were so many quirky elements to the home (a see-through floor in a hallway?) that they had to take a large loss to sell it. So this couple is in their early 60s with no retirement savings, no money, and are paying for a monstrous debt on a home they never lived in. They have already conceded that they can never retire. And yes, these are financial professionals!

I have many, many more examples, but you get the point. What are some symptoms of dream-home syndrome?

• House hunting when you don’t have the money or a planned-out budget
• Continuing to house hunt even though you just bought a home
• Wanting to mimic a friend’s spectacular new home or fabulous remodel
• Continue making additions to the list of features for your dream home
• Failing to consider all of the costs to maintain your dream home

Let me end with a counter example. A friend of mine lives in Nevada. In the real estate boom before 2007, several of his friends and neighbors moved to bigger homes with much larger mortgages. His wife pleaded for them to get a bigger home as well but he refused to upgrade and wouldn’t budge. Five years later, those friends were losing those larger homes to foreclosure, going through bankruptcy, and sometimes divorce. In the meantime, my prudent friend paid off his mortgage and considered buying one of those upscale homes at half the price that his friends bought at the real estate price peak. Everything you purchase must be affordable or, sooner or later, it will be taken from you. The term “Dream Home” should fire off red alarms that your financial life may be in peril if you move forward without a thoughtful and sustainable budget.

I know a retired school teacher whose annual salary never exceeded $60,000. Yet, when he retired early in his late 50s, he had a portfolio worth nearly $2 million by employing a simple strategy. Both he and his wife worked and they saved 50% of their income. This 50% savings rate was one part of their strategy, the other part was investing the money in conservative stock and bond funds; nothing fancy.

When I first began working out of college, a colleague and her husband also saved 50% of their income. This aided them in buying a home in a short amount of time and prepared themselves for living on only one salary for a while when they expect to have young children. I later learned that another couple I know had the same 50% savings plan as soon as they got jobs out of college. By saving at such a high rate, 18 years later they were able to buy a second home, a lake house with all of the aquatic toys.

I am acquainted with a real estate investor that saved 50% of his day-job income for many years for down payments on single-family homes. Once he had a large portfolio of homes making him income every month, he ratcheted up his purchases to small apartment buildings. In middle-age, he quit his job to manage his growing real estate empire and he now lives in a spectacular home and enjoys a very high standard of living from all of his rental income. But he never reduced his savings rate; he actually increased it and now lives very well but only spends 17% of his income.

• Can you save 50% of your income? Of course you can.
• Will you do it? That is a personal choice that is up to you.
• How about starting with a 25% savings rate to pile up a little money?
• Or, you could join the average American and only save 5.7% of your income, and live in continual financial stress and struggle.

Are you prepared for the next economic recession? Can you remember what a recession is?

Looking back a few thousand years, economies and industries move in cycles, seasons, waves – never in a straight line. Psychologists have a term to describe the failure of people to imagine or prepare for a scenario that they haven’t recently experienced: normalcy bias. This is a dangerous trait to apply to your finances because everything economic moves in waves: interest rates, currency rates, commodity prices, unemployment, and the overall economy. The most successful people are those that anticipate, prepare, and are ready to act in advance of economic moves that others do not expect.

When there is a recession, short-term interest rates go up, unemployment goes up, and people spend less because they are unsure of their jobs. These ripple throughout the economy: raises are smaller or non-existent, overtime disappears, layoffs are common, and repossessions by lenders increase because people cannot make payments. Your personal finances must include the possibility of a recession. If you’re living paycheck-to-paycheck when one hits, your lifestyle may be imperiled with a single hiccup in your income.

The average time between recessions in the U.S. is 6 years. However, since the 2008 financial crises, the economy has been growing so slowly that the economy never over-heated (which can turn into a recession). This slowest-ever expansion is now the longest on record. When will the next recession arrive? There are a few recession predictors: federal government tax receipts fall, short-term interest rates rise, new home sales shrinking, falling real estate values, train and shipping cargo shrinking, loan default rate increasing, business inventories increasing, and many more.

What are these recession predictors indicating today? Many of them are pointing to recession. By being aware of economic cycles of expansion and contraction, demographic changes, and anticipating these changes, you can be prepared for these changes instead of getting hit in the chin when they materialize.