The national economy versus your personal economy

Yesterday I attended the mid-winter conference of the local financial planning association. I listened to various speakers talk about the economy and how it relates to personal finance.

One of the presenters was John Mitchell, a local financial guru, who spoke about the current economic climate in the state, the nation, and the world. Mitchell's presentation was outstanding — I wish I had recorded it. He argues that this country has encountered similar problems before, and has always overcome them. He's confident we'll overcome this one, too, but it's going to be painful, and it might take a long time.

A Generation-Changing Moment

Mitchell says that the current recession is a “generation-changing moment”. Events like The Great Depression, Pearl Harbor, 9/11 — and the current economic crisis — fundamentally change the way people act and behave. He cited his own father, who was a teenager during The Great Depression. “For him, high-risk investment was a passbook account,” Mitchell joked. Because he had seen the bank failures of the 1930s, he was leery of even a basic savings account.

The current economic crisis will create the same sort of scars. Mitchell noted that it used to be when somebody moved to a new city and planned to stay a couple of years, they bought a house, confident that they could sell it later for more than the purchase price. Not anymore. Now when somebody intends to stay someplace for a short time, they're reluctant to consider a home purchase.

Mitchell seems to think that economic calm lulled us into complacency. “When there are only 16 months of recession in 25 years, what assumptions do you make?” he asked the audience. People become accustomed to unending growth. Their risk tolerances relax. They make choices that don't mesh with history, because the only history they see is recent history. Now risk tolerances are swinging the other way. People are panicking because, again, they're only looking at recent history.

In fact, some investors have rushed to abandon the stock market. This reminds me of a comment that NickK left here last autumn:

I'm in the [financial] industry…I can tell you now that when the markets tanked during October, people with less than (approximately) 100k behaved significantly different from investors with 100k+ in the market. Also, people who did not have an emergency fund behaved significantly different than those who did, generally to their own detriment.

These actions lead me to believe that people with substantial assets tend to ride out the market and not worry about short-term fluctuations, whereas people with smaller amounts of assets lock in losses by removing assets from the market at poor times. Then, when/if they get back in, they've missed out on several days of big gains…

As it was happening I was shocked by the clear income demarcation that seemed to separate rational behavior from irrational behavior. Do small investors make behavioral mistakes that keep them from becoming wealthy?

I've read a lot of commentary lately about how the stock market is a sucker's game, and that the wealthy just want you to buy in for their own ends. Here's an alternate proposition: Maybe the wealthy recommend buying into the market because that's what has worked for them in the past. And maybe they're wealthy because they're willing to take risks when others won't. (Note that I'm not saying that you should put all of your savings into the market. I'm asking you to think about the current situation with some historical perspective.)

Fiduciary Responsibility

Another speaker at the financial planning conference was a woman named Kevin from the Oregon Division of Finance and Corporate Securities. Similar to NickK above, Kevin observed that a lot of people have been calling financial advisers and asking them to move 100% of their portfolio to cash. Kevin cautioned advisers against this.

“Advisers are not order-takers,” Kevin said. “You have a fiduciary responsibility. If, as an investment adviser, you think this is foolish, it's your job to resist. You may even have to fire the client.” The implication — and the sentiment in the room — seemed to be that it doesn't make sense to move to a 100% cash position.

As in any economic climate, it's important to understand risk tolerance, asset allocation, and diversification. Remember: On the whole, diversification decreases risk while increasing returns.

The Basics of Wise Investing

I've written before about why it pays to ignore financial news. The media is in the business of selling news, and to do that, they sensationalize it. “Irrational exuberance has become pervasive gloom,” John Mitchell said at the end of his presentation. Neither state of mind makes sense. They're both extremes that lead investors to make poor decisions.

When you pay too much attention to national or international economic news, you can find yourself making decisions that don't make sense for your personal economy. Three years ago when the housing bubble was in full swing and credit was flowing freely, many people bought into the idea that quick profits could be made from real estate. Now some of them — including my own brother — are facing foreclosure. That media-fueled frenzy has turned into media-fueled despair. If you didn't give in before, don't give in now.

It's my by belief that a strong personal economy is still built on fundamentals such as these:

  • Clear financial goals
  • An adequate emergency fund
  • Limited use of debt
  • The practice of thrift
  • Smart investing for the future

The national economic situation does affect our personal financial decisions to some degree. When unemployment soars, it's important to maintain an adequate emergency fund and to limit your use of debt. When the stock market is down, you need to understand your investment objectives, and how these relate to your risk tolerance and your investment timeline.

The foundation of a strong personal economy is education. To become a wise investor, you must be an educated investor. And you must recognize what you can and cannot control. The national (and global) economy affects your personal economy, but ultimately all you can control are your personal finances.

If you need more information on investing, go to your public library and borrow The Random Walk Guide to Investing [my review] or The Four Pillars of Investing [my review]. The Oregon Division of Finance and Corporate Securities features some excellent free publications for download, including The Basics of Wise Investing [PDF]. Read up on the subject, seek a professional adviser, and make your decisions from a position of knowledge and strength, not from a position of fear.

More about...Economics, Investing

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Writer's Coin
Writer's Coin
11 years ago

I think it’s fascinating that only a year or so ago everyone talked about how the US didn’t save, that we weren’t a country of “savers,” how horrible that was, etc, etc. And now here we are, after a “generation-changing moment.” People are changing their behavior. They are saving more money and spending less. The “impossible” is happening. As for the fiduciary responsibility bit, it’s a shame that people would think of financial advisers as “order takers.” This is precisely the time to listen to sensible advice on handling their money. We’ll see how many of these people look back… Read more »

Leslie
Leslie
11 years ago

Bravo! Excellent article…

Beth @ Smart Family Tips
Beth @ Smart Family Tips
11 years ago

Fear is contagious. It’s hard not to get caught up in the gloom and doom hype, and it’s true that decisions based on fear are rarely sound ones. I like the suggestion to step back and focus on the five things you listed that are always important (and a rational way to make decsions) in personal finance:
Clear financial goals
An adequate emergency fund
Limited use of debt
The practice of thrift
Smart investing for the future

@Writer’s Coin: I agree that the impossible is happening and it’s truly amazing.

Eivind
Eivind
11 years ago

I don’t know why some people do that — buy when there’s been a period of strong growth, and sell when there’s been a period of loss. It’s completely bananas stupid. Past performance (as in the recent past) is REALLY no indication of future performance. I’ve been investing steadily trough it all, started 5 years ago, and this far it’s been good overall, despite the recent turmoil. It don’t bother me either, I’m saving long-term, as in I want some cash for my retirement in 25 – 30 years. The current crisis gives low prices, I get a lot of… Read more »

plonkee
plonkee
11 years ago

One of the things that most concerns me is that it often appears that many people in the UK don’t even realise that their pensions are invested in the stock market at all. It’s not that I think that’s a bad place for them to be, on the contrary, but if you don’t understand where your money is, it’s going to come as a surprised in a bad way when there are down periods, and do ill-considered things, like pulling it all out. I wish people would realise that there isn’t a secret magic money cupboard. Then learn about risk… Read more »

frugalscholar
frugalscholar
11 years ago

I have a somewhat different perspective. I too have been “riding this out.” But I am near retirement and have been saving for 20 years. It’s hard to see your equity funds drop 40% when you’re in your 50s. It’s harder in your 60s. And it’s harder still for my recently widowed mother–in her 70’s. It seems to me that it’s easier for people fairly new to the savings game. Their loss isn’t that great in dollar terms, though it is the same in percentages. And they have a longer future ahead of them. Much more time to earn and… Read more »

ABCs of Investing
ABCs of Investing
11 years ago

There is always an overreaction when someone learns a lesson the hard way. Whether it’s falling off your bike for the first time or watching your 401k shrink after years of increases – it is tempting to just not participate in that activity which caused your pain/stress. Part of the recent shocks could have been avoided with more education – buying a house “for a couple of years” was always a risky proposition – it’s only recently that the risk ended up on the downside. Same thing with being invested in equities – markets go down almost as much as… Read more »

Curt
Curt
11 years ago

I have to disagree, you said… “When you pay too much attention to national or international economic news, you can find yourself making decisions that don’t make sense for your personal economy.” “It’s my by belief that a strong personal economy is still built on fundamentals such as these: …” Things are much different from the Great Depression. We live in a global economy, which means that national economies and world events effect our personal finances. Your fundamental personal finance strategies are all under attach from the governments policies to manipulate interest rates and currency supply. Your money is not… Read more »

RobertD
RobertD
11 years ago

The article is very true, but at times a little off. Although the wealthy always have money in the stock market, they do not always have the same percent invested in the market. People need to stop and think a little, get themselves organized and then start working on their financial future. An awful lot of people got themselves into trouble by not doing things in the right order, they bought into the financial services industries lofty advertising and bought investments when they shouldn’t have. You have to start at the beginning and follow all the steps. First comes thrift,… Read more »

Simon
Simon
11 years ago

fascinating!

squished18
squished18
11 years ago

JD, I think a more profitable message for you to write about is HOW to pay attention to the news and not to simply not “pay too much attention” to it. I agree that a lot of news is sensational. However, I believe that there are reasons for paying attention to quarterly earnings reports and a good way to interpret them. I feel that what you have written so far on the topic is too vague and not helpful. For example, an article about “20 different people that are suffering in this economy” is pure fluff and worth ignoring. However,… Read more »

J.D.
J.D.
11 years ago

@squished Great suggestion. I love the idea of an article on how to pay attention to the news, about ignoring the emotional and irrational stuff, and trying to extract the things that are useful. I’ll see if I can’t come up with something along those lines. One of the problems, though — and this seems to have not made my final edit above — is that I mostly avoid the news. From my experience, watching the daily news only makes me worried and tense and doesn’t contribute to my well-being, financial or otherwise. So I don’t do it. I glean… Read more »

Paul
Paul
11 years ago

All rhetoric and politics aside, pouring astronomical amounts of new debt onto the existing conflagration cannot pass the common sense test (outside of the Beltway). There may be bear market rallies, but money in the market is more at risk than it’s worth to anyone who is trying to preserve capital. Risk only that which you can afford to lose. “The Market” isn’t the place for capital you’re depending on (at least not until debt is reduced and the U.S. economy stabilizes – and in just how many years will that be?). So… is any responsible financial advisor really recommending… Read more »

SavvyChristine
SavvyChristine
11 years ago

It’s (strangely) funny that as people are pulling out their money from the stock market, I’m just now getting into investing. I opened my first retirement account last month, and it feels so good to be “greedy,” as Warren Buffet would say.

I don’t pay attention the the news — like J.D., I limit my exposure. I also don’t have much to lose, having just started contributing. Is it strange that I’m not worried?

Chris
Chris
11 years ago

With constant government intervention and changing of the rules, no wonder everyone is pissed off and doesn’t know what to do.

“Never let a good crisis go to waste”..

I would suggest finding whatever country has the most laissez faire economy, minimal taxes, and property rights and dump my money there. Our big growth years are over.

J.D.
J.D.
11 years ago

I would love to see a study on the relationship between news consumption and general disposition. My hypothesis — which would need testing, obviously — is that those with less news exposure (financial and otherwise) are happier. In my own life, the people I view as generally pessimistic are the ones who are most “in touch” with current events. Those who are generally optimistic (including myself) are more “out of touch”.

I’m not saying that one is right and one is wrong. I’m simply curious about the effects of news consumption on attitude (and behavior).

Neal Frankle
Neal Frankle
11 years ago

Another great post.

As a financial adviser, I appreciate it so much. I also agree that advisers are not order takers. But having said that, remember that after a certain point, the client is responsible if they continue to clamor for cash.

I’ve had a few cases where folks have discussed the option of moving everything to cash and after I make my case known, they still want to go ahead. In those cases, its really up to them.

Jason
Jason
11 years ago

JD,
I attended the FPA mid-winter conference and I want to thank you for attending. I appreciate your efforts in the community and wish you the best of luck.

Jason

Kat
Kat
11 years ago

The idea that the current mess is a “generation-changing moment” is precisely why I don’t believe we’ll be coming out of it for years – possibly decades. We’ve (the nation) been living in a lifestyle bubble fueled by cheap credit and pie-in-the-sky funny money investments that drove market highs of around 14,000. With tightening credit markets (which really means going back to the old rules of lending to people who have a reasonable ability to pay) and regulation of the funny money masters of the universe, we’re back to the lifestyle that should have been all along. Consumers are now… Read more »

Funny about Money
Funny about Money
11 years ago

It’s easy to say that you should keep your assets in the market until after the storm has been weathered. However, as Frugal Scholar notes, some of us don’t have that much time left. I have well over $100,000 in the market. And yes, I’ve dutifully stayed the course. My financial advisors have invested intelligently and, in response to the falling market, moved into cash, bonds, and gold. The result is that as I’m on the cusp of retirement, I’m expecting to be laid off my job at any time — and I’ve lost $153,000 of my life savings. Even… Read more »

Kent @ The Financial Philosopher
Kent @ The Financial Philosopher
11 years ago

J.D. (and Squished): I would be happy to write a guest post for GRS with regard to attention. As an adviser, I have observed in my clients a high correlation between irrational investment behavior and the consumption of news media. The proper perspective with regard to attention is not “paying” attention but “allocating” attention, much in the same way one would allocate a portfolio of mutual funds. Allocating attention to one area more than others increases overall “risk.” Likewise, some information sources are more “risky” than others and should therefore receive lower allocation percentages. Finally, more information (ala the internet)… Read more »

Kevin
Kevin
11 years ago

“Another speaker at the financial planning conference was a woman named Kevin”

Uhm…. what?

As a lifetime holder of the name “Kevin,” I’ve gotta say, I’ve never met a *female* with my name.

J.D.
J.D.
11 years ago

@Funny
You are absolutely correct. There is not one size fits all answer. It’s vital that investors assess their risk tolerance and use their investment horizon (the time until they need the money) to determine their asset allocation. This is fundamental stuff that people forgot or ignored during the boom years. Great comment.

Scordo.com
Scordo.com
11 years ago

Good post, J.D. Call me greedy, but I always aim to put my “personal economy” in front of the US economy. My strategy for spending and savings doesn’t really change with the economic swings in our economy. I think living below your means, saving, not buying new, etc. are sort of universal personal finance principles!

Best,
Scordo.com

Chuck
Chuck
11 years ago

“Advisers are not order-takers,” Kevin said. “You have a fiduciary responsibility. If, as an investment adviser, you think this is foolish, it’s your job to resist. You may even have to fire the client.” – WRONG! Cash is a position! I don’t think the collective intelligence of most of these “investment advisers” is that much greater than that of their clients. These people are SALESMEN! Why would I pay someone to manage my money that knows less than I do? Furthermore, do these people follow their own advice? There should be some transparency there!

The Personal Finance Playbook
The Personal Finance Playbook
11 years ago

I agree that this is the type of event that changes the way people view the world. It hasn’t impacted me, personally, all that much, yet, but some of the fear in the news and around me has leaked into my brain. I haven’t sold any of my equity positions yet, and I don’t intend to. I’m thinking of adding to some of my positions – one in particular. It’s a period of great uncertainty. Hopefully things will stabilize – sooner rather than later – especially for those of you who have stated you are close to retirement.

JerichoHill
JerichoHill
11 years ago

JD,

There are studies that show that those who consume less “daily” news tend to have higher investing returns than those who do not, and most of the difference is attributable to the costs of churn.

Amy
Amy
11 years ago

JD-
Question for you……my husband and I both contribute $100 a month into our 403B accounts. We don’t have much of an emergency fund but are slowing building it up. Lately, we’ve been thinking about cutting back to $50 a month into each of them with the way the market has been. Do you think that is a wise idea or should we just ride it out until the market gets better? Any thoughts you have on the subject would be appreciated.
Thanks-Amy

Suburban Dollar
Suburban Dollar
11 years ago

I certainly agree that too many people panic and act irrationally as a result of some half researched, or poorly reported news story. I think people need to educate themselves, as you said, to better understand what they are seeing and make their own interpretations of what is best for their situation.

J.D.
J.D.
11 years ago

@Amy (#28) I can share my thoughts on the subject, but please realize that ultimately you have to make the call based on what you know of your life and your goals. I haven’t changed my retirement contributions. I’m continuing to contribute as much as possible to index funds. However, I also have a substantial emergency fund already saved. I think that you’re actually making a smart move. You recognize that you’re nervous about the market, and so you’re doing something to adjust your habits based on your risk tolerance. Yet, at the same time, you’re not just swinging 100%… Read more »

Dana
Dana
11 years ago

The very well-known term “Ignorance is Bliss” is around for a reason.

There is also that quote by Hemingway (I think): “Happiness in intelligent people is the rarest thing I know.”

Kristina
Kristina
11 years ago

I’m a little tired of the pity party for retirees (or near retirees), which is reflected in some of the comments above and in the media. Here’s why: 1) Much of the supposed “losses” in retirement accounts were not “real” gains anyway. Much of what people lost was in fact bubble-fueled increases that no one should have been counting on anyway. You are not entitled to perpetual, insanely high annual returns. And when you lose some or all of these returns, that’s what’s to be expected in a bubble. My parents (and anyone with any common sense or ability to… Read more »

Ken
Ken
11 years ago

If everyone had a solid personal economy and their own game plan…they wouldn’t be swayed by the financial storms we’ve seen in the last year. Deciding what you control is critical to success in money and a gyrating market.

Marc
Marc
11 years ago

I agree with a lot of what Kristina said. Those that are older and are saying 20 and 30 year olds can afford to say ‘just ride it out and everything will be alright’ need to stop. If you’ve read books about asset allocation or personal finance all of them say that as you get older you should phase your money more and more OUT of stocks. The hard and fast rule is that 100 – your age = the percentage you should have in stocks. It’s no fault but you’re own if you kept a large percentage in stocks… Read more »

Lydia
Lydia
11 years ago

In an extension to #8’s reply – since Congress is getting ready to print TRILLIONS of dollars (putting our country in even more massive debt and risk for rampent inflation) – how should this in particular affect one’s investing habits? During the Great Depression, we were still under the gold standard – since that is not the case anymore, how does that change things?

Rick Francis
Rick Francis
11 years ago

@Funny about Money (#20) First don’t beat yourself up about not being able to time the market- because no one can do it! The Random Walk Guide to Investing addresses market timing and makes a great argument that it can’t realistically be done. I would question how good your advisors are because they moved your assets AFTER a market fall- that seems like they are trying to time the market and failing. Do you think that they will be any better at timing the move back into stocks? If you had a good manager wouldn’t they have had a solid… Read more »

Camille Gaines
Camille Gaines
11 years ago

The point about complacency surrounding risk is so on track. As in all painful experiences there is much to be learned from this recession and the related stock market decline.

sandy
sandy
11 years ago

My husband and I have been in the market for 20 years.(We’re 47) Last spring, when it became obvious that things were starting to unravel, he started putting his contribution in a money market within the plan he has at work. Mind you, it took 6 years for us to get back to the previous level after the 2000-01 recession. He keeps saying that he feels like we should put that money in now while the market is low, but I tell him that we’ve already got money in at that level…money we put in 15-20 years ago. Fortunately, when… Read more »

NewsWatcher
NewsWatcher
11 years ago

I think being a “news alarmist” is something you should consider facing up to and overcoming – rather like an alcoholic not attending social functions with alcohol at first, then attending and being able to smile and say “No thank you” and sipping the grape juice happily. I do think that nobody should be afraid of the news, and that it shouldn’t ruin your day (unless it is something like Sept 11). Here are some of the things I think could cause a type of “news phobia”, and in some cases some suggestions to counter them: 1. It is gloomy/depressing/feel… Read more »

ackislander1
ackislander1
11 years ago

A great post and a good discussion. Someone in the original article asked, “Do small investors make behavioral mistakes that keep them from becoming wealthy? ” The short answer is “Yes”. There is a rule of thumb in the investment business that whatever the small investor does is wrong. Small investors swing for the fence. Larger investors are happy enough with incremental after tax returns about 3% over inflation and are ecstatic if they do better over the long haul. If you see an infomercial about an investment strategy or opportunity, you should run the other way. They follow the… Read more »

ackislander1
ackislander1
11 years ago

This is in a separate post because it addresses a different issue in these responses, namely the confusion about investment professionals. There are three kinds: brokers, who are compensated by commissions on your trades; investment advisers, who are compensated by commissions or by fees; and investment managers. You should not take investment advice from anyone who gets a commission on your activity. You can use them as a source of information, but remember it is in their interest to get you to trade a lot, and successful investors don’t trade very much. Investment advisers who get a fee based on… Read more »

Melinda
Melinda
11 years ago

I think there’s another group of us too, those who are not yet at the $100k in stocks, however are working towards it and are prepared to ride out the market.

A year ago we had just over $60k in shares. Today we’re at $31k. Same shares, in fact we actually own more now than we did a year ago. We’re actively buying more shares now that the prices have dropped than we ever have before.

Historically the stock market will rise again. We have the time to wait it out and see that increase.

Associate Money
Associate Money
11 years ago

Sometimes, it is better to buy and then think that the stock market has closed for one to two years. That way, we are not reminded of our losses and will not be tempted to sell out.

Often, the moment we despair and offload our stocks, is the time when the market begins its recovery.

Sofia
Sofia
11 years ago

Newswatcher-

I’m with you. I think avoiding news is a problem that should be faced head on! Funniest comment, I think it should be boxed.

J.D.
J.D.
11 years ago

Just for Sofia and Newswatcher, I’ve highlighted the latter’s comment. It is funny. And Newswatcher, go check out Happy News. It’s already been done! 🙂

quinsy
quinsy
11 years ago

I’d just like to point out a logical discrepancy in the comment from Funny about Money: The commenter is comparing her own situation to that of a friend who got out of the market prior to the market going down. But the final note is that perhaps the moral of the story is that people should not stay the course AFTER the bottom has dropped out of the market. Funny, your friend did not get out of the market after the bottom dropped out, they were lucky enough to get out before that. Once you have already lost 50% of… Read more »

Mark
Mark
11 years ago

I just want to add something on watching daily news; I don’t do it anymore as well. I used to but it just made me feel bad… afterwards I felt hopeless, like I couldn’t do anything about it, that it was all »above me« and »too big«. It only served the purpose of grotesque “entertainment” for me. Then I realized, what’s the point in watching news if I only do it for these »entertainment« purposes? If I never act on any of it because it makes me feel so powerless in the first place? What kind of sick way to… Read more »

mwarden
mwarden
11 years ago

Great articles recently, JD.

thomas
thomas
11 years ago

downfalls in the bigger economic picture are true opportunities for investment. I have not changed my investing strategy and will hopefully enjoy this buy low opportunity in my later years.

Charlotte
Charlotte
11 years ago

#16 JD: I completely agree with you. I never watch or read the news except what I come across in daily life – from co-workers, family, and radio. I am significantly more calm than my husband who peruses all the information he could possibly get. Online, TV, radio, co-workers, etc. He is always worried and kind of negative. Granted, we do have some things to worry about but I’d rather spend my energy finding a solution or educating myself. #6 and similar comments: Shouldn’t you take less risks the older you get? I had a co-worker retiring in 2 years… Read more »

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