What’s in?

Besides high, black Converse sneakers making a comeback, what else is in style? Saving is back in vogue even though the personal savings rate has been declining. As early as 1990, the savings rate was over 5%. By the year 2006, the savings rate had gone negative. That’s right, a negative savings rate. As a country we spent more than we made. This, of course, coincided with the peak of the housing market. How did this happen? There’s a multitude of reasons, but lets just address the basics….

Many people had little or no savings. They would just spend all the money they had. When they ran out, they spent whatever money they could borrow. Today there is no money to borrow. So people have to save or at least start to pay down their debts. This is a good thing in terms of cleaning up their balance sheet. While this may be good for the individual, in the short run it may not be the best thing for the economy. It’s good for people to save…its money they aren’t spending. Instead of going out to dinner or playing a few rounds of golf, the money is going…gulp…into the bank. So the restaurateur and the golf course are going to have few less customers this week and likely next week.

In the longer run, however, it is healthy for people to save money. An increase in the savings rate means more pain for the economy now to make it better down the road. The parallel here is working out. You know…no pain, no gain.

What’s out?

What’s out of style? Conspicuous consumption is out because almost no one can afford it anymore. For the few that can afford it (but clearly not all) they don’t want to come off that way. McMansions, expensive European cars, and extended family vacations are out. The Ferrari dealer is lonelier than the Maytag repairman.

How did we get here? Well, there are lots of reasons. We’ll just hit the biggest highlight—the ability for consumers to obtain credit. We won’t dwell on the greed, fraud, or any of the other illustrious traits that transpired during this time period.

It started in 1982 when interest rates began a long and steady decline. This lessened the cost of borrowing. Additionally, whatever lending standards there were on mortgages all went away. I should retract that. There still was one standard…you needed to be able to sign your name on the loan documents. That’s it. Anyone can sign their name. As my brother-in-law said, “There’s a lot of ink in this world.” And everyone got mortgages and bought houses.

It was rock-and-roll time for the American Dream. Borrowing money for everything else including cars, appliances, and home furnishings was even easier. You didn’t have to go to a closing and sign your name twenty times. Just sign your name once and mail in the application. You didn’t have to worry; once the ink was dry you qualified. So, with low interest rates, no underwriting, and the need to have all of the latest “stuff”, consumption was good. Well, it was probably too good.

Times have changed just a wee bit. Banks have something new now called under-writing criteria. This term may be strangely familiar to some of you over the age of forty. At any rate, a loan applicant now has to prove he has a job so that they can pay back the mortgage. Banks also now expect a borrower to put down a down payment, provide copies of tax returns, and be subject to a credit check. Can you believe this? No wonder real estate sales have slowed down. All of this due diligence, fact checking, and paperwork must really slow down the process of buying a home. There are even rumors of some borrowers now being declined for loans.

Back to the Future

Where do we go from here? Banks and mortgage companies that have underwriting criteria is actually a good thing. A solid and performing loan portfolio should produce a profit which will encourage shareholders. But I’m not convinced that hula-hoops, pet rocks, and polyester leisure suits are making a comeback anytime soon. I’m also not convinced that the majority of people are on this austerity bandwagon. Why? Although it is somewhat more difficult than it was, it is still far too easy to borrow money for consumer loans. So, if you want to continue trying to keep up with the Joneses (yes, they’re still here; it’s just that their extended family is much smaller now) you can. And it is also far too easy to declare bankruptcy if you get in over your head.

Conclusion

With that said, the thrifty mindset appears to be gaining some traction even if this new found love for penny pinching is mostly out of necessity. How long will this go on? Who knows? Economic cycles can go on for a long time… sometimes far longer than they are predicted to. What we do know, or at least strongly believe, is that it won’t go on forever. The tide will turn and spending and consumption will again be the “New Normal.” It’s only natural and it’s only a matter of time.

With that said, I guess it’s time for me to fess up……Inevitably many people I meet will eventually get around to asking me, “If you were me, what would you do?” And I politely have to tell them that I’m not you—I’m me. We all have different goals and objectives. Everyone will have a different plan. It’s not too difficult to sit at my keyboard, produce this newsletter, and dispense advice. Reality—well, that’s another story. So what has gone right and where am I lacking a little?

Home Mortgage

Let’s start with my mortgage. My wife and I have a fixed-rate mortgage. When we moved into our home, we had a variable rate. Then one day it dawned on me that while interest rates will vary, it appeared they were only going to vary in one direction—up. So, it was time for us to get a fixed rate mortgage, and I’m happy we did. In this interest rate environment if you have a variable rate mortgage, I would suggest taking a hard look at getting a fixed rate mortgage. As you know, interest rates will fluctuate. If you have a variable mortgage, it’s OK when interest rates fluctuate down. It’s not so pleasant when interest rates rise. We also have a home equity line of credit that we’ve used periodically. Trust me—this has not become our own personal ATM machine like some people have used them the past few years. Essentially, the home equity line of credit is a backup to our cash reserve fund. This allows us to maintain a lower cash reserve fund. It has also been used for some home improvement projects. If it was indeed a rainy day and we really needed some money, we could access this. Although we don’t need financial rainy days, we know we will likely have them at some point. We try to plan for the worst and hope for the best.

College Education Funds

Unfortunately, our college education funds are not what they should be. Why is this? Well, like everything else in life this can be simplified. I paid for a significant percentage of my college education. Don’t worry—I’m not going to bore you with walking three miles to school uphill both ways in a snowstorm. The truth of the matter was I usually biked to the Broad Brook Grammar School and I was able to bike home for lunch. At any rate, when you go to college and you’re paying your own way, you tend to be a little more focused and work a little harder. When I went to college a couple of hundred years ago, my tuition was about $4,000 a year. Things have changed a little bit since then. Now it costs about $40,000 a year. Where I went to school it used to be a college. Now it is a “university.” Universities must be more expensive. Yikes! I’m sure glad I went to a college. Anyway we’re behind with our college funding. Tim is in High School and Megan is in Junior High now, and we’re starting the “Fourth Quarter Scramble.” We’ll see what happens when Tim heads off to college. My wife has adopted the three hour rule for our children when they go. This means that they can’t go to a college any more than three hours away. This seems logical. Getting him to and from school shouldn’t be too difficult if he’s less than three hours away. Now that my son is sixteen, there are days when it appears as if this rule might get changed ever so slightly. The rule on these days becomes a three hour MINIMUM distance away from home. Experience has taught me to stay out of the line of fire on these days. However, we are sticking with the 50-50 Club. This means we will pay half of their college education and they will pay the other half. They know that their membership in this club expires four years after high school graduation. And yes, whether they pass or fail, we are only paying for each class once. There is no mulligan allowed here.

Retirement Planning

We keep working towards our retirement funding. However, this continues to be a moving target. The bad news is that thanks to inflation, the “number” keeps going up. Also, unfortunately, we won’t ever be seeing a pension check. We don’t take any solace in knowing we aren’t the only ones in this boat. If you are going to be getting a pension, make sure to have a toast to your employer! As I’ve said before, retirement as we know it will change dramatically in the future. We have all of the appropriate estate planning documents. This includes a will, trust agreement, power of attorney, and healthcare proxy. This is always fun to do. Actually, most of this was easy except for the “if both spouses die at the same time, who will get the kids” conversation. This seems to be a pretty big stumbling point for most of you with minor children as well. It appears that a lot of people start but don’t finish their estate plan. Remember—you don’t get any points for starting your estate plan, just for completing it. We also have reasonable insurance coverage. However, we don’t own a long-term care policy yet. This is probably the only time I can say we’re “too young” and really mean it. But, once again, I’m just rationalizing. The fact of the matter is that anyone in their mid 40’s (unfortunately, I graduated without distinction like all of my graduations from this club) should start to look at long-term care insurance. Now it’s back to priorities again. After health, life, disability, auto, homeowners, and umbrella, we decided we’ve invested enough on insurance. We will, however, be revisiting long-term care insurance again in a few years.

If you have some “True Confessions” you would like to discuss, give us a call at (860) 645-1515 or e-mail TomS@Borgidacpas.com