Despite Lower Real Income, Consumers Keep Spending

There was a wealth of financial information from this past weekend's Parade magazine annual feature on "What People Earn." So much good stuff, in fact, that I'm going to be sharing and commenting on the piece for the next day or so.

The first thing I want to note is that while the article notes that wages are down, the economy is still humming along due to borrowing. Here are the details on where wages were for 2005:

The median weekly salary in 2005 was $659 (half of all workers earned more, half earned less). After inflation, that’s 1.9% less than in 2004. Average hourly pay for all production and nonsupervisory workers was $16.11—a 0.7% decline when adjusted for inflation.

So, wages are down. As such, you'd think that people would curtail their spending. But not in our society. Not when you can borrow to keep up with the Joneses:

The economy has grown while real wages have fallen because consumers keep spending—thanks to soaring real-estate values and low-interest loans. In 2005 alone, Americans borrowed an estimated $887 billion from their homes through mortgage refinancing and equity loans.

This is not a healthy financial situation. Sooner or later, the real estate bubble will burst (or at least deflate a bit) and people who are stretched to the limit will encounter some serious financial hardships.

My thoughts? The key is to spend less than you earn and do so on a regular basis, saving for future purchases to pay cash for what you need/want.

FMF recommends Emigrant Direct.

Comments

[Steve]

I'm beginning to wonder though, if those with lots of debt might end up getting the last laugh... If we enter a period of high inflation (anyone remember the late 80's?), all that debt will be worth less money (as will all of the investments we savers hold in cash). Debt which is backed by real property (i.e. real estate) would actually have turned out to be a good thing to have since you'd be paying off the debt with devalued dollars. Just a thought...

[Jen]

I think you are right, Steve. I don't drive a nice car or have a nice house and furniture because I lost my savings when MCI stock went down to 0 a few years ago, along with all my other "safe" investments. Now, there is absolutely no reason to save, unless you want to make some scammer richer. Sooner or later, someone will take your savings.

[Chris]

Jen wrote:
> I think you are right, Steve. I don't drive a nice
> car or have a nice house and furniture because I
> lost my savings when MCI stock went down to 0 a
> few years ago, along with all my other "safe"
> investments. Now, there is absolutely no reason
> to save, unless you want to make some scammer
> richer. Sooner or later, someone will take your
> savings.

I know the above comments are two months old, but for the benefit of those who still stumble onto this post, and for Jen if she is still reading...

Jen, that is the absolute wrong attitude to have. A more accurate assessment of your past experience would be: there is absolutely no reason to put all of your eggs in one basket when it comes to savings. And in my opinion, that is what individual investors do when they buy individual stocks.

Do this:

1) pay off credit card debt and don't carry balances any more; use credit cards for convenience only, and for building a good credit history,
2) build a six-to-nine month emergency savings fund in a high interest bearing online savings account such as HSBC Direct or EmigrantDirect, linked to your checking account. These funds are in U.S. dollars and are FDIC-insured. That means no one can take them away from you, not even inflation as long as it doesn't rise above the 4.5% APY that online savings accounts are currently paying,
3) if you have a 401(k) available to you at work, fund it sufficiently to get 100% of your company's match if they offer one, and here's the most important part: diversify it properly across asset classes and rebalance on a regular schedule, say annually or quarterly. If your 401(k)'s fund options suck or their fees are too high (I'd say greater than 1.25%), lead a campaign at your company to replace them with better funds. (Work for a small employer who doesn't offer a 401(k)? See if they offer a SIMPLE IRA. Work with them to start one if they don't),
4) fund a Roth IRA up to the legal limit ($4000 in 2006), again using low cost index funds; Vanguard's Target Retirement 2045 fund is hard to beat,
5) now go back to increasing your 401(k) contributions until you reach the legal limit ($15,000 in 2006, with higher "catch up" limits if you are over 50), and then
6) pay off your car loan at an accelerated rate; that's an immediate ROI of whatever your loan interest is.

Saying that saving is pointless because some scammer will just take it from you is nothing but an excuse to avoid personal responsibility for your financial well-being, and it's a bad excuse at that. There is risk in everything. Stocks go up and down, often based on little more than emotions. So do commodities, real estate values, and currency values. Companies can engage in accounting fraud, fail to perform due to poor management decisions, or get taken out by a competitior or a natural disaster. I don't blame you for feeling a little gunshy about investing.

But there are many clear signs that saving and investing, and avoiding debt, is more important than ever:

* the steady extinction of traditional pensions
* ever-increasing job instability
* rising health care costs
* peak oil and the associated rising energy costs in the years to come
* rising higher education costs
* the ability of real estate values to outpace peoples' ability to save for down payments and afford monthly payments without exotic mortgages
* the very real possibility that Social Security and Medicare will disappear or at least be diluted radically
* the likelihood of much higher taxes in the future to pay for our grossly irresponsible federal government's fiscal deficits and exploding Baby Boomer retirement and health care costs
* global competition from lower cost workers who may be better educated and more motivated

The list goes on and on.

So please don't throw in the towel based on a bad experience. Learn from it and come back stronger. Do you want to find yourself at 65, 70, 75, not able to retire or even to work less because you can't afford it?

The biggest risk of all is to do nothing.