Living on the Financial
Edge
At Paragon Financial Advisors, we
recommend our clients have a 3-6 month cash “ready reserve” to meet unexpected
expenditures. For most Americans, accumulating that amount appears to be much
easier said than done. In the May, 2016 The
Atlantic magazine, Neal Gabler wrote an article entitled “The Secret Shame
of Middle Class Americans.” Some of the items he mentioned (and the sources he
quoted) are shown below.
Unexpected Expenses
A Federal Reserve Board survey
designed “to monitor the financial and economic status of American consumers”
found that 47% would not be able to cover a $400 unexpected expense unless they
borrowed, sold something, or could not cover it at all. David Johnson
(University of Michigan) surmised that Americans usually smooth consumption
over their lifetime: borrowing in bad years and saving in good years. People
are now spending any unexpected income (bonuses, tax refunds, etc.) instead of
saving it.
A 2014 Bankrate survey found that only
38% of Americans had enough in savings to cover a $1000 emergency room visit or
a $500 car repair. Nearly one-half of college graduates could not cover the
expense through savings. In 2015, A Pew Charitable Trust study found that 55%
of households didn’t have enough liquid savings to cover one month’s living
expenses.
Another study by Annamaria Lusardi,
Peter Tufano, and Daniel Schneider asked whether a household could raise $2000
within 30 days for an unexpected event. More than 25% could not; another 19%
would have to pawn something or use a payday loan to raise the money. Nearly a
quarter of households with an income of $100-$150,000 per year could not raise
the $2000 in one month.
Liquidity or Net Worth
Is this situation only a liquidity
problem or is net worth (the net sum of all assets including retirement
accounts and home equity) also at risk? Edward Wolff, an economist at New York
University, reported that net worth has declined significantly in the last
generation. Net worth declined 85.3% from 1983 to 2013 for the bottom income
quintile, decreased 63.5% for the second lowest quintile, and decreased 25.8%
for the middle quintile. He looked at the number of months a household could
fund its current consumption by liquidating assets if the household lost all
current income. In 2013, the bottom two quintiles had no net worth; hence, they
couldn’t spend anything. The middle quintile (with an average income of
approximately $50,000 per year) could continue spending for 6 days. A family in
the second highest quintile could maintain current spending for a little over 5
months.
Research funded by the Russell Sage
Foundation found that the inflation adjusted net worth of the median point of
the wealth distribution was $87,992 in 2003. In 2013, it had declined to
$54,500—a decline of 38%.
Debt
Value Penguin did an analysis of
Federal Reserve and Transmission data pertaining to credit card debt. In 2015,
credit card debt per household was $5700. Thirty eight percent of households
carried some debt; the average debt of those households was greater than
$15,000. Apparently the rise of easy credit availability has supplanted the
need for personal savings. The personal savings rate peaked around 13% in 1971,
fell to 2.6% in 2005, and has risen only to 5.1% now. These debt levels reflect
only personal debt; no serious attention is being paid to our $19 trillion
government debt.
What’s Going On?
Financial products are becoming more
sophisticated, both in quantity and complexity. Such additional products should
provide a better way to manage personal financial “hiccups.” Lusardi and her
associates (in a 2011 study) found that the more complex a country’s financial
and credit market became, the worse the problem of financial insecurity becomes
for its citizens. That study measured the knowledge of basic financial
principles (compound interest, risk diversification, the effects of inflation,
etc.) among Americans ages 25 to 65. Sixty five percent were basically
financially illiterate.
Why are we at a financial advisory
firm writing about this situation? The United States finds itself in the midst
of a most unusual political situation. Some candidates for President of the
United States are espousing theories or programs outside the normal
capitalistic structure. Are conditions such as the ones described above
partially to blame?
A crucial part of managing investment
portfolios is attempting to monitor the economic, political, and social
conditions that might affect the investing environment in the future. What will
that environment look like and how will it affect the selection of assets going
forward? We at Paragon Financial Advisors don’t have a crystal ball for the
future, but we do try to help our clients invest for the long term. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management services to our clients.
