Financial Train Wreck For American Consumers & Investors ?

[VJW]

Home Equity Cash Outs

According to Gretchen Morgenson at the New York Times, since 2000, American households have spent more than they have earned, which is quite a shift from the prior 3 decades. Q3 2005 household spending was a record $531 billion more than their after-tax earnings on an annualized basis. Consumer spending was a record high 76% of Q3 GDP, up from 73% in 2000. Residential real estate is a record 204 percent of disposable personal income, compared with 150 percent in 2000.

#

[jnsaver]

Do you think this has any implications for people who do save?

[jmjj215]

People are getting in over their head, pretending truly tough times won't ever come again.

[jnsaver]

Yes, that is what the article said. But what happens to the folks who aren't pretending? What implications does this have for them? If the implications are equally as bad for savers and non-savers, maybe non-savers spend through the nose because they have no reason to save.

[sweeps]

Originally Posted by jnsaver

Do you think this has any implications for people who do save?

That question is deceivingly complex. It depends on numerous factors.

1. It depends on your personality. For some people, being in debt keeps them up at night, but for others they are fine with living life to the fullest and are willing to deal with the consequences.

2. It depends on where you are saving/spending/investing. Are you acquiring debt to buy your primary home? Are you borrowing to get an education? If you're spending your money on assets that will appreciate, you're probably going to come out ahead, while blowing your money on electronics, clothes, cars, vacations, etc. you're probably going to lose. But then again, no one can be sure which assets will appreciate and which ones will depreciate in the future.

3. It depends on what happens to the economy. As was mentioned in another thread, in a worst-case scenario where we have a currency crisis, your cash equivalents (cash, checking accounts, savings accounts, CDs, T-Bills) will immediately drop in value. So while someone else was "blowing their money" they actually got more value from their money than you will get.

There's more factors, but I think you see the point.

Having said all that, here is a likely scenario. Let's say most American families are overextending themselves (i.e. building up huge credit card debt, pulling all the equity out of their homes, buying stuff they can't afford, etc.), and you are saving your cash. At some point those people will snap under the financial pressure, giving you the opportunity to buy their assets (real estate, stocks and bonds, personal assets, etc.) at reduced prices.

[jnsaver]

Ah . . . I think I get it now. Spending money that doesn't exist leads to inflation by artificially increasing the GDP, right? Inflation lowers the value of anything not protected from inflation. Thereby punishing people who save rather than invest in stocks/etfs or spend (as you mentioned), as inflation and reckless spending is good for the stock market.

People who invest in various things like homes, education, successful businesses etc are also rewarded because all of these will go up in dollar amount if inflation ensues.

So when the fed raises interest rates to curb inflation, are they rewarding savers and punishing home owners, investors, students and business people? I think this also means that the dollar value of a spender's stuff decreases. Does this mean that there are a number of people opposed to making the dollar stronger?

Do you think the social pitfalls of American spending will be so far reaching that it will negate any opportunity to buy assets at reduced prices? For example, will taxes, crime and illiteracy increase?

[sweeps]

Here is a great article on what causes inflation.

Please note that very few things are immune to inflation. Precious metals like gold are, but holding and trading them presents other problems. Stocks are NOT immune to inflation. Over the long term, they have the best returns of assets, but they are affected by inflation just like everything else. (Companies' costs -- especially wages -- go up just like ours when inflation is high.)

However, inflation or not, it is better to have $5,000 or $50,000 saved, rather than $500. The more you have saved, the more you are protected in case of an emergency (loss of job, etc.), and there is less of a chance that you will have to sell something you don't want to (your home), etc. Plus as I mentioned, you'll be able to buy these assets at low prices when others default.

The Fed isn't out to punish or reward anyone by adjusting interest rates. It simply has a job to keep inflation from being rampant. In general, higher interest rates benefit savers (assuming your interest rate is not locked) and lower interest rates benefit spenders (again assuming a floating interest rate).

Re: crime, taxes, illiteracy. Try not to get carried away with doomsday scenarios. Sure, anything is possible, but fretting over worst cases is a waste of your life. The chances of a major downward spiral are pretty slim. Maybe our economy will continue to go sideways for a while. But so what? Those that invested in stocks during the 70's stagflation years won big in the 80's and 90's. If you spend below your means and invest in a diversified portfolio, you'll be fine.

[jmjj215]

they are fine with living life to the fullest

that statement kinda bugged - as if being debt free keeps you from living life to the fullest. I'm sure that's not what you intended though

[sweeps]

Originally Posted by jmjj215

that statement kinda bugged - as if being debt free keeps you from living life to the fullest. I'm sure that's not what you intended though

Good call. I meant to say blowing their wad.

[jnsaver]

So increased use of credit cards for consumer spending would fall under factor 1 demand-pull inflation according to the article? (The money supply is artificially increased via credit, hence creating an increase in aggregate demand?)

Also, if inflation is about aggregate supply and aggregate demand, wouldn't something that's always in demand, like a blue chip stock, be more protected from inflation than something that fluctuates in demand, like a plasma TV? Especially, when that thing in demand is something you can't increase the supply of without rewarding the person who owns it (Splitting stocks is good for investors, right?)?

I know that over the long run, savers finish ahead and investors win the game, but I'd like to see more of the whole picture. Good advice is easily found, but much of it is reflective, rather than predictive because it focuses on what worked for a particular group of people at a particular time and place rather than critical analysis and careful weighing of costs and benefits of various courses of action. While predicting the future can involve remembering the past, don't you think strategy also has it's place in the game?

[sweeps]

Yes, this is mostly demand-pull inflation because of the high availability of money. But some of it is cost-push inflation due to the quick rise in fuel prices. Cost-push inflation is really bad because the Fed is limited in what they can do without either stoking inflation or pushing us into recession.

Yes, some stocks naturally perform better in inflationary conditions -- especially those of companies that can quickly raise their prices. Fuel companies such as Exxon/Mobil. Or food suppliers such as Sysco. Or near monopolies such as Microsoft.

However - remember we're talking macroeconomics (the big picture). You really can't extrapolate what's happening at the national level to what happens with an individual stock or individual good. The value of plasma TVs can fluctuate for any number of reasons (cost of parts, availability of substitutes, customer preferences, cost of shipping from Asia, etc.). The national economy is only one factor. The same holds for all goods and assets.

In fact, predicting what will happen in the future is a dangerous game. Some people get lucky but most people lose by taking big gambles on one stock or by timing the market. Gold, for example. One thread is dedicated to whether you're buying gold at $500+. That is a highly speculative move. Maybe it'll keep rising to $700 but it could easily drop to $300 as factors change. If you have some money to burn, sure, swing for the fences and go for a big win. But overall I highly recommend a diversified portfolio of stocks, bonds, cash -- both national and international -- and perhaps a little bit of real estate and other hard assets sprinkled in. And continue to add to this portfolio through dollar-cost averaging. That way you'll buy more when prices are relatively low and less when prices are relatively high.

My $.02.

[jmjj215]

Originally Posted by Sweepsplayer

Good call. I meant to say blowing their wad.

Succinct to say the least! Very nice

[jnsaver]

Do you think there is a huge difference between going with hype (Buy Gold! Invest in Technology! Jump on the housing bandwagon! Buy Yen! Store crude oil in your garage!) and using basic principles to critically analyse the costs and benefits of various courses of action? I think there's a big difference between someone like Warren Buffet and RK Rich Dad. RK has nothing to offer but hype and false optimism, but if we only knew half of what Warren Buffet knows we might be able to get somewhere.

The principles that you mentioned: wide diversification and cost-dollar averaging are both based on the principle of "regression to the mean." Essentially, there are random highs and random lows, but, on average (over the long run) things follow a stable predictable path. If you diversify, you'll get both the highs and the lows, but you'll grow at a predictable rate. If you cost dollar average, you'll buy both highs and lows, but on average you'll get a fair price. This is why in the long run predictable, hands off savers come out ahead and passive diversified investors tend to win the game. Old news, right? It's kind of like taking a true/false test and answering everything "false" without reading any questions. You're going to be right atleast half the time if correct answers are evenly distributed.

However, there are a few statistical principles missing from current discussions of personal finance: the role of multicolinearity, kurtosis and skew of the growth distribution and the role of outlier stocks in creating growth. If there was a way to understand these things, we might be having a very different discussion.

[jnsaver]

About lump sum vs. dollar cost averaging
http://www.fpanet.org/journal/articl...ad/16527_1.pdf

[sweeps]

Sorry, I slept through most of my statistics classes so I'm not going to be much help there. IMHO, trying to beat the market with sophisticated statistical analyses is not very useful in the long term. First, investing involves people and people often act irrationally. Often there is no logical or mathematical reason why certain things rise in value and others fall in value. Second, people adjust. Any mathematical strategy designed to time the market never lasts long. People figure it out and attempt to beat you at your own game, and then others attempt to beat them at their own game, etc. Again, IMHO. If you come up with a winning strategy, do yourself a favor and don't announce it to anyone.

Now what's the difference between Joe Schmo and Warren Buffet? Time, resources, and money. Warren Buffet has the time and money and investment advisory committee to research thousands of investments. His company can pore over statements line by line, visit offices, factories and warehouses, and speak one on one with CEOs and CFOs and a company's customers. I don't know about you, but I don't have that privilege. Perhaps just as importantly, he has the power to influence the market. If he goes all in on a company, people take notice and usually jump in right along with him. Again, I don't have that privilege.

Therefore, I'm satisfied with spreading out my bets. I take issue with the true/false test analogy. I think a better analogy is getting in the car and driving to a place 1000 miles away. I'm satisfied with going 70mph and being reasonably confident I'll be there in about 14 hours. Sure, I could go 110mph and possibly cut my trip to 9, but there's a much better chance I'm going to get into an accident, get arrested for reckless driving, or blow my engine. It's not worth it to me.

[jnsaver]

The beauty of statistics that no one really understands is that they ARE based on real people. They are the averages and tendencies of hundreds of millions of people through their most rational and irrational moments with a 5% margin of error. Unless your theory of human behavior is similiar to theories of the behavior of airborne dust particles, there should be a method of predicting it. It just hasn't been found. My guess as to why, is that we've made statistical assumptions about the market that are unfounded. Growth may not even be normally distributed. What would you do if you found out that the mean and the modal growth of companies in the S&P 500 were significantly different from each other in 2005? Shouldn't that be a reason to flip out?

I don't think most people would jump on an esoteric statistical bandwagon even if it proved successful. I'd guess that there are about 200 Ph.Ds. in the US capable of exploring multicolinearity and capable of understanding how it applies to financial advice and failure of mutual funds to give returns above etfs. Atleast 100 of them will be in social/behavioral science.

Check out that link above. The article was written 26 years ago. It's been replicated numerous times, but it's too esoteric for most people to understand or relate to. So people keep following bad advice.

[sweeps]

Well, more power to you. If you come up with the universal theory of investing, I'll be the first to congratulate you.