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22 November 2011
Occupy Wall Street is creating a great deal of buzz around the globe, and it is a remarkably fascinating movement to witness. No matter what side of the proverbial fence you reside on, this movement is drawing a great deal of attention to several issues our country’s leaders have long ignored.
Opponents and critics of the movement argue that there is no leadership, no direction and no central reason for its existence. And while proponents may have had no consensus rationale for participating in the first place, many are beginning to rally around the general idea that their future has been compromised in one form or another. For the rest, it simply appears to give them something to do.
It is unfortunate that it often requires devastating pain and suffering to draw attention back to issues that we turned a blind eye to in the past. While the Wall Street movement is drawing some attention to our macroeconomic and political issues, we ought to pause individually from time to time to consider the personal financial decisions we, collectively, have turned a blind eye toward the last several years.
While our political leaders and the big, bad banks had plenty of involvement in the financial crisis, consumers played an equally vital role. While it is unpopular to state this, much of the angst and turmoil “caused by the financial crisis” is really the result of poor (or a complete lack of) planning.
Before we cast stones, let’s take an honest assessment of our personal situations and the decisions we have made to ensure that we have built an adequate moat around our financial lives.
We talk often about creating a margin of safety in your financial life. This concept is derived from Benjamin Graham’s book, The Intelligent Investor. It merely means that when making investment decisions, one ought to ensure that they are buying a company at a price well below its real value. This concept is equally important in our ongoing financial decisions.
As an example, consider how many people purchased a home that stretched their budget to the max (or beyond the max!). The banks’ role in this process was knowingly allowing people to purchase more home than they could afford. However, the purchasers of these homes were equally responsible for allowing their eyes to get bigger than their stomachs. In the pursuit of bigger and nicer, we forgot to consider what happens when things do not go as planned.
Most households manage their cash flow pretty effectively until a “surprise” expense throws them off. Another “surprise” expense pops-up the next month, and then two more arise in month three. This creates a cascading snowball effect and results in a death spiral it is extremely difficult to recover from. What makes these scenarios worse, however, is that the “surprise” expenses often come in the form of car repairs, health care costs, a broken furnace, etc., which are really not surprises at all. The timing is unknown, but the expense itself can be reasonably anticipated.
The alternative to the death spiral is something like a job loss. Without question, a job loss is a far more financially devastating event, and far more difficult to prepare for. However, these are precisely the reason financial planners insist on their clients maintaining substantial cash reserves, or emergency funds. When a financial expert jumps on CNN or Fox News and tells everyone to maintain reserves of 3 -6 months of living expenses, they have situations like this in mind. For many folks, the idea of establishing and funding an adequate cash reserve was deemed unnecessary or far-fetched. In reality, if you can’t afford to build a cash reserve with your current cash flow situation, you are living beyond your means with no margin of safety.
Bruce Berkowitz of Fairholme Capital Management has famously discussed his methodology for protecting himself and his investors: kill the company. “We spend a lot of time thinking about what could go wrong with a company, whether it’s a recession, stagflation, zooming interest rates, or a dirty bomb going off.”
Consumers could gain a lot of ground on their financial security by simply practicing this with their ongoing financial decisions. In your personal space, the company is your household’s finances. Instead of focusing on what could go right, focus on what could go wrong, and make sure you are adequately protected against it.
Cash reserves are critically important in this regard. Adequate life and disability insurance will protect against the loss of the breadwinner’s earnings. Be realistic about your job security and forward-looking earnings. Do not over-commit to future expenses. Save consistently and with purpose. If you realistically have a hard time “killing the company”, you can probably afford that bigger house or car. However, if this exercise highlights significant exposures in your financial life, or a relatively likely event will lead to financial ruin, you must have the discipline to walk away.
Intelligent Decisions. Simplification. Peace of Mind.
