Welcome to another edition of Notes Along the Path!
This month's topics:
- The Psychology of Money
- Not Your Typical Economic Recovery
- Couples' Money Problems: 6 Traps to Avoid
- Link to Key Tax Changes from the Tax Cuts and Jobs Act
Please consider sharing this with someone you know who might be asking themselves (or you!) questions about their financial future.
The Psychology of Money
Financial advisors come up in our careers being taught certain tenets about money and investing. Maybe you have heard some of these as well:
- Financial planning starts with a clear definition of your goals.
- Diversification is the key to reducing risk.
- In an efficient market, the current price of a stock reflects all publicly known information.
- Never fall in love with an investment.
In his 2020 book The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by award-winning author Morgan Housel doesn't exactly turn these tenets on their head, but it does give us a new way of looking at money and investing by using 19 short stories to explore the strange ways people think about their finances. Housel is a partner at the Collaborative Fund and a former columnist at The Motley Fool and the Wall Street Journal. I think his views are worth examining, so here are some of his most practical takeaways.
1. You don't need a speciﬁc reason to save
Some people save for a down payment on a house or a new car, or retirement. That's great, of course. But you can save just for saving's sake.
Saving is a hedge against surprises popping up at the worst possible time. Having money in the bank allows you to think. It gives you options and flexibility. The return on cash in the bank (at 0% interest) is incalculable if it allows you to take a sabbatical, change careers, or just feel safer living in an unpredictable world.
2. Don't confuse luck with good decision-making
Bill Gates would never have founded Microsoft if he hadn't been born into an affluent family and attended Lakeside prep school in Seattle, one of the world's only high schools to have a computer in 1968. Gates is crazy smart and even more hardworking, but he admits the factor of luck in his success: "If there had been no Lakeside, there would have been no Microsoft," he told the school's graduating class in 2005.
Some successes are due to sound decision-making, while others are due to luck. It's important not to confuse the two. Success can be a lousy teacher if it seduces smart people into thinking all of their successes are their own doing.
3. Luck also works the other way—then it's called risk
When factors beyond your control threaten to cause adverse consequences, it's called risk. When managing your money, it's easy to mix up the role of luck/risk versus good/bad decision-making.
Say you buy a stock, and five years later, it's gone nowhere. It's possible you made a bad decision by buying the stock. It's also possible that you made a good decision that had an 80% chance of making money, but you ended up on the unfortunate 20% side. Failure can be a lousy teacher because it causes smart people to think their decisions were terrible when they sometimes reflect the unforgiving realities of risk. The trick when dealing with failure is to arrange your financial life so that a bad investment won't wipe you out.
4. Wealth is what you don't see
Spending money to show people how much money you have is the fastest way to have less money, which is one of money's greatest ironies. We tend to judge wealth by what we see because that's the information we have in front of us. We can't see people's bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars. Homes. Instagram photos. But wealth is the nice cars not purchased. The diamonds not bought.
Singer Rihanna nearly went bankrupt after overspending and sued her financial advisor. The advisor responded: "Was it really necessary to tell her that if you spend money on things, you will end up with the things and not the money?" Wealth is an option not yet taken to buy something later. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.
5. History is mostly the study of surprising events
The most important events in history are the significant outliers, like the Great Depression, World War II, ARPANET, September 11th, the fall of the Soviet Union, and, of course, the pandemic. The fallout from each event has compounded over many years. For example, 9/11 prompted the Federal Reserve to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $1.6 trillion in student loans with a 10.8% default rate.
A majority of what's happening at any given moment in the global economy can be tied back to a handful of past events that were nearly impossible to predict at the time. So the most important lesson we can draw from history is that there will be surprises. And by definition, we don't know what those surprises will be.
6. Investors are not all playing the same game
An idea exists in finance that seems innocent but has done incalculable damage. It's the notion that assets have one rational price in a world where investors have different goals and time horizons. It's not irrational for a day trader to pay a high price for a stock when momentum suggests it will sell for an even higher price later in the day. Short-term traders can make money in a bubble.
Bubbles do their damage when long-term investors playing one game start taking their cues from short-term traders playing another. Cisco stock rose 300% in 1999 to $60 per share. At that price, the company was valued at $600 billion, which is insane. Sixty dollars was reasonable for the trader who could count on selling it for a bit higher later in the day. It was a disaster for anyone planning on holding the shares for the long run. Few things matter more with money than understanding your time horizon and not being persuaded by people's actions and behaviors playing a different game than you are.
As I always tell people, you have to run your own race. Set your goal and go get it! But never forget that comparison is the quickest route to unhappiness.
7. Your plan will not go according to plan
One thing blackjack card counters know is that no matter how accurate they are in their count, an unexpected card could come up. They weigh the probabilities of this based on how many cards remain to be played. Then they adjust their bets accordingly, betting more when the odds are good and less when they are not. Blackjack players know they are playing a game of odds, not certainties.
Benjamin Graham, the famous investor, knew this too. He created what he called a margin of safety. When you don't (can't) know what card will come up or what rate of return your portfolio will earn over the next ten years, or exactly what date you'll be able to retire, you create a margin of safety. One example of this is to assume your investments will earn one-third lower than the historical average and then base your savings plan and retirement target date around that.
8. Some risks are never worth taking
While you have to take risks to get ahead, some risks are never worth taking. Some call this is the "Russian roulette (should statistically work)" syndrome: an attachment to favorable odds when the downside is unacceptable in any circumstances.
9. It's OK to love your investments
"Never fall in love with a stock" is an age-old investing tenet, the rationale being that you won't want to sell when it goes against you. But look at it this way: the historical odds of making money in U.S. markets are 50/50 over one-day periods, 68% in one-year periods, 88% in 10-year periods, and (so far) 100% in 20-year periods. Anything that keeps you in the game has a quantifiable advantage. If you love your investments, you'll be more likely to stick with them during temporary market downturns.
Money Problems Couples Can Avoid
"Stop in the name of love before you break my heart." We know The Supremes weren't alluding to the pitfalls couples face when they grapple over money issues. But our own experience tells us that money plus love can lead into minefields we'd rather avoid.
So, let's recognized the obvious. Financial matters are an essential part of any couple's relationship. Face them head-on.
For some couples, this will be second nature. For others, it's a challenge, but we're here to help.
If you take the time to get on the same page, you can solidify your finances and strengthen your relationship. Working towards the same goals is critical. It's time well spent.
Six money issues you and your spouse must navigate
1. Setting Goals.
One's a spender, and the other's a saver. Or, one has an always-expanding list of toys they would like to add to their collection, and the other spends most of their time thinking about growing the family's emergency fund and how they can max out their 401k contributions. Does that sound familiar?
It's too late to have "the talk" after putting a big purchase on your credit card. So, sit down and have a money date. Talk about your goals and write them down. Without goals, you won't know where you are headed.
Share your feelings and (this is important) actively listen to the other's viewpoint. Compromise may be needed, but agreeing on common goals will allow you to move forward in a unified fashion. When you have completed this task, I am confident you'll feel an enormous sense of satisfaction.
2. All for one and one for all?
Marriage is about unity, but not the absorption of one's self into the collective whole. Our interests won't be perfectly aligned. The same can be said about handling our finances.
A joint checking account and a joint credit card are perfect for joint expenses, but separate accounts for separate interests are a good idea too. When you set your goals, establish boundaries regarding spending and saving patterns.
3. Money secrets are a no-no.
It's OK not to disclose the secret handshake you learned from your college fraternity or sorority. It's not OK to keep money secrets hidden from your spouse or partner.
Major secrets may be a symptom of more significant problems that can threaten the stability of your relationship. Don't destroy the trust that can take years to rebuild.
4. Who handles the monthly bills?
It's a good idea to put as much as possible on autopay. But you don't want to get caught flat-footed with overdue bills or late charges that may slip through the cracks and ding your credit report.
Therefore, who takes care of the bills? It may make sense for one person to be in charge, so there's no confusion and regular payments aren't missed.
But checking in monthly or bi-monthly is an excellent way to keep both individuals on the same page. Check-ins also allow you to make any adjustments, as a couple, to your goals.
5. What comes first, the chicken or the egg?
It's an age-old but unanswerable question. Should we go in the direction of retirement savings or college savings?
Having children means putting your kids before yourself more times than you'll ever be able to count. But when it comes to saving for retirement or college for your kids, put yourself at the front of the line. Doing so will better position you to receive financial aid from most colleges.
Pensions are disappearing, and Social Security isn't enough. You must consider your retirement needs first. There are exceptions, and we can look at ways to fund both goals. But do your best to maximize retirement savings. At the minimum, capture the full amount of your company's match.
Keep this in mind: If you don't fund your retirement, who will? The burden could fall on your kids.
6. Failure to stash away cash for an emergency.
Did you know that just 39% of Americans have $1,000 to handle an emergency? The rest would have to use a credit card or borrow to cover an unexpected need. I know you have ample reserves, but sadly, that's not the case for all Americans.
If you received a stimulus check in December and didn't have an emergency fund, please save it.
Money is a complicated topic made more complicated in the context of your closest relationship. I truly understand that. Treat each other with respect and actively listen when you set goals. Goals provide you with a roadmap, and they can reinforce the bond you have towards each other.
If you aren't sure how to get started, please reach out to us. We're here to help and get you pointed in the right direction. As always, procrastination is the enemy. Get started today.
Not Your Father's Economic Recovery
Technically, the economy is still in a recession. The National Bureau of Economic Research (NBER), the arbiter of recessions and economic recoveries, has yet to declare that the recession is over. When it does, it will likely backdate the end of the recession, as it has done in the past.
Key economic reports would suggest the low point for the economy occurred in April. These include employment, consumer spending, and manufacturing production (U.S. BLS, U.S. BEA, and the Federal Reserve, respectively). The top of the prior cycle occurred in February.
Whenever the NBER makes its declaration, this economic recovery has been far from what might be considered an average recovery. The pandemic that led to the steepest slide in quarterly GDP on record (U.S. BEA, quarterly records began in 1947) has also shaped one of the most lopsided recoveries we've ever experienced.
Look no further than service-based industries that require personal interactions to thrive, which is something we took for granted pre-Covid.
As you know, social distancing restrictions and fear of contracting the virus have severely impacted airlines, hotels, travel, restaurants, concerts, and movie theaters. These industries and more have struggled to adapt to the new normalcy.
Did you notice football and other sporting events that were played in nearly empty stadiums? It's not only wealthy owners that have been hurt--consider all the folks who worked at those events.
Even health care has suffered. According to data from the U.S. BEA, spending on health care is down 12% versus one year ago (Q4 2021 vs. Q4 2020). Health care spending accounted for over 10% of GDP in the final three months of last year. I know I have put off my eye doctor and my dermatologist, who I used to see every year.
But other industries have adapted. For example, housing relies heavily on the personal touch. But record-low interest rates and a scarcity of supply have spurred strong sales in housing.
Essential retailers, home improvement, auto sales, and grocery stores have experienced robust numbers. Consequently, manufacturers were caught off guard by the resurgence in sales.
A February 22nd story in the Wall Street Journal sums it up nicely: Consumer Demand Snaps Back, Factories Can't Keep Up. Snarled supply chains, labor shortage, thwart full reopening; "Everyone was caught flat-footed."
Reopening various sectors of the economy has helped, and generous jobless benefits and two rounds of stimulus checks have left many with cash to spend. While the final touches aren't yet on the latest relief package, more cash is likely on the way.
But here lies the problem. Government restrictions prevent most of us from attending sporting events, museums, and the theater. Moreover, many are not entirely comfortable traveling on airplanes, spending a night in a hotel, or enjoying a restaurant meal.
The extra government support that has helped fuel growth has been funneled into some industries or savings, as artificial barriers, which I recognize are needed, have severely hampered others.
You might consider your circumstances. Have you noticed smaller balances on your monthly credit card statements? Or have you noticed a different mix in your outlays versus pre-pandemic? Are you streaming more movies rather than going out to dinner or enjoying the theater? Have your recreation choices been altered?
A new and costlier relief package that's currently pegged at around $1.9 trillion seems likely to pass soon. Expect the new cash to support the economy and to continue to support various sectors that have benefitted at the expense of other sectors.
What might help the beleaguered industries that have suffered under today's restrictions? For starters, a successful rollout of the vaccines dramatically reduces the odds one can contact Covid. President Biden's commitment on March 3rd to have vaccines available for all adults by the end of May will undoubtedly be a boost as it gets closer to fruition.
It's been a challenging year, and there's plenty of uncertainty, but prospects this year look bright.
One closely followed GDP-tracking model places Q1 growth at a 10% annual rate. A survey of economists by Moody Analytics suggests GDP growth this year could top 6%, which sounds about right to me although economic forecasting is, of course, always tricky.
A Last Word
Yesterday I sent out a note on some key changes to remember when doing your taxes this year.
If you would like the information in .pdf form, please don't hesitate to send a note and I will get it to you right away.
I hope you've found this review to be helpful and educational.
I understand the uncertainty facing all of us. We are still grappling with an economic and a health care crisis, so of course there are always questions. If you want to talk any time, let's have that conversation. That's what I'm here for.
If you like it this newsletter I encourage you to pass it on to any contacts you have that might benefit.
I remain honored and humbled that my clients have allowed me to serve as their financial advisor. Thank you for your support.
All the Best!