Are there new rules of financial security?
Has the financial crisis totally changed how the rules of the game? Money Magazine thinks so and lists 7 new rules for financial security. I’ve listed them below along with some commentary.
Rule #1: Risk
Old thinking: If you can stomach the ups and downs that come with risk, you’ll be rewarded.
New rule: Risk isn’t about your stomach. It’s about making or missing an important goal.
I’m not so sure that this is a new rule as perhaps an old one that people just chose to ignore. Investments will always carry risk and those with higher risk offer the possibility of producing higher rewards. There are only 3 ways to reach a financial goal. Save your way there, invest your way there, or do both. If the goal is too important to risk losing money then choose safer investments and plan on saving more money to compensate for the loss of interest.
Rule #2: Cash
Old thinking: Keep enough money in ultrasafe accounts to cover life’s emergencies, but no more.
New rule: Relying more on cash can rescue you in an “asset emergency.”
The article suggests that you save up cash (or at least low-risk, low-return investments) to pay for impending big ticket items like a wedding, the down payment on a house or college tuition. Again, is this really a new rule or just an old one that people forgot about? The article also suggests that you consider downsizing these investments (e.g. state college instead of private college) if you can’t afford them. To which I say, “well, duh.”
Rule #3: Human capital
Old thinking: The longer your time horizon, the more stocks you should own.
New rule: Time isn’t everything. You must also consider your earnings potential.
I think that the point that they are trying to get at is that your career is your most valuable asset and you should try to maintain it and to grow it. But let’s be honest with each other, there are plenty of un-growable jobs out there. I’ve worked in several of them. If you are have a job that isn’t going anywhere focus on maintaining it and on growing other income sources as possible. Or focus on spending less or becoming a better investor.
Rule #4: Borrowing
Old thinking: Borrowing sensibly is a good way to build wealth.
New rule: Borrow cautiously.
How did this become a new rule? This is common sense. Try to avoid accumulating debt at any and all costs. You can not borrow your way to prosperity.
Rule #5: Housing
Old thinking: You can expect your house to appreciate handsomely over the long run.
New rule: Your home won’t make you rich. But it is an important savings tool.
While I fail to see the newness of this rule, that does not undermine it’s importance. There have only been two real estate booms in modern history, just after WWII and the current one. Other than in those booms real estate hasn’t performed too well as an investment. So what if your house isn’t an investment. It’s still a good savings device and it’s a house, which allows you numerous benefits over apartment living.
To be realistic the real estate market is going to stay dead everywhere. Some places will heat up again and there will always be places where you can flip a house and turn a profit. These markets won’t be as widespread or as hot as they once were but they will still be there. If you actually understand the real estate market and aren’t just in it to make a quick buck there will still be money to be made.
Rule #6: Diversification
Old thinking: A diversified portfolio lowers your risk.
New rule: Diversification won’t always save you - and you need more of it than you think.
Despite what they say, a diversified portfolio will almost always lower your risk. But they are right, you probably need more diversity in your portfolio than you think you do. I recommend building a simple portfolio of mutual funds that cover broad indexes, such as the US stock market, the US bond market, the international stock market and the international bond market.
Rule #7: Retirement
Old thinking: Retiring early is a prize.
New rule: Retiring early is a problem.
Retiring early will always be a prize because most normal people aren’t in love with their jobs, but you don’t get the prize without a lot of planning and a bit of luck. Not only did the current financial crisis wreck many people’s retirement accounts, but there are many more people who barely had any money saved up to wreck. Unfortunately, this means that early retirement or even on-time retirement are no longer options for a lot of people. Additionally, many retired people may now have to re-enter the work force in order to help ends meet.
