The chattering class in Washington DC and elsewhere is abuzz with concern about the “fiscal cliff”, involving legislation passed in the summer of 2011 requiring tax increases and spending cuts to decrease the exploding US Federal deficit. The Washington Post suggests that this “fiscal cliff” would raise taxes over $2,000 per year on many middle income families, decrease spending, fray the safety net, and push the US economy into another recession. The “fiscal cliff” is simply the latest in a series of financial troubles that have plagued man throughout history, including such the Dutch Tulip Mania of 1720, the Great Depression of the 1930s, the Great Recession of 2008, and countless others. As always, the media is convulsed with worry, ordinary people differ in their responses, with some feeling helpless, others ambivalent, and a few confident.
Though I have not done formal interviews, those who feel helpless seem to believe that they will lose their jobs, their expenses will skyrocket, and there is nothing that they can do about it. These people wring their hands in fear and impotence and find it harder to function in their day to day lives. Those who are ambivalent usually don’t know what is going on. A few have confidence based on their assumption that everything will turn out fine because it always has in the past.
The last group also includes those who are knowledgeable and confident, and to them we will now turn our attention. These people generally have ordered their lives in such a way that they have plenty of resources, personal, social and financial; to weather whatever “fiscal cliff” others dream up.
Those people who are confident that they can withstand financial shocks have a reliable source of income and contingency plans if that source diminishes or even dries up. The income source is usually a job, but it can be investments or even a pension. If that source fails through job loss, investment losses or sickness, these people have a solid contingency plan, including several months of living expenses tucked away in safe investments, or even close family and friends that will help them through the hard times. Support for the aged rooted in family and community existed for millennia before Otto von Bismarck developed the first federal Social Security system in Germany in the late 19th century, and will be around long after the last company and last government pay the last pension check, should that unfortunate outcome happen. People who have reasonable plans and strong relationships can have confidence in the harsh times.
The confident ones also know that no job is completely safe, and so they continually update and hone their skills to be competitive in the ever changing market. My father used to say “the world doesn’t owe you a living”, and despite the large numbers of people who believe that the world owes them everything, my father was right. To survive in today’s hypercompetitive environment, companies can’t afford to keep workers who underproduce or whose skills are out of date. Some might think that they government will support them, but the government draws its revenue from the people. If the people don’t produce wealth, the government will have nothing to redistribute. For years governments at every level in America have spent too much, but this cannot go on forever. No nation can tax enough to support the indolent or the entitled.
People who are confident in the future carefully analyze opportunities for financial benefits as well as risks. In some families a second parent takes a full time job to make more money. If the income potential is high and the expenses are low, this makes sense. Often, however, the expenses, both obvious and subtle, are so great that sending the second parent to work does more harm than good. Consider a stay at home mom who takes a full time job to bring more money into the family. If she is a lawyer, nurse, businesswoman or in some other career with high earning potential, it may make financial sense. If she takes secretarial work, the cost of a daycare, meals out, a second car, and a new wardrobe may cause the family to lose more money than she can bring home.
Those who stay confident in economic hard times spend less than they make. They may accumulate debt for specific and time limited reasons, but in the medium and long run they produce more than they consume. Money is not an end in itself but a tool to accomplish some greater good such as the well being of the entire family, the mission of a company, or the ministry of a church. Confident people see material possessions not as things they deserve but as things that they use. They do not accumulate stuff to brag to their friends or even to indulge themselves but to be of service to others.
Every individual and family has two kinds of expenses, fixed and variable, and should strive to decrease both. Fixed costs are relatively unchanging from month to month; including such things as house and car payments. It is hard to decrease fixed costs in the short term but easier in the long term. Moving from a large to moderate house and buying a less expensive car are two ways to decrease fixed costs.
Variable costs are those that vary directly with volume of use, and often include utilities, groceries, fuel, and discretionary expenses. These are easier to decrease in the short and long term and are the first areas that people should cut when facing financial adversity. Getting a cheaper phone and internet plan, canceling cable or satellite television and replacing inefficient with efficient light bulbs, and insulating the house will decrease costs for utilities. Purchasing cheaper foods, clipping coupons and buying with a list will lower expenses for groceries. Driving less will cut the amount spent on fuel, and curtailing meals away from home will improve family relations, minimize waistlines, and slash costs. For example, bringing a bag lunch and thermos of coffee every day rather than buying lunch and having one latte can easily save $10 per day or $200 per month. It can also save 500 calories per day, or 10,000 (three pounds of weight gain) per month. Trips to libraries, parks, and free or low cost community events are abundant in most cities and can replace some expensive trips to amusement parks and movie theaters. There are hundreds of other ways to cut costs and all of them involve effort. Each individual and family is different, but anyone who wants to be confident of their financial future in hard economic times will change their lifestyle to pare their expenses to a minimum.
We must say a word about debt. Though some Americans seem to think that debt is no big deal and bankruptcy is an easy out, our countrymen for centuries have disciplined themselves and implored others to avoid this vile trap. Benjamin Franklin wrote that “it is better to go to bed without supper than to rise in debt”, and President Andrew Jackson warned “when you get in debt you become a slave”. Thomas Stanley, author of The Millionaire Next Door and The Millionaire Mind did extensive research on the wealthy in America. During his research, one of his interviewees noted “We (the lenders) own it all…all of it. The businesses out there…, you borrowers just run these businesses for us. You guys run them for us, the financial institutions (p2).” Personal debt for large items such as house and car has become normal in the United States, but it was not always so. Such debt is tolerable only in some cases, only for the short term, and only with a sound exit strategy.
The best thing to do with debt is to get out of it as fast as you can. Some suggest that families in debt pay off the smallest one (by amount) first, and then apply the money saved to paying off the next smallest one. In my family we paid off the one with the highest interest rate first and then used the money saved to pay off the debt with the next highest interest rate. We proceeded apace until, except mortgage and auto loan, we became debt free. Credit cards generally have the highest interest rates and should be paid off first. For example, if a man in debt is given $100 for his birthday, it makes more sense to pay that against a 14% credit card debt than to put it into a 0.9% rate of return savings account. The only thing that should delay paying off debt is building an emergency cash fund, typically three months living expenses, to meet financial needs when unexpected emergencies arrive.
Shared services are a terrific way of cutting expenses. Churches and other community organizations usually have people with a broad mix of skills and interests. Friends and acquaintances in the group can share skills, minimizing the need to pay for expensive specialists, and save everyone involved money. One friend in our neighborhood is a terrific handyman and another nearby is a general contractor. Such simple things as rides to and from the airport can save surprising amounts of money. By sharing advice, skills, and labor, we build our relationships and make each other better able to fend off financial difficulty.
Another advantage of slicing expenses is that it will also slice taxes. State and local sales taxes, federal gasoline tax, highway tolls, and many other expenses that nibble away your hard earned cash will diminish. It is impossible to know how governments will change tax rates in the future, but people with confidence in the future do not helplessly hand over their money. Instead they think and act to meet their needs, those of their loved ones, those of their community, and those of their nation…in that order.
Saving and Investing
People who are confident about their financial situation in the future are those who save money. Life is uncertain and having some set aside, along with appropriate levels of insurance, can reduce fears from that uncertainty. In addition to the emergency fund mentioned above, people need to save to buy big ticket items such as a house or a car, to acquire education and job skills for themselves and others, and to meet their needs in old age when they may not be physically able to earn money. As more children are taking care of their aging parents, those who wish to face the future with confidence also set aside some money to meet this need.
Where to save money is an important question. Wealth can be held in two primary kinds of assets, liquid and illiquid. People buy things with cash and so liquid assets are those from which a person can rapidly generate cash, such as savings accounts, short term bonds, and money market accounts. Illiquid assets are those which cannot be turned rapidly into cash, such as real estate, vehicles, art, and long term investments. Households who have confidence in the future have the right mix of liquid and illiquid assets. Imagine two families, each with $100,000 in total wealth. Family A has $80,000 in home equity, a car with a resale value of $15,000, and various bank accounts and other assets totaling $5,000. Family B has $50,000 in home equity, a car with a resale value of $15,000, and various bank accounts and other assets totaling $35,000. In case of an emergency like home repairs or medical bills, Family A may not have enough cash to get them through the crisis without selling assets far below their market value or taking out expensive loans. Family B should have enough cash for emergencies, but since investments that can be rapidly converted into cash don’t typically pay much interest, may be getting a lower return on their investments.
Young people who want to stay confident in hard economic times tend towards slightly riskier investments because they have the time in life to make up for greater losses. Older people who want to stay confident in hard economic times tend towards slightly less risky investments because their needs for college expenses for their children and retirement income for them is more imminent. Each should have an emergency fund as noted above.
Giving money away
Those who are the most confident in hard economic times are those who have learned when, how much and to whom to give money away. Even if charitable giving loses its tax deductibility, personal charitable giving, done wisely, decreases the burden of poverty, sickness, and other ills in society and helps the nation as a whole to prosper. According to Philanthropy.com, people in Utah and Mississippi gave over 7% of their annual income to charity while people in Massachusetts gave less than 3%. A good rule of thumb is that people should live on 80% of their income, save 10% of their income, and give away 10% of their income.
Givers should give to causes in which they believe strongly and should carefully screen organizations they would consider donating to. Thousands of charities promising to fix every ill in the world want money, but relatively few use the money wisely. Local causes are generally better than national or even international ones, because people who give money to local organizations are likely to volunteer in them as well.
Readers may be puzzled to find a section titled “character” in an article on how to have confidence in hard economic times, but actually character is one of the most important discriminators between those who prosper and those who do not economically. This is not to say that everyone who is wealthy has good character and everyone is not does not. However, it is true that certain positive character traits are associated with success in finances, and many other areas of life. In his works noted above, Thomas Stanley discovered that integrity, discipline, social skills, a supportive spouse, and hard work were associated with success.
This stands to reason, as many unexpected factors influence both income and expenses. A man who can’t get along with others may lose hard fought financial security by losing his job, eliminating his income stream, or losing his marriage, vastly increasing his expenses in attorney’s fees, alimony, child support, and setting up another household. One who smokes, eats poorly and is out of shape is a set up for decreased income through sickness and lost productivity and increased medical bills. A woman who is estranged from family and friends will have to handle problems alone, increasing her likelihood of stress and ultimate failure. Family and friends are never perfect but generally play positive and supportive roles. A man who can’t be trusted will not succeed.
Financial crises are inevitable. Jobs are lost, medical problems arise, the government takes too much in taxes, or greed drives financial systems down. Many people, perhaps most, will feel helpless, ambivalent, or blithely confident. A few will have sound preparation and justified confidence. Their reasons are ultimately more based on character and knowledge than on balance sheets. My hope is that we all will have more confidence, and better character, with this information than we had before.