From the newsstand to the World Wide Web, the headlines are all around us:
“Debt Can Be Bad for Your Health”
“Rise in Bankruptcy Filings One Year after New Bankruptcy Law”
“Middle-class Families in Worse Shape than Ever”
It’s a fact of 21st century American life: families are spending, but they’re not saving. Last fall, the Center for American Progress published a study revealing that less than a third of American families had saved income equal to three months of their salaries. Most were middle-class, two-income families, the majority of whom had not saved enough to deal with such emergencies as job loss or medical crises.
Why is it, then, that many of these same families are convinced that they are not flirting with financial danger?
At the core of this question is the challenge to convince families that these headlines are not about nameless, faceless, anonymous far-away families but about themselves.
Financial professionals encounter these folks every day. They have late-model cars, occupy lovely homes, send their kids to fine schools and work for a living. They purchase top-of-the-line televisions, computers, the latest electronic gadgets and fashions – just about every piece of merchandise currently on the market. Because they own and acquire pretty much what they want, they have developed a sense of entitlement.
Along the way, they have also depleted their savings, accumulated debt and eviscerated the equity in their homes. The facts are screaming at them from every published study, every newspaper, and every financially savvy pundit: average job growth is down 20 percent over previous business cycles, wages are flat and most critical items – health care, fuel, food, education, real estate – are escalating in cost.
Can it be that the majority of middle-class Americans is deluded? Forbes.com reported in September that in 2005 the personal savings rate as a percentage of disposable income in this country was negative 0.5%, by far the lowest of any industrialized nation. In France, the savings rate was 11.6%. Germany’s rate was a robust 10.6%. Japan clocked in at 6.7%.
The truth is that while Americans are accumulating material comforts – even necessities – they are amassing enormous debt. Using credit cards, home equity loans and student loans to pay for the present while sacrificing financially secure futures and incurring enormous interest charges, families are setting themselves up as victims of a financial dustbowl. All that hard-earned income and equity are being blown away.
If a couple comes to me with an average income of $100,000, enormous credit card debt, daunting mortgage payments, regular car insurance, two college tuition bills, student loan bills and climbing health insurance premiums, two things are certain: they have limited or no savings and they have no likelihood of imminent retirement – especially when it takes 30 to 50 years to pay down credit card balances alone. These folks are caught up in the 21st century delusion of entitlement that has collided with the 20th century American dream. And the collateral damage of that collision has taken an enormous toll not only on the emotional and physical health of Americans but on their bankrolls as well.
Medical experts are not the only ones to affirm the serious health ramifications of financial stress. One of my personal acquaintances – a delightful person overburdened by his growing liability portfolio – recently suffered a severe stroke that left him blind. He was 43 years old. On the surface, he had it all: a job, a house, a few consumer electronics gadgets, and a car. He had nothing in the bank, except obligations.
Gone are the days of savings passbooks and Christmas Clubs. Today, Americans are reeling in finance charges from credit cards and home equity loans. That 7 ½ percent mortgage rate demanding one percent payment? It’s called a payment-option ARM (adjustable rate mortgage). Borrowers leap at the chance to make current loan payments at a mere one percent rate, ignoring the fact that the starting interest rate of 7 ½ percent is adjustable – and may escalate to a higher rate after only one month. The “underpayment” (i.e., the amount paid that is less than the current rate being charged) is added to the principal balance. The result is that home equity evaporates monthly.
The mission of financial professionals is to rescue these earnest people from themselves. And we believe that it should be a national priority for those of us with the knowledge, skills and technical resources to reverse a trend toward financial self-destruction.
We must contend with the impact on personal finance of recent and powerful changes in household debt. Financial planners should consider clients’ liabilities as a portfolio rather than a series of unrelated obligations. The Financial Liability Portfolio should be managed much as one would manage a portfolio of different growth assets, but with the opposite goal.
When a professional manages an asset portfolio, fixed income instruments and various securities are treated differently within the portfolio, with the goal of building consistent growth and insulating against the adverse fluctuations of the market. A Financial Liability Portfolio operates in a similar manner; in this case, the credit obligations are being closely managed and paid down in a systematic way that allows clients to live that American dream without working until 85 to achieve it.
And what happens at retirement? People who depend upon a pension are likely to be in for a rude surprise. U.S. companies are rapidly switching to defined contribution plans from defined benefit plans. In other words, employees are burdened by the risk of market fluctuations. In the past, employees could rely on a fixed monthly pension for life, irrespective of market performance. Today, employees and their employers contribute to pension plans that depend on the investment savvy and discipline of the future retiree.
Professional financial advisors must place the client in the driver’s seat, not in the trunk. Liability Portfolio Management replaces the illusion of solvency with the reality of liquidity, ultimately giving clients the freedom to build a healthy asset portfolio.