by Susan Lavery
Since the financial crisis of five years ago, the economy has been slowly (very slowly) recovering. But have we, as earners and consumers, learned our lessons from that time? According to the Wall Street Journal there are six money lessons we should have learned from that time:
Ignore Wall Street’s forecasts. In fact, it is well documented that randomly-chosen “index funds” perform as well or better than those hand-picked by the financial “experts.” The problem is that the financial experts try to predict future happenings from past data – and that data is often sparse and limited. Conventional Wall Street wisdom at the time was that home prices always go up, stocks produce average returns of about 9% a year, and bonds produce average returns of about 5% a year. What we have learned: you cannot always reliably predict the future based just on the past. Be prepared in case stocks and bonds do worse than expected.
Wall Street experts and economists don’t know much more than you. There is almost too much to discuss here so I’ll condense. All the financial big wheels, including the International Monetary Fund, the Federal Reserve and, of course, the Wall Street bankers, thought that the mortgage blowup would be contained, that housing would continue to grow, and that the best investments would be foreign stocks and the worst would be domestic US bonds. Guess what happened? The exact opposite! Financial experts are primarily in the business of managing their own careers, which means not going against the herd and agreeing with “conventional wisdom.”
Avoid debt as much as possible. The U.S. was on a debt binge from the 1980’s through 2008. This includes individuals, businesses, and the government. Wall Street said this was okay, in fact they thought this was “risk transfer” that would make the system safer. They gambled on a stable economy, and they and everyone else lost that gamble. Records numbers of layoffs, bankruptcies and foreclosures are still affecting our economy today.
How comfortable are you with risk? Financial planners say that clients often state that they are willing to assume some risk when investing in stocks, but when the stock market crashes, they want to sell. Seeing your hard-earned cash evaporate before your eyes is tough to handle. The stock market is riding high again, but could you cope with another selloff? Be prepared or be conservative in your investing strategy. I have a personal confession to make – in the past when minor crashes occurred in the stock market, I held on to what I had or even took money out of savings to buy more – and I made a lot of money doing that! But I was in my 30’s and 40’s with little to no debt and was gambling on a long career ahead of me. Would I do that now that I am in my (ahem) 50’s? NO. In fact, a couple of years ago I transferred about half of my IRA to lower risk funds because I have become more risk-averse as time goes by. Re-evaluate your investments yearly and be very conscious of your real aversion to risk.
Simple is beautiful. Credit default swaps, hedge funds, complex derivatives – these are the clever and ingenious investing products that crashed in 2008. The simpler investments – stock shares in established companies – dipped somewhat but were much more stable than the complicated ones. The lesson is: don’t invest in assets or strategies that you don’t understand.
Cash is still king. Wall Street wants us to “put our money to work” (partly because that is how they make their money). Yet in 2008, those who held hefty reserves of cash were the ones who prevailed. Warren Buffett, the king of informed and simple investing, was loaded with cash and used it to buy bargain stocks amid the panicked sell-offs. Keep enough money in your bank account (or mattress) to meet household expenses and handle an economic crisis. I have often heard that you should have 6 months worth of expenses in cash. Remember the old saying about “saving for a rainy day”? It still holds true today. Would your life be able to withstand an accident, a layoff, a natural catastrophe? Save!
Now, for the real estate aspect, since that is supposed to be the primary subject of this blog. Homes are a great investment, if you treat them as such. That means choosing a home in the size, style, configuration and area that promises to be appealing to most people, and not putting a lot of money into customizing it for unusual hobbies or tastes. Shop around for a mortgage – just as with any home improvement it’s best to get at least three quotes. Not only do mortgage companies differ in the lenders they work with, but also the fees they charge to process and close on your loan. Ask the lender or mortgage broker for a Good Faith Estimate so you know exactly what those charges will be.
Additionally, keep track of your credit rating and scores, which means buying some items on credit but not buying any long-term or high ticket items during your home shopping period. Saving for a good down payment (10-20%), also figuring in closing costs of about 1% of the home’s value, will get you the best interest rates and terms, and will save you the mandatory PMI (mortgage insurance) required of a lower down payment loan. Have a few thousand in reserve as well, to take care of any unforeseen or emergency repairs you might face in your new home. Although most home buyers expect to stay in their homes for many years, the regional average in southeast Florida is 7-9 years, which means that paying points up front to lower your interest rate/monthly payment generally does not make financial sense.
For most Americans, our home is one of our biggest investments, both financially and emotionally. Maintenance is ongoing but is cheaper than repairing a major problem caused by lack of it, and will pay off when it is time to sell or pass it on to your heirs. And most of all – enjoy it!