Wednesday, July 12, 2017

Your Personal Financial Stress Test

Banks are forced under regulations passed by the Obama Administration, to pass a "stress test" - could you pass one as well?

When the economy melted down in 2008 and George Bush signed the bailout legislation, many argued that if banks had only been better regulated, these "too big to fail" scenarios would not have occurred.   So regulations were passed under Obama to force banks to have more capital on hand and take less risks.   Until they could pass a "stress test" showing they could survive a recession, they could not do things like pay extensive dividends to shareholders.  And in fact, they might have to be broken up, so each piece was not "too big to fail".

Bank of America recently passed this test, and now will pay dividends, which the media posits as a "windfall" for Warren Buffet.  But it is not a "windfall" - you invest in a stock, you expect to make money, hopefully dividends.   I expect to get this windfall as well.  But the media loves a "rich getting richer" story as the plebes love to wallow in self-pity and their own crapulence.

But the story begs the question:  Could your finances survive a "stress test" as well?  And it is relevant, as after eight-plus years of slow growth, we may be headed for a mild recession next year.   Are you able to handle the heat?

What would happen if you lost your job for six months?  Suppose your new job paid less?  What if you had a medical or other emergency that required you to spend $10,000 or more?  Suppose your child was arrested and you had to hire a lawyer?   What if you wrecked your car and all the insurance company paid merely paid off the loan?   Could you survive any of these sorts of stresses?

Most Americans could not.   The media is rife with stories such as "Most Americans have less than $1000 in savings" which is never clear to me whether this means Americans have no savings at all, or whether they merely are smart enough to take that money out of their savings account and put it into an investment account, such as an IRA.  The question asked was "How much money is in your savings account?" and if they asked me, well, many times there is under $1000 in it.  That doesn't mean I'm broke.  A better question would have been, "How much do you have saved, including retirement and other investment accounts?"  - but that doesn't generate click-bait headlines, does it?

But regardless of how flawed the online surveys are (and online surveys are always suspect!) I suspect many Americans are indeed unprepared for financial stress.   And one reason this is so, is the "paycheck to paycheck" mentality so prevalent in America, that leads to fear which in turn leads to poor financial choices, which in turn leads to the paycheck-to-paycheck mentality.

For example, I discussed high-deductible health insurance before.   Before Obamacare (which really screwed up insurance rates) you could get a high-deductible health insurance plan ($10,000 deductible) for not a lot of money.   My brother-in-law had a $1000 deductible plan for him and his wife that cost more than $10,000 a year more than our high deductible plan.  His wife made the argument, "well, where would you get ten grand if you had to go to the hospital?" - failing to realize that every single year they were coughing up that much money to the insurance company.

If you have $10,000 in liquid assets, or indeed, even in a line of credit, such expenses are not worrisome.   You can afford to go to higher deductibles and cheaper premiums, and thus make even more money over time.   The snowball effect kicks in.

Or, you could by like my former massage therapist, who is stressed over buying collision insurance on a $2000 car.   "It it got in a wreck," he says, "how could I afford another car?"   But he pays at least $500 a year more than I do for insurance, effectively buying himself the insurance company a new car every four years.  Poverty behavior leads to more poverty.

This is not to say you should go out and cancel all your insurance policies tomorrow, or go to a higher deductible.   Your situation is unique.   The point is, when you are stressed financially - and usually because of lifestyle choices not because of life events, you put yourself in a situation where one minor blip in your finances could sink your financial rowboat.   This leads to fear, and it leads to people paying more money for "peace of mind" to keep their financial house of cards from toppling over.

For many years, my finances could not withstand such a stress test, which is akin to flying blind in the clouds.  You hope everything works out OK, and if it doesn't...... oh shit.   While I had money in my 401(k) and IRA, and also had available credit, these are not things you should be counting on as your safety net.   And the simple reason is that if you have to cash in your IRA to pay bills, you will be tempted to do just that.   And in addition to paying a 10% penalty, you no longer have a retirement account, or at least it is that much smaller.

So how do you build up a buffer of after-tax savings (which need not be in a savings account, so please, don't get extremist on me.   It could be in stocks, bonds, or whatever as well)?   Well, the easiest way is to stop spending so much, and while people say they "need" a new car or "need" a new cell phone or "need" cable television, these are wants more than needs.   When you look at some purchase and think, "I can afford this with my current paycheck!" you have to ask yourself first, "but have I funded my stress-test yet?" as well as, "could I afford this if I lost my job?"

The mistake I made was buying stuff until I ran out of paycheck, and that was a dumb idea - particularly when you are self-employed.   Buying crap until you run out of money is never a smart move, and yes, we all have choices in this.

It is funny, but frugal habits, once adopted, are hard to shake.   We find that we are spending less now, even though we have more money than any other time in our lives - and the two are connected.   We have friends that go out to eat every night and spend a lot of money on drinks at the bar.  But quite frankly, we find we just can't bring ourselves to spending $5.50 for a beer at a bar that serves mediocre food.   We can't see ourselves spending $100 a month on cable TV when it sucks.   And I see no need to spend over $1000 (!!!) on a new iPhone 8, when my $99 Samsung does everything I need it to.

People do have choices.   And living paycheck-to-paycheck is usually a choice for the middle-class.