— Read the newspapers these days and you’re seeing a lot of coverage indicating that there’s an economic recovery on the horizon:
1. Last week, ADP said that employers cut 491,000 jobs in April, versus the 708,000 that were lost in March. In fact, job losses were at their lowest since November of 2008.
2. Fed Chairman Ben Bernanke forecasted a turn-around for later this year, saying that conditions in the financial markets have improved and the banking system is gradually being repaired.
3. President Obama said on Friday that “the gears of our economic engine do seem to be slowly turning once again.”
4. The Dow Jones Industrials gained nearly 165 points and finished up 4.4 percent for last week — the eighth gain for the index in nine weeks.
Is this good news? Eh. What I really think it is is less-than-bad news. But the fact that it’s being played so positively could cause problems for you and me. If individuals follow these encouraging headlines they can become too optimistic and sabotage their financial future. When we feel too good, too powerful, too in control of the future, it tends to backfire. There are studies from Duke University that found that when people see the glass as too full, they behave in ways that aren’t good for their future. They overspend. They accumulate debt. They fail to save. On the other hand, mild optimists — people who are happy, but not complacent — save more and are likely to have emergency funds.
What’s an understandably confused consumer to do?
Pay down debt
Recovery or no recovery, you should absolutely continue to pay down your debt. Outstanding consumer credit fell by a seasonally adjusted $11.1 billion in March to $2.55 trillion, according to the Federal Reserve. It was the sixth decline in the last eight months, after years of our debt averaging a steady growth of close to 7% a year. Revolving debt - mostly credit cards - fell $5.4 billion, or 6.8%. Sure, part of this is due to the fact that banks have become less willing to lend, but another chunk can be attributed to the fact that consumers are less willing to spend, and they’re instead putting that money into getting balances down. If you managed to pay off $2,000 in debt over the last several months, but now you turn around and charge those cards back up again, it will cost you some $350 in interest alone over one year if you make only the minimum payment each month on an 18.9 percent card.
The savings rate has popped, and that’s good news. In the last year, the percentage of after-tax income that people don’t spend has risen above 4 percent. Still, a study by MetLife released in March found that half of Americans have a one-month cash cushion or less. 28% said they wouldn’t be able to survive financially for more than two weeks if they lost their job. In a good economy, I advise having at least three to six months worth of expenses, these days you need six to nine months, which means that even if we are headed for recovery, we still need to be stocking away some emergency cash.
Just yesterday, I saw one headline that suggested we’re in a mini-bubble about to burst and another suggesting the Dow could top 10,600 by year end. Either way, your strategy should remain the same: Pull your short-term funds out of the market if they’re still there. Anything you need in the next 3 to 5 years doesn’t belong in stocks. Then where your long-term funds are concerned, dollar cost average in on a regular basis, making sure that you have the appropriate asset allocation for your age and risk tolerance.
Don’t under insure
A new study by the Insurance Research Council found that although many Americans have taken steps to reduce their insurance costs in response to the downturn, most still consider home and auto insurance a priority. However, five percent of homeowners and 14 percent of renters reported canceling their insurance. Insurance is a non-negotiable, and if you scaled back your coverage during the downturn, one of your first priorities after a recovery should be re-evaluating your policies to make sure that you have the coverage you need. You should do this every year anyway.
A recent Pew Research Study found that Americans are paring down the list of things they can’t live without. In 2006, 68 percent of adults considered a microwave a necessity. Earlier this year, only 47 percent did. In the same study, Pew found that six in ten Americans said they were shopping more in discount stores or passing up name brands in favor of less expensive products. One in five said they’ve started doing their own home repairs or mowing their own lawns. These things may seem small, but they add up fast, and once you get in the habit of spending a few hours on the lawnmower every Saturday, why break it? Instead, you can bank that savings or use it to pay down high cost debt.