Personal Finance Tips

No, I’m not talking about hiding your money under a mattress or stocking up on ammo and canned goods before moving to a self-sustaining farm to live out your days. Those types of “alternative investments” may appeal to some but are not realistic or desirable options for most people.

Nor am I saying that we will be in a recession; I am the first to admit I cannot predict the future and won’t try to. However, many people I talk to are concerned about our economy over the next ten years and with good reason. We have a largely incompetent legislature battling Washington for first place in the “lack of efficacy” category, and many indications point to the new norm for the foreseeable future being 9% unemployment (really more like 14% if you look at all the numbers). Let’s not forget about global economic problems (Greece – please just default and get it over with so we can all move on).

America has enjoyed a nice run of inflated consumer spending, ballooned further by government insistence that everyone should own a home with one shiny new car per each driver and a 48″ flat screen. Don’t forget the DVR, goodness what would we do…read? You mean that old thing where you process words from left to right and think about them? “O.M.G.”… I don’t like to use that type of expression, but it’s a little scary that you immediately know what it means, eh? Thank goodness people are at least buying Kindles; hope is not completely lost. But I digress.

Things are changing. All joking aside there is a good chance we’re entering an extended period where consumer spending is down, retail contracts or remains stagnant as a result, and growth is sluggish at best. It doesn’t mean the end of the world, but it means that if you want it to not feel like the end of the world to you and your family, you need to live thoughtfully and spend wisely. I speak to people who aren’t optimistic about the economy but are still over extending and don’t even think about it. Obligations like credit card debt, auto and home loans, and notes on our precious recreational toys can quickly take the joy out of enjoyment and replace it with “trouble” if the economy takes another hit. Get it… “entroublement”. I know it’s not a word, and I’m not a politician so I won’t try to make it official. My point here is you don’t want your purchases to leave you naked out in the cold if the future doesn’t turn out to be as rosy as you had hoped.

It may be the case that you are blessed with substantial assets and plenty of liquidity. If that’s your situation I’ll be the first to say congratulations. You may be spending wisely and saving for the future, and I am happy for you.

However, it seems you are the minority. And with all the things I see people spending their money on these days it’s a conundrum to me that I find the same people unwilling to save for the future. I feel compelled to ask why?

Granted, you may be scared to invest for retirement now. You might have a negative sentiment about the stock market or investments in general, and are fed up with the system. Maybe you’re even “occupying” a particular block in your city and feel that investing is “playing into the system”. Putting politics aside, you still have to think about what is best for you financially. Like it or not it’s important to save and invest wisely. I have written before about the importance of finding an investment manager who realizes the importance of playing defense. I won’t address it again now but for the following analysis we’ll assume you’ve found someone who manages risk instead of just simply slapping on a “60/40 diversified portfolio” and charging you for “management expenses”. We can revisit that another time.

Right now we’re going to look at a hypothetical example of losing money versus saving – the case of Jim financing a new car VS John building for the future. Put on your thinking cap, it’s about to get a little technical.

Jim really wants a spiffy new SUV that costs $30,000 so he buys it. His interest rate is 5% on a 5 year loan. He puts down $2000 and gets $5000 for his nicely running paid-off trade-in. His payment for the new ride is going to be about $434 per month. Over the course of this loan, he will ultimately pay $28,042 for the car, in addition the $5000 value of his trade-in. In 5 years, the value of the SUV will be close to the $5000 mark of his previous trade-in, so Jim effectively lost $28,042 over five years.

Now we look at John:

John decides he can keep driving his older model car, because he has 100,000 miles to go before the average car like it begins to experience serious problems. He spends $20/month on maintenance and puts his $2000 of cash in to an investment account, to which he adds $414/month ($434-$20). For this example as well as the first we’ll leave out taxes and inflation for simplicity.

Of course there is no guarantee against loss or of any return on investments, but let’s say modestly that he earns an average of 5% on his investments (the real, inflation-adjusted average 1950-2009 was 7%). Over the course of five years, johns result looks like this:

-He arrives at a value of $30,841.17.

-This is a wealth swing of $58,883.17 versus Jim who just had to have that new SUV.

John is now feeling even better about his decision and decides it’s time to get a new to him, briefly used SUV for $25,000. He can still get $2,000 for his trade-in because it drives on to the lot just fine, and he puts $10,000 cash from his investments in as a down-payment for his nice used SUV with 10,000 miles on it. $12,000 total down-payment leaves John with a $13,000 obligation. John now has more assets and can get a better loan than Jim did so he chooses a 4 year loan at 3.8%.

Even with his new car payment of $291.44 John still has $122.59 to deposit in his investment account every month, to add to the $20,841.17 left over after his large down payment.

Who do you think is more relaxed? Throw in a job loss in year one of the original five year scenarios. Now who is sleeping soundly during his job search and who isn’t?

Of course I don’t want anyone reading this to experience a job loss in the next five years. But by statistics alone some of you will. Even in a good economy there will be at least a few job losses among the budding readership I have.

I want to encourage you to be positive and remain optimistic. Positivity breeds positivity. Spend wisely, work with diligence and intensity and have faith that good things will come of it. But regardless of your outlook on the economy and your own career please think through your purchasing decisions and think seriously about how you are setting yourself up to confront what might happen in the future. You might just avoid hardship and set yourself up to be one of those people that can smile care-free as the world crumbles around them.