How worried should I be?
That’s a question financial people get a lot when the market is as unstable as it has been over the past several weeks. Actually, it’s a question we ask ourselves in those environments.
Having both asked and answered that question several times recently, let me share some of the answers I’ve come up with.
Down 500 points? No big deal.
The stock market has hit some major downdrafts lately, including days when the Dow Jones Industrial Average lost over 500 points.
Inevitably when this happens, the media post pictures of Wall Street traders tearing their hair out. That’s okay. Baldness is an occupational hazard, and they are compensated well enough to afford Rogaine.
An important thing to remember about those traders is that they have large amounts of money at stake on very short-term market positions. Outside of the financial sector, though, most investors are trying to save for the long term, for retirement. This means accumulating wealth over 20, 30, or 40 years. Have you ever seen what a 3 percent loss (roughly the equivalent of a 500-point drop at today’s level of the Dow) looks like on a 40-year chart of stock market returns? It is barely a ripple, something you wouldn’t even describe as a speed bump.
Bigger problems than market downturns
For long-term investors, then, most day-to-day or even month-to-month fluctuations can be shrugged off. What is more disturbing is that, for all its ups and downs, the stock market has made very little progress over a long period of time.
Since the beginning of this century, the S&P 500 has gained just over 34 percent, or a compound average of 1.90 percent a year. Throw in a couple percent a year for dividends and you would roughly double that on a total return basis. But returns in the neighborhood of 4 percent a year are far below the growth assumptions people make when they are doing retirement planning. This has been going on for more than 15 years now, which is a significant chunk of anyone’s retirement time horizon.
Add to that the low yields on bonds over the past several years and the even lower rates on savings accounts and other bank deposits, and you are looking at long periods of sub-standard returns for most U.S. investors. This is a bigger problem than any short-term market downturn.
Economic reality vs. perception
Markets are one thing; the economy is another. While the U.S. market was going through all the angst of late August, one very positive piece of economic news went almost unnoticed. The official estimate of U.S. gross domestic product was revised upward to 3.7 percent, a substantial improvement over the original estimate of 2.3 percent, and significantly better than the first quarter’s rate of 0.6 percent.
The contrast between the stock market and the underlying economy is even greater in China. For all the attention the dramatic plunge in Chinese stocks has gotten, what is less reported is that their economy is continuing to grow, albeit at a slower rate than in recent years. Squeezing some of the speculation out of the Chinese stock market should be good for investment there in the long run.
Protecting your number one asset
When the investment environment gets worrisome, your attention should turn to your number one asset. This probably is not your portfolio or even your house. It is your job.
Keeping that stream of income coming — and growing it through career advancement if possible — can help pick up the slack when investments are doing little to build your wealth. Keep your skills sharp, and look to add value at your job to a degree that would make it difficult for your employer to do without you.
Control what you can control
Besides attending to your career, the other thing you can control when investment results disappoint is your spending. Lower returns may mean you have to lower your spending expectations, both now and in retirement. Doing this on your own terms is much less painful than having austerity forced on you when you can’t pay your debts. Just ask the Greeks.
One way to think of all this is that you should be concerned rather than worried. Concern means that the situation is serious enough to merit some attention, particularly with regard to safeguarding your career, tightening up your spending habits, and being alert for investment opportunities. Acting out of concern is distinct from merely worrying, which usually involves unproductive activities like checking the market every five minutes or lying awake at night worrying about decisions that are already behind you.
This notion of acting constructively toward things you can control is perhaps the best cure for a worrisome environment. Once you’ve done all you can do, it is easier to stop worrying and turn your attention to other aspects of your life while the stock market’s drama plays itself out.
The worst thing about bad credit isn’t being turned down for a loan or a new credit card. After all, there are worse things than not being able to borrow. The bigger problem with bad credit is that it can cost you money in a number of ways, and that added cost makes it easy for small money problems to become big money problems.
The more you understand about the hidden costs of bad credit, the more motivated you will be to keep your credit clean.
6 ways bad credit can cost you
Here are 6 ways having bad credit can cost you money:
- Higher credit card rates. Credit cards often have different rate tiers for different customers. People with good credit pay lower rates than people with bad credit — and if your credit rating slips after you sign up for a card, the credit card company can charge you a higher rate on future purchases. The irony is that the people who get the best credit card rates rarely actually pay those rates, because they don’t carry balances on their cards over from month to month. In all, the average rate for credit card accounts that have to pay interest is over a full percentage point higher than the average for all credit card accounts.
- Higher loan rates. Credit cards are not the only form of borrowing that gets more expensive as your credit deteriorates. Everything from car loans to mortgages are likely to cost more if you have bad credit. Lenders view part of the interest rate they charge as a cushion against the risk of the borrower defaulting, and the bigger the risk your credit rating suggests you are, the bigger that interest rate cushion will be.
- Larger down payment requirements. In addition to charging a higher interest rate, lenders also hedge their credit risk by making borrowers with bad credit put more money down on their purchases. This can cost you by forcing you to wait longer before making a major purchases, which often results in paying a higher price.
- Higher insurance rates. Some insurance companies offer discounts to customers with good credit histories. This is yet another example of how people who are already in good shape financially get the kind of breaks that can make their finances even healthier.
- A red flag for prospective employers. Increasingly, employers are reviewing credit histories as part of their background checks on job candidates. Credit problems have several negative implications from an employer’s perspective — they suggest a low level of personal responsibility, they could raise concerns about putting that person in a position of financial trust or lead them to believe that the candidate may let dealing with money problems become an ongoing distraction on the job. So, credit problems can make it tough to get ahead because you might miss out on the best job opportunities.
- Limited financial flexibility. Even if you are able to get a mortgage or a credit card initially, poor credit can limit your flexibility to manage your debt in the future. Poor credit could prevent you from reaping the financial rewards of refinancing or taking advantage of cheaper credit card offers.
4 habits that will keep your credit clean
Naturally, living within your means is the key to avoiding credit problems, but you also have to develop good habits for taking care of your financial responsibilities. Here are four habits that will help keep your credit clean.
- Organize your payments. Don’t treat bill paying like a chore that you will get to when it is convenient; you need to have a process to make sure it gets taken care of consistently. Setting aside a specific time of the week for bill-paying and automating some of your payments can help.
- Don’t use automatic bill-paying for everything. Automatic bill payments are a useful tool, but they are best suited to bills that are for a predictable amount of money month after month. For more variable bills, you may want to handle them yourself to make sure an unusually large amount does not cause an overdraft, and so you can spot any overcharges or other problems.
- Make the timing work. Coordinate the timing of your payments so they will arrive by the due date and so they are in sync with your pay schedule to ensure you will have sufficient funds in your account.
- Never borrow without a repayment plan. This is especially important for credit cards, because it is all too easy to use them impulsively. Figuring out how you will repay the money makes you stop and think before you borrow.
You’ve probably heard the phrase “the rich get richer and the poor get poorer.” One way to think about that is that financial conditions have a way of feeding on themselves. Credit problems usually make life more expensive, and thus those problems become harder to overcome. Keeping your credit clean can stop a downward spiral from ever starting.
If you have been able to buy a house or refinance a mortgage in recent years, then congratulations. You have been a beneficiary of the Fed’s extraordinary effort to keep interest rates low. For many others though, monetary policy hasn’t been so favorable — in fact, it has cost them dearly.
Ostensibly, low interest rates are a monetary device to stimulate the economy, but more subtly they also serve to bail out banks and borrowers. Who suffers from that? Primarily savers. Whether you have a short-term savings account or a long-term retirement portfolio, low interest rates have made earning any money on your savings an uphill climb.
Recognizing the various ways low interest rates may have hurt you is not important simply so you can mutter rude things about Janet Yellen when she comes on the television. It can help you make adjustments to adapt to the low interest rate environment and the subsequent fallout that will result when rates return to more normal levels.
Here are seven bad things about low interest rates:
- Low interest rates on savings accounts. Deposit rates are closely linked to short-term Fed funds rates, so the low interest rate policy has been very clearly evident in driving savings account rates down to near zero. This is especially hard on retired folks, who typically invest their money conservatively and had grown accustomed to being able to earn some retirement income on their savings. Virtually wiping out that income for people who often don’t have another means to earn a living is a pretty harsh blow. There is no way to fully make up for the destruction of savings account income that has taken place, but it does underscore the importance of shopping around for higher-yielding savings accounts, and perhaps committing your deposits to longer-term CDs to earn a higher rate of interest.
- Low yields on bonds. Long-term Treasury bonds have been a staple of retirement plan investments, but low interest rates have helped drive their yields to below 3 percent. You might argue that the drop in interest rates created a windfall for bond investors because prices rise as yields fall, but this would be reversed with a return to more normal yield levels. In the meantime, low yields on a significant portion of retirement investment portfolios is going to make it hard to reach the return assumptions on which retirement funding is based.
- Fanning the flames of inflation. The Fed has persistently said it wants to keep interest rates low to encourage higher inflation. I can’t help thinking that encouraging higher inflation is like saying “Beetlejuice” three times — you might live to regret the help that you called for.
- A stock market on PEDs. Performance-enhancing drugs, or PEDs, inflated the statistics of professional baseball a few years back, just as it artificially inflated the physiques of the cheaters who used them. Similarly, low interest rates artificially pump up stock prices — in the long run though, all you have are companies that are more expensive, but not actually more valuable in terms of having boosted their revenue-generating power in line with the rise in stock prices.
- High checking account fees. Checking account fees have risen steadily in recent years, and free checking has become a rarity. Back when interest rates were higher, banks were happy to offer free checking just to attract deposits. With interest rates low, having those deposits on hand is not worth as much to banks, so one recourse is to raise fees. In fairness, it is worth noting that another government policy is also partly to blame for the rise in checking account fees. The Durbin amendment to the Dodd-Frank Act arbitrarily cut the fees banks could charge retailers for debit card transactions. Banks raised fees to make up for this, but don’t hold your breath waiting for retailers to pass their savings along to consumers.
- Low mortgage approval rates. The frustrating thing about the low mortgage rates of recent years is that relatively few people have been able to qualify for them due to tough lending standards. When mortgage rates are no higher than the long-term rate of inflation, it leaves little margin for defaults, so lenders are particularly wary about making loans in that situation.
- A subsidy for banks. Yes, mortgage rates came down quite a lot, and credit card rates came down a little, but neither fell as far as deposit rates. So, the rates banks pay consumers fell by more than the rates consumers pay banks. That means banks win and you lose.
Of course, low interest rates have not been entirely bad, and I can even accept the argument that they were a necessary evil in the depths of the financial crisis. However, the longer the Fed prolongs the era of low interest rates, the more it seems that savers are getting a raw deal.
It’s one of the most awkward questions a friend can ask you: “Will you lend me some money?” Awkward for your friend to have to ask, and awkward for you to have to answer. Saying “no” could adversely affect your friendship. However, saying “yes” could also put a strain on your friendship, and your finances.
If you get asked that awkward question, you should follow up with eight questions of your own before you decide whether or not to lend a friend money.
1. Why does your friend need the money?
Sometimes, there is a clear, one-time need for which a timely loan can get your friend through a particular situation — for example, Bob has found the perfect house but is a couple thousand short on the down payment, or Jane’s son needs dental surgery. Situations which are out of the ordinary and are not likely to recur at least suggest that a loan might be a one-time thing.
Unfortunately, more often when people turn to their friends for financial help, it is because of long-standing money problems. In that case, your loan is likely to be nothing more than a temporary stop-gap, leaving your friend with the same set of problems in a few months, and you with little chance of being repaid.
2. What other debts does your friend have?
If a friend comes to you for money, it may well be because he or she has exhausted all other sources of borrowing — meaning that the credit cards are maxed out, and possibly mortgage, car, or student loan payments are coming due.
If your friend owes money to credit card companies or lenders, you are probably going to have to stand in line behind them before any money you lend gets repaid — which significantly reduces your chances of seeing that money any time soon.
3. Is this an amount you can afford to lose?
Institutional lenders use a variety of techniques to assess loan risks, and they make thousands of loans. So the cost of the occasional bad loan can be absorbed by the money they make from interest on good loans.
You have neither those underwriting tools at your disposal, nor the opportunity to broadly diversify your lending risk. This makes a one-off type of loan especially risky, and you should not lend more in that situation than you could afford to lose.
4. How formal should the arrangement be?
This loan may be an understanding between friends, but that doesn’t mean you shouldn’t formalize it with a signed, written agreement. Aside from protecting your financial interests, it can be important to the friendship to document your understanding in a way that ensures you both remember things the same way after some time has passed.
5. Should you charge interest?
Remember, there is an inflation cost and possibly an opportunity cost to tying up your money. Charging interest need not mean profiting at your friend’s expense. It can simply be a way of recouping the cost of having the money unavailable for a while.
One argument in favor of formalizing the arrangement and charging interest is that, if you don’t, the IRS may deem it a gift rather than a loan. If there is a large amount of money involved (the exemption limit is $14,000 for the 2015 tax year), this may mean having to pay gift tax — and the giver rather than the recipient is on the hook for gift taxes, so this could come out of your pocket.
6. What is the repayment schedule?
Part of the formal arrangement should be a repayment schedule. That way you both know what to expect about repayment terms.
7. Has your friend budgeted for repayment?
Another benefit of a repayment schedule is that it can serve as a reality check. Once you have a repayment schedule worked out, it is fair to ask your friend how he or she intends to find the money for those payments — especially if that friend has been having financial problems already.
8. Which will affect your friendship more: saying no or saying yes?
It might seem to be the path of least resistance to say yes, but saying no means you can both quickly put the incident behind you. On the other hand, a burdensome loan could prove to be an ongoing strain on the relationship for years to come.
Consider the alternatives
If the analytical approach described above seems too hard-headed, consider an alternative besides saying yes or no to a loan: simply giving your friend the money. If your friendship is close enough that you really want to help, giving rather than lending money allows you both to move forward with no strings attached.
On the other hand, if simply giving the money away is not something you can afford, you should think very analytically about lending the money. If things go wrong, a bad loan to a friend could cost you both the money and the friendship.
As I was coming of age, I became aware of too many examples of people who had gotten into trouble with credit card debt. It made me avoid getting a credit card for several years. Eventually, though, I overcame my fear of plastic, and realized it is the user and not the card that should be in control.
A healthy concern about credit card use is not misplaced. After consumers reined in their spending in the immediate aftermath of the Great Recession, they have expanded their credit card debt in each of the last four years, and that debt is on the rise again in 2015. Still, having a credit card does not have to mean having credit card debt. Actually, if you make it a practice to pay off your balance every month, the benefits of having a credit card can outweigh the disadvantages.
This may be more true now than ever before. Here are six good reasons to overcome a fear of plastic, some of which were true 30 years ago when I got my first credit card and some which came into greater prominence in the 21st century:
- You win when you get free use of money. Because there is a lag between when you charge something and when you start paying interest on the amount you borrowed, you effectively get free use of the money for a short period of time. The catch is that once interest starts being charged, it is very expensive — credit card companies charge an average of 13.49 percent on outstanding balances. Still, if you pay your credit card bill in full and on time, you can avoid incurring interest charges. As long as you choose a credit card without monthly fees, then used correctly a credit card can be a convenience that doesn’t cost you anything.
- You win even more when you get free rewards. Not only can you have the convenience of a credit card for free if you pay your balances off promptly, but you can also get cash back or other rewards on your purchases. Credit card companies do this to induce you to use their cards, both for the interchange fees they get from merchants and on the assumption that many people won’t pay the money back right away and so will have to pay interest. It is especially important to avoid carrying a balance on rewards credit cards because they typically carry higher interest rates than non-rewards cards, but if you can pay your balances off on time earning rewards means the card company is paying you for using their credit card rather than the other way around.
- A responsible credit history can help you save on insurance. I was shocked when our auto insurance carrier wanted to raise our family rate a few months ago, even though we have pretty clean driving records. It turns out the deer that jumped into my son’s car a couple years back was not insured, so that accident is counting against us. When I complained, my agent suggested a program they have that offers lower rates for people with strong credit histories. I figured we would qualify, and we did, as a result of which our insurance premiums went down rather than up. Getting a credit card can be an important step toward establishing a credit history.
- You may need a credit history to rent an apartment. Never mind needing good credit to buy a home — you may need it just to rent. Landlords consider your credit history as an important indication that you will pay your rent and meet your other obligations as a tenant.
- Traveling without a credit card is very difficult. When I first started to travel for business, I actually used to get by with carrying a large amount of cash with me to cover the hotel bill. These days though, decent hotels tend to frown on letting you check in without a credit card, and forget about renting a car without one.
- Establishing a digital discipline is becoming essential. The reason some people shy away from credit cards is that they make it all too easy to overspend and get into debt trouble. This was my reasoning 30 years ago; but back then, not having a credit card was enough to avoid the temptation to spend impulsively. Nowadays, with financial affairs increasingly conducted digitally in a variety of ways, you simply have to develop the discipline not to abuse these tools. Otherwise, you will find more than one way to get into money trouble electronically.
If you want a simple decision rule for using a credit card responsibly, try this: Any month you cannot pay off your balance, put the card away and don’t use it until your current debt is paid off. This is a crude-but-effective way of making sure the accumulation of debt does not outweigh all the positive aspects of having a credit card.
My wife and I were talking recently about a June 5, 2015, New York Times article that described the lifestyle of “Millionaires Who Are Frugal When They Don’t Have to Be.” It got me thinking about the word “frugal.” It will probably never be a sexy concept, but neither does it have to seem like a dirty word.
The title of the article seems to conjure a slightly pejorative image — people who are well off but needlessly pinch pennies. The actual content of the article is more favorable. It focuses on people who have settled into a particular niche — the Times describes them as single-digit millionaires. It’s an interesting position. Obviously, they are very well off, but they are not crazy rich enough to afford every extravagance that crosses their minds. Also, people in this position often made their money themselves, so they can remember what it was like to get by with less.
None of the lifestyles described will ever be fodder for a reality show — not only aren’t these people splashy enough spenders, but they seem more focused on living their lives than on demonstrating their wealth to the rest of the world. Still, while I can see the article’s point about frugality, what struck me is that each of the people profiled had some form of indulgence, whether it is an extra piece of property or the occasional trip to Italy.
In other words, these people are not making themselves miserable by living a monk-like existence when they could afford more. They are enjoying their wealth even while being very conscious of not blowing it.
Enjoying a frugal lifestyle
Of course, the people in the article are far from typical. Even a single-digit millionaire has been far more fortunate than the average American. Still, I think there are some lessons in the lifestyles described that show how frugality does not have to mean miserable self-denial.
Here are some thoughts on how to leave room for joy in a frugal lifestyle:
- Budget for some discretionary spending. Living within a budget requires having the discipline not to exceed that budget, but it does not have to mean every expenditure is specifically planned or even logical. Whether it is $50 or $50,000, leave yourself a some room in your annual budget to spend impulsively, indulgently, or however you see fit. That way, you will get to feel a sense of financial freedom, while also knowing that you are staying within the framework of your budget.
- Own up to your splurging. The worst over-spenders I know always have a rationalization every time they splurge on an unnecessary expense. This translates into a sense of denial which prevents them from recognizing how often they do it. Be realistic. It’s OK to splurge occasionally, but recognize it so it does not become a thoughtless habit.
- Make the big decisions count. No offense to one of the guys described in the article, but you can darn your socks all you want, it will still be the big financial decisions that matter. What did you pay for your home, and what mortgage rate did you get? Did you strike a hard bargain on your last car? There are a handful of big decisions that have real big-money impact.
- Enjoy the little things. Building a 25,000 square foot palace can drain even a millionaire’s finances, but buying a little better bottle of wine or a weekend getaway are smaller indulgences that shouldn’t leave a lasting mark. If you learn to enjoy little rather than big indulgences, you can enjoy your money without overspending.
- Maintain some form of income. Take it from someone who is in his second career — it feels great to downshift without completely slamming on the brakes. I enjoy working, and even with some money saved there is nothing more reassuring than seeing some income continue to roll in.
- Get on the same page as the rest of your household. The wealthy couples described in the article all seem to share a philosophy toward money with their spouses, and this is very important to being able to be happy with a modest lifestyle. If you want to drive around in a seven-year-old Toyota while your spouse wants to live like a Kardashian, neither one of you is going to be very happy.
- Keep positive goals in mind. Don’t focus on the denial aspect of financial responsibility; focus on the positive aspects of it instead, such as a brighter future and a stronger sense of control over your life. View financial responsibility as an act of empowerment, not one of denial.
The people profiled in the Times article are living such good lifestyles that I probably would not even have used the word “frugal” in the title. To me, it just seems sensible; but that probably says something about my overall mindset, not to mention why my wife showed me the article in the first place….
Around this time of the year, new college graduates are leaving their schools with a wealth of knowledge. At the end of their four (or six, or eight…) years of college, graduates have typically tackled a wide range of academic subjects, often with an impressive degree of complexity. Unfortunately, one type of lesson many of them are missing as they venture out into the real world is basic schooling in personal finance.
Here are seven personal finance lessons that recent grads might find helpful, because they probably were not taught these things in school:
- Student loans need a repayment plan.
According to the National Foundation for Credit Counseling, the average American college student now has $27,000 in student loan debt at graduation. Make sure you know the schedule of when payments on your loans will start coming due (typically, this is six to nine months after graduation). If it looks like you will have trouble paying, explore options for alternate payment schedules. Most of all, stay in contact with your lender to find a workable solution. If you simply default, it can have drastic consequences which can include having your wages garnished, your tax refunds confiscated, and long-lasting damage to your credit record.
- Credit cards should be for short-term borrowing.
Recent grads are often deluged with credit card offers. This is not necessarily a bad thing. Credit cards can give your finances some flexibility while helping you build a credit history. The key is to understand and live by this rule: Credit cards should be used only for short-term borrowing. If you use them as a cash substitute during the month and pay off your balance at the end of each month, they can be a free resource, and you might even earn some rewards points in the process. However, if you use them to maintain a lifestyle you can’t afford, you will end up with two big problems: That lifestyle will come to an abrupt end when you reach your credit limits, and credit card debt carries a very expensive interest rate.
- The job market may be very different in the next state.
Having trouble finding a job in your area? Use the fact that you are probably not tied down yet to your advantage and look elsewhere. The unemployment rate in some states is more than twice as high as in others, and the job market can vary even more greatly in some professions.
- There is more to a job offer than salary.
When you compare job offers, be sure to calculate the economic value of any benefits that come with those offers. This includes things like how much they might pay toward your health insurance, or what kind of employer match they make on retirement plan contributions. These amounts can be in the thousands of dollars, so differences in benefits could easily tip the balance in favor of one job over another.
- Don’t be on the hook for your roommates.
Pitching in with others is often the only way a recent grad can afford a place to live, especially in expensive urban areas. Just be careful about whose name is on any legal agreements such as leases or utility accounts. You should take your share of responsibility, but make sure it doesn’t all fall on you if the others don’t pay their share. People’s lives can change quickly in the months after graduation, so avoid financial commitments that involve others.
- The right saving account will pay you for doing nothing.
As you handle the wave of new responsibilities that comes after graduation, you might fantasize about getting paid to do nothing. In a sense, the right savings account will do this. Most savings accounts these days pay almost no interest, but a few are paying around 1 percent. Find one of these relatively high-paying savings accounts, and it will keep paying you month after month with no further effort on your part.
- Overdraft protection is a sucker’s deal.
When you sign up for a checking account, your banker will probably offer you a helpful-sounding service known as overdraft protection. Be sure to decline it. In exchange for temporarily covering any overdrafts in your account, the bank will charge you a fee for each occurrence that is often several times the amount of the overdraft itself. This is a deal that is good for the bank but bad for the customer, so opt out.
It is commonplace to say that there is no teacher like experience when it comes to handling money, but imagine if you took that approach to biology, accounting, or whatever your chosen field is. If you had to experience everything first hand, knowledge would never get a chance to progress very far! Learning from others can help you get more out of your own experiences — and when it comes to personal finance, it can help that experience come at a much cheaper price.
On the surface, savings account rates seem to be stuck in the same rut they have been in for the last couple years; but if you look a little closer, there are some isolated developments that could start to put the interest back in savings account interest rates.
According to the FDIC, the average savings account rate nationally is just 0.06 percent — a level that average first dropped to two years ago and hasn’t budged from since. However, some banks are beginning to buck the low-rate trend. Those banks remain exceptions, but the rarity of positive rate developments makes it well worth taking note of those exceptions.
Some notable exceptions
MoneyRates.com conducts a quarterly survey of bank rate conditions, called the America’s Best Rates survey. Looking at the big picture, there have been no surprises in recent quarters, as the average savings account rate has dropped in each of the last two surveys. However, a review of the top 10 rates in the survey tells a different story.
Several of the banks in the top 10 raised their savings account rates in each of the last two surveys, with a few of those banks reaching the 1 percent mark. These banks are going their own way by raising rates while the overall average is still declining, and that independence makes them stand out all the more.
Seeing a handful of banks raise rates in this way also suggests that there is some healthy competition going on at the top of the rate tables. HSBC has just upped the ante in that competition, by offering a 1.5 percent rate on a temporary basis. Short-lived teaser rates are nothing new, but HSBC is pledging to keep this rate in place till January of next year. Given that savings account rates are subject to change at any time, that commitment shows that at least some banks are starting to view higher rates as a means of attracting business again.
The good news and bad news about higher rates
Besides competition among banks, there are some economic conditions that may be prompting these rate increases. There is both good news and bad news for consumers in those conditions.
The good news is that after a stumble in March, job growth got back on track in April, suggesting the economic recovery is alive and well. Economic strength increases demand for capital, encouraging banks to offer customers higher interest rates for their deposits.
The potentially negative reason rates may head higher is if inflation revs up. After falling sharply last year, oil prices are on the rise again this year, and that could push inflation higher. Interest rates would move higher in response, but this doesn’t really benefit consumers if it is offset by rising prices.
What consumers should do
Whether bank rates are pulled up by competition or forced up by inflation, consumers should not get caught waiting on the sideline. Clearly, some banks are acting to raise rates sooner than others, so here are some things you can do to get on the leading edge of this trend:
- Don’t assume conditions are the same everywhere. Low rates remain the norm, but they are not universal. One good thing about the banking industry is that, because it is highly fragmented, you have a lot of choices — and some of those choices are starting to offer higher rates. If your bank isn’t one of them, don’t assume all other banks are being similarly passive.
- Start shopping actively for rates. In business, companies adapt to change in different ways and at different times. That means that as interest rates start to turn around, banks are going to read and react to the trend in varying ways. This could cause the gap among the rates offered by different banks to widen, making this a particularly rewarding time to shop actively for higher rates.
- Rein in your CD terms. If you have a CD maturing soon, you might want to consider a shorter term when you roll it over. This will help you avoid locking into today’s low rates for an extended period when CD rates may be poised to start rising.
- Look for CDs with low early withdrawal penalties. An alternative to shorter CDs is a long-term CD with a relatively mild (i.e., six months or less) penalty for early withdrawal. This allows you to benefit from the higher rates of longer-term CDs, but still have an affordable way out if rates rise significantly. Step-up CDs, which offer the option of increasing your rate at some point during the CD terms, are also a possibility, but often these offer such a low initial rate that you would be better off shopping for a higher rate and simply paying the early withdrawal penalty if necessary.
Consumers have had a long wait for higher bank rates. Why wait around any longer, when a few banks are already starting to act on raising rates?
I told the story elsewhere of how my wife and I woke up in our late 40s to the fact that our investment cupboard was bare. We were not alone, millions of Americans in their 40s or 50s don’t have nearly enough money saved to retire.
So what can you do if you find yourself in that position? After you shake off the scorn of the self-righteous around you and stop beating yourself up, it is time to get to work because the good news is that there is hope. We managed it. You can do it, too.
The first step is you have to cut your expenses to the bone. The key number you’re looking to improve is the difference between your income and your expenses, and the quickest and easiest way to do something about it is to focus on reducing your expenses.
If you are serious about getting caught up, Step 1 is to put together a budget, listing income and expenses. Then you need to put the knife to the expenses, sparing no holy cows: vacations, eating out, movies, hobbies, smartphone, car(s), everything has to come under the knife.
The good news is that you are usually at or close to your peak earning years, so creating a surplus is usually a lot easier than for a 20-something. But still, it isn’t going to be easy. Expect pain. Saving and living on a budget is not pleasant, especially if you are not used to it. Doing it to catch up is even less so.
2. Earn more
Set a target, starting small, like $200 a month. Find things to do like moonlighting, selling off collections, or monetizing a hobby — the list of possibilities is limited only by your determination to catch up.
Here is an interesting thing many people discover: Once you start pursuing opportunities for extra income, more present themselves. It’s almost as if they crawl out of the woodwork. Then you can begin to set your target higher.
Many discover that once they begin to turn their hobby into an income, they do better than they expected and it becomes a natural segue into a fulfilling and profitable retirement. But you rarely get there without taking that first uncomfortable step.
3. Save aggressively
Rather than save what is left over between your income and expenses, save first — and force your expenses to match what is left over. If you don’t pay yourself first, chances are you will not get caught up.
Make maximum use of the tax-advantaged funds available to you. My wife and I made our first priority maxing out both our IRA and 401(k) contributions. Easy, it wasn’t; but desperate times call for desperate measures and results trump easy when you are in the position of playing catch-up.
On top of the retirement accounts, pay down as much on your home mortgage as possible. That’s most everyone’s largest expense, and once that is gone, your monthly nut drops significantly.
4. Research social security
I heard from a financial planner that there are 587 ways for married people to file for Social Security. How and when you do it can affect your payout significantly. This is something we didn’t do, and we still haven’t figured out how to do it without involving financial planners who want to sell you annuities.
5. Plan to work past 62
Many people fixate on 62 because it is the youngest age at which one can begin to collect social security. However, if you have a job and can hold on to it, it will be worth your while to plan on staying past 62. The good news is that life expectancy is increasing and improved health means many more people are capable of working well beyond 62.
However, increased health and longevity can be a double-edged sword. It means we all will probably live longer than the generation which preceded us. In turn, that means that whatever funds you have set aside for your retirement will need to last longer than you anticipated.
Working past 62 not only adds to the fund, it postpones the day you begin to draw against it.
6. Change your lifestyle
This might sound the same as cutting expenses, but it is meant to cover a lot more. Think of it as Phase 2. This is where you would explore options like going from two cars to one, scaling down your home to the minimum you can live in.
If you are looking at an underfunded retirement, you know at some point you will have to make drastic changes to your lifestyle. The earlier you do that, the less likely a change like this will be traumatic for you.
7. Stop supporting dependents
It may sound callous or cruel; but if your retirement fund is short, it makes no sense to put the needs of children, their families, or other people who should be taking care of themselves before your own needs if that would result in your ending up unable to support yourself.
Once your finances come into line, you can always resume doing nice things for others. However, continuing to support dependents when you are at financial risk is short-sighted.
8. Become knowledgeable about investing
Warren Buffett’s famous rule for investing is: “Don’t lose it.” That, of course, refers to avoiding unnecessary risk. However, when you are 50 with no retirement fund, you have forfeited to a large extent the luxury of picking investments with modest earnings but high security that you would have enjoyed in your younger years.
There are investments with higher returns than safe index funds, but reaping those requires more than a passing knowledge. You might think of it as another career, and in a way it is. The only way to “not lose it” is to know more than most other people, and that takes time and effort.
If this sounds like an uncomfortable topic and strategy, it is. “No pain, no gain” is not just true with exercise. But if you know it up front, you can knuckle down and get where you want to be.
What got my wife and I through the serious sucking-it-up part of getting ready for retirement in a hurry was our view that this was a challenge, a project. We never had a woe-is-me attitude. Instead, we looked at it as a challenge — not easy, but not impossible, either.
Admittedly, we didn’t have to make emotionally tough choices like cutting back on things for kids or grandkids, and we didn’t have health issues, which can wreak havoc with any plan, normal or catch-up.
We also had a few investments work out unexpectedly well for us. Although there is no guarantee that will happen, I suspect it happens to many people; but when it does, they react like I did when I was younger: they celebrate by spending it. When you are in project-mode, those windfalls don’t disappear. They become crucial building blocks.
Is it easy to catch up building your nest egg when you wait till it looks too late? No. But it is possible — and, in balance, that is at least some good news.
If you are old enough, you will remember 1973, when OPEC caused the price of oil to quadruple. (If you’re too young, simply Google “1973 oil crisis images” to see an endless parade of people stranded at gas stations with hand-written signs like the one in the picture.)
That crisis changed life in America forever, starting with an almost instantaneous recession, as businesses couldn’t absorb such a dramatic hike in one of the most pervasive costs in the economy. The malaise brought on by the oil shock lasted more than a decade. Inflation became a part of daily life, while the economy stagnated, giving rise to a new term: “stagflation.”
It got worse in 1979, just when ordinary people had become used to higher oil prices, and it precipitated the worst recession since the Great Depression. Home mortgage rates spiked to over 18 percent before the economy recovered (as it always does).
Since then, we’ve all adjusted to an environment which includes high oil prices.
Our high-oil-price world
New home appliances continue to use less energy. When our furnace went out recently after 30 years of service, even the cheapest model we could buy was way more energy efficient than the dinosaur headed for the landfill. The biggest users of oil — namely, automobiles — continue to use less fuel every year too. It wasn’t much more than a year ago when manufacturers tried to outdo each other with their 40 mpg mainstream models — unthinkable even 10 years ago. We don’t bat an eyelid at electric cars anymore, even luxury electrics like Tesla.
The adjustment is due, in part, to Government regulation; but it also reflects a shift in our culture and values. Despite the culture of conservation, however, the development of other countries and general population growth across the world have led to a consistent rise in the demand for oil. Production has kept pace; but, as Jigar Shah, founder of SunEdison pointed out recently, about 3.8 million barrels per day’s worth of low-cost production is lost each year as older, low-cost wells run dry. Adding capacity to replace that supply requires higher-cost sources. If those sources are not developed, demand will outstrip supply and the oil price will rise again.
In 2008, the price of oil spiked above $100 for the first time, but the financial crisis saw worldwide demand decline and, with it, the price of oil. As the world’s economies recovered, though, so did demand and the oil price, until the world seems to have become accustomed to oil prices north of $100.
That environment brought us things like fuel surcharges on just about every bill we pay, and hybrid and electric cars. It even caused a bit of a renaissance in the railroad industry as long-distance freight shifted from trucks to more efficient intermodal rail transport, causing the illustrious Warren Buffett to start buying up the nation’s railroads one by one.
As high prices tend to do, it also created a “new” industry: American and Canadian oil production from shale and tar sands. Those technologies only work when oil prices are high, though; but when they work, they seem to work extremely well — so much so that the United States in 2014 was poised to become the world’s largest oil producer.
That’s when things changed, however, in rather quick and dramatic fashion. According to Abdullah al-Badri, its Secretary General, OPEC decided in November not to cut its production to compensate for the additional American production, thus creating an oil glut of about 1.5 million barrels a day.
Consequently, 2014 saw one of the most dramatic drops in the oil price since those first two oil shocks, as this chart from the Federal Reserve shows:
So, did this drop bring joy and happiness to all who have suffered for the past 40 years? Not nearly as much as you would expect.
Airlines have reaped a windfall, naturally, but have come out declaring publicly that they are not passing the savings on to consumers. UPS started imposing fuel surcharges back when oil prices were high, but have not made any significant reductions since the price of oil started falling. I’ve seen no reports of utilities dropping their rates as natural gas and oil prices have reached historic lows either.
The list goes on. Knowing how businesses live to make profits, I guess that is not surprising. In time, if oil prices remain low, competition will soon create cracks in the dam and those costs will start to drop, too. But…
Will oil prices stay low?
My guess is not, and I base that on the the comments referred to above, of OPEC’s Secretary General. A recent Reuters report quotes him as saying, “Now the prices are around $45-$50 and I think maybe they reached the bottom and will see some rebound very soon… It will take some time,” he said. “It will take another four-five months and we will not see some concrete efforts before the end of the first half of the year due to the reason that we will see how the market behaves at the end of the first half of 2015.”
So, now we have two independent factors tracking for significant changes this summer:
- OPEC revisiting its oil pricing strategy
- The Federal Reserve revisiting its intention to raise interest rates
Should those two events coincide, it is not beyond the realm of reason to expect the economy to react negatively.
Moral(s) of the story
1. Don’t buy that gas-guzzler on the assumption that oil will stay low. (Conversely, if you have one, it will fetch a good price now.)
2. If you considered getting into energy stocks or mutual funds, now may be a good time.
3. Be prepared for disproportionate price increases as the same businesses who didn’t drop prices with low oil prices use the rising oil price as justification.
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