Wednesday, January 13, 2010

Is the Good News Bad?

I know last week’s financial tip indicated that people are worried about their credit, instead of their savings.  My strong belief in saving and my personal preference toward the future might have gotten me out-on-a-limb.  This month, the Federal Reserve Bank reported that in November the total borrowing dropped by $17.5 billion, a much larger decline than the $5 billion that had been predicted by my economic brethren.  This is the biggest drop in credit, since 1943, the year they began to keep records.  The largest drop was in credit cards which fell by $3.7 billion.  This was an 18.5% decrease, compared to November, the largest decline since a 29.6% decrease recorded in December of 1974.

 

The indications are that people are borrowing less, as a result of fear of (or actual) job losses.  In December, employment did decrease in our country with a decline in 85,000 jobs, although the unemployment rate remained constant at 10%.  Employment was seen to particularly fall in the industries of construction, manufacturing, and wholesale trade, while increases were recorded in temporary help services and health care.  More can be read at the Bureau of Labor Statistics. (Click here for more information.)

 

To make matters worse, there is mounting evidence that banks are increasingly reluctant to lend money, as many banks have tightened lending standards.  Fannie Mae and Freddie Mac have tightened their rules, by limiting lending solely to consumers, as opposed to developers.

 

At the same time many are recognizing the need to save more, in order to replenish their portfolios.  Remember a few months ago we mentioned the Paradox of Thrift by Lord Keynes, where people tend to save at the precise times when the economy needs them to spend more.  The American consumer accounts for 70 percent of all economic activity (and is the reason for all economic activity) and when the consumer cuts back, the economic shrinks.  I also pointed out that, while others are spending, those that save can make a personal difference in their futures.  Hence, there truly is a paradox of savings.  So, what is my tip, in the context of this information?

 

The main thing is to stick with your savings plan, if you have one.  If you don’t have one, start one.  The fact that credit is being reduced may slow the economy but the fact that there is cash on the sidelines or in the banks, indicates that money will continue to be inexpensive for a while (i.e., low interest rates) and that eventually money will come off the sidelines and be employed in productive investments.  Knowing this, if you continue a well diversified investment program, such as through index mutual funds across various investment classes, you should be fine and will eventually reap rewards.  Use dollar cost averaging to reduce risks further, if you are just beginning to get in the market. For those that are risk averse and afraid that the government’s borrowing will lead to inflation, consider TIPS, otherwise known as Treasury Inflation Protection Securities. TIPS pay a relatively low rate of interest, yet Treasury Inflation-Protected Securities are marketable (meaning you can sell them to others) securities whose principal is adjusted every six-months by changes in the Consumer Price Index. When inflation occurs, as measured by the CPI, the principal amount of the TIP increases by the same percent as the rate of change in inflation. In the event of deflation, where the CPI falls, the principal decreases.  The point is that they are guaranteed by the US Government and they are “inflation-proof”, while fixed-payment and fixed-principal bonds are not.

 

So, is the Good News Bad?  I’d say the answer is “No” - not if your focus is on your disciplined plan toward your financial success, rather than today’s latest fear - or greed - news.

 

GOOD NEWS ITEM:  Ryan Law is now employed as our Director of the Office for Financial Success.  He comes to us by way of Texas Tech University.  I expect you’ll have a chance to learn more about him, as he joins us in our mission of helping others find success in their financial lives. If you have ideas for him, send him an email: lawr@missouri.edu .