Cash is King and Other Financial Lessons
Thakor and Kedar
As we reflect back on 2008, five key financial lessons jump out at us. Warren Buffett is famous for saying, "It's when the tide goes out that you see who is swimming naked." We hope these lessons will keep you from swimming without a suit on as you venture into 2009.
- Cash is king. Financial advisors warned us about the importance of emergency funds for ages, which fell on deaf ears. In 2008, the rationale for this advice became crystal clear. According to the American Payroll Association, roughly 70 percent of Americans live paycheck to paycheck. When the credit freeze took hold and the layoffs began, Americans learned the hard way about the importance of having a financial safety cushion. However, we have a long way to go. The American Education Savings Council estimates that less than one in three Americans save the minimum recommended 10 percent of our gross (before-tax) income.
- Don't put money in the stock market if you have to spend it over the next five years. This used to be an age-old investment axiom. The rationale behind it was that stocks historically are the ultimate example of two steps forward and one step back — since 1926 stocks have gone down once every four years before investors saw the typical 10 percent return on investment. Unfortunately, over the past decade people began to view the stock market as a checking account — lured by the prospect of large returns, they threw caution to the wind. Now millions of near-retirees are paying the price, seeing their portfolios shrink.
- Watch out for the Joneses (and the Zeta-Joneses). Personal finance is a subject that we are all expected to just "pick up" along the way. However, unlike parenting there is not a lot of societal support for admitting lack of knowledge in this area. As a result, people tend to follow their neighbors example — and even the celebrities — to see what is "right and normal" in terms of spending and lifestyle. This may have worked back in the 1950s when credit was hard to come by so you could only spend what you have. But armed with modern day credit cards, we Americans had a financial bazooka in our hands. In 2008, we all learned that if you spend more than you make in an attempt to keep up with the Joneses (and the Zeta-Joneses), you will end up in a financial black hole.
- If it sounds too good to be true, it likely is. There are no quick wins. If you want to make extra returns, you will have to take on extra risk. If a portfolio of stocks generates consistent steady returns in a volatile market, take a closer look. That's not so far off from being sold a piece of property in a town where it never rains and the sun shines every single day. Possible, yes. Likely, no. What we've learned in 2008 is that if it sounds too good to be true, it likely is.
- The line between good debt and bad debt is now crystal clear. It used to be that "good debt" was debt spent on homes, a car to get to work, or education and "bad debt" was discretional consumer debt (think electronics and cars). This simplistic thinking led millions to buy way more home than they could afford (or invest thousands in educations that will not result in a commensurate rise in wages). With the onset of the credit crunch, what we learned is that good debt is debt that you can comfortably service. For most people that means a house that is roughly three times their annual household income and a total value on cars that is roughly one-third of their household income. Bad debt is any debt that is a struggle to make payments on. In 2008, we learned that bad debt can be incurred for good things. We will not look at homes, cars, and college educations quite the same way again.
For more advice on ensuring financial security in 2009, visit Military.com's Banking and Saving channel.
