Thursday, April 21, 2016

A series of terrible financial decisions

There have been a number of "personal finance disaster" books written in the wake of the Great Recession. (One that I remember was Edmund Andrews' "Busted: Life Inside the Great Mortgage Meltdown."

The latest entry in this genre is an article in The Atlantic Monthly titled "The Secret Shame of Middle-Class Americans"; the author, Neal Gabler, talks about, among other things, the difficulty some folks have with covering surprise expenses: 
Since 2013, the Federal Reserve Board has conducted a survey to “monitor the financial and economic status of American consumers.” Most of the data in the latest survey, frankly, are less than earth-shattering: 49 percent of part-time workers would prefer to work more hours at their current wage; 29 percent of Americans expect to earn a higher income in the coming year; 43 percent of homeowners who have owned their home for at least a year believe its value has increased. But the answer to one question was astonishing. The Fed asked respondents how they would pay for a $400 emergency. The answer: 47 percent of respondents said that either they would cover the expense by borrowing or selling something, or they would not be able to come up with the $400 at all. Four hundred dollars! Who knew? 
Well, I knew. I knew because I am in that 47 percent.
The article is quite excruciating to read, especially for folks who cringe at bad financial decisions. Here was one of the author's that I was surprised to read:
We have no retirement savings, because we emptied a small 401(k) to pay for our younger daughter’s wedding.  
Assuming this is true and there is no other context to this statement, this appears to me to be a profound error in judgment. Don't let this happen to you, dear reader. Emptying out your 401(k) for a party (no matter how important the party) is not a wise decision. 

25 comments:

  1. every high school should have a short primer on personal finance. it's really just as important if not more important than all the other stuff you learn in school

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    1. Completely agree. It's ridiculous that many people have absolutely no idea what compounding interest is, how a 401k works, or even what the APR means on that credit card in their pocket.

      I try not to be too cynical, but sometimes I feel that the higher ups don't actually want them to know. The plebeians would be a lot more pissed off if they really knew what was happening to them.

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    2. When I was in high school, the lady who taught the special ed class for mentally challenged kids Xeroxed her checkbook and had her class practice writing checks. The special ed kids literally got more education about personal finance than everyone else!

      I would say at least 80% of my classmates in calculus class never used it in real life, but those same people are completely ignorant of the difference between a 30-year fixed and an ARM, or how much they need to put into a 401(k) to retire at 65.

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  2. I think attitude-impotence is more appropriate than financial impotence for the writer. He fails to see all the wonderful things he has and instead opts for representation by a sad faced brown bag on the head.

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  3. I feel the same way whenever I read one of those articles about a family paying off some obscene amount of debt which they got into by way overconsuming. "We stopped eating out every night and traded in our BMW for a Honda." Wouldn't it have been better not to do those things in the first place?

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  4. Clucking your tongue at these people is exactly the wrong response. More middle class people need to come forward with these types of stories, and judgmental reactions work against that.

    And the smug comment above about the miracle of compound interest was probably made by someone who hasn't been in a bank for a while. Nowadays, you earn more from the "miracle" of Uncle Bob pulling a quarter from behind your ear.

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    1. Anon12:29pm: Assuming you're talking to me, please let me know which aspects of the post you find judgmental. On this post in particular, I feel the need to make sure it's as persuasive as possible.

      I also profoundly agree with comments about compound interest (as seen from the perspective of banks/money markets and the like.) Encouraging children to put their money in savings accounts for the long-term seems wise, but the mathematics are not there like they used to be.

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    2. What I'm getting at is what Keynes referred to as "animal spirits." Human beings make decisions based on more than cost-benefit analysis and probabilities. No kidding, right. However, if you can't understand why someone would cash out their 401(k) for their daughter's wedding, then I'd say you don't truly understand the bundle of love, joy, pride, despair, fear, shame, and optimism that constitutes a normal human being.

      Clearly, the author is not an abnormal freak. The Federal Reserve Board's data makes it abundantly clear that a lot of Americans are in the same boat. So you aren't. Congratulations. Good job. I try to manage my finances rationally as well, but I also try to acknowledge that I need to keep the animal spirits in my household happy. (If you think that's an easy, simple task, then you're probably not doing it right.) Getting the balance right is hard for most people, and nearly half, it appears, are getting it wrong.

      And I think teaching your kids about starting and running a business, investing in markets, and basic Econ 101 concepts would be far more useful than passing down the old saws we were given. Personally, I gave up on teaching my kids about compound interest once I realized that a better lesson could be had from them buying a pound of sugar and a bag of lemons.

      Sorry if this comes off as a personal attack. It isn't. I love your blog and encourage you to keep up the good work. But on personal finances, we obviously have different perspectives. I hope I've explained mine well enough that you might lend Mr. Gabler, 47% of Americans, Greece, etc. a tad more respect and little less smug.

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    3. That's the reason why Social Security and similar programs exist - people cannot be counted upon to prepare for their own future.

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    4. It would be interesting to know which was the bigger expense: the wedding or living in NYC. My guess is that NYC was the major expense burden.

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    5. Private school in New York or college would probably have been bigger contributors than the wedding - if they're making that much money, they would not have gotten much aid, and $60K/year will put a dent in a lot of incomes. (Note that even preschool is likely to be expensive there, so kids in private school are going to cost a lot - http://blogs.wsj.com/economics/2016/04/11/states-where-day-care-costs-more-than-college/). Add in rent/mortgage and things get out of hand quickly.

      I can understand that someone might end up in a bad financial situation like this, and I would agree that self-righteousness is unhelpful (because the fact that someone might make worse decisions than me doesn't make my decisions better, and doesn't mean I wouldn't do worse in their shoes), but we expect people to take some responsibility for themselves. If you have the means to take care of yourself (and lots of people don't) then not being able to do so ought to be discouraged, because everything that's important to you and everyone depends on being able to make good choices and execute them. It is not a good idea to expect other institutions to take care with you, because they don't care about you (why people have 401Ks if they're lucky and not pensions), so that if you can't look out for yourself, bad things will happen.

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    6. "if you can't understand why someone would cash out their 401(k) for their daughter's wedding, then I'd say you don't truly understand the bundle of love, joy, pride, despair, fear, shame, and optimism that constitutes a normal human being."

      Nope, any way you slice it this is simply irrational behavior regardless of how many Americans or Greeks engage it in. Eating one's seed corn for has never been a smart move and unlikely ever will be. Unfortunately it seems many many people think they're entitled to big houses, lavish parties, and fancy cars without putting in the work to afford them.

      Teaching kids about economics/business is very important, but in the end (as the old saw goes) cash will always be king. Nothing wrong with having a bag of lemons, but they're not good eats when the market is down (which it inevitably will be).

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    7. Anon, you've explain your perspective very well. And since "smug" is your chosen descriptor, clearly I have failed and I apologize to you and the undoubted many who feel the same way.

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    8. "without putting in the work to afford them"

      Actually, there is close to zero correlation between hours worked and income for those that have full-time jobs. Whatever factors influence earning and the income gulfs that separate us, "hard work" is barely among them and only to a minor degree. Bill Gates is not worth 10,000 times what you are because he works (or worked) harder.

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    9. "However, if you can't understand why someone would cash out their 401(k) for their daughter's wedding, then I'd say you don't truly understand the bundle of love, joy, pride, despair, fear, shame, and optimism that constitutes a normal human being."

      What about the tribalism and dislike of the 'other'? No free welfare for the Democrat/Republican tribe! I'd still give him 400 bucks if it was a real emergency, he asked really nicely, and his voting patterns perfectly aligned with mine.

      Wow... humans can be jerks. I don't think we deserve social security... Or at least I don't. I'm too animal spirited.

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    10. Exactly, people are chastising this guy for the wedding but it seems to be the real culprit is the exorbitant cost of living in NYC.

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  5. Part of the issue is this person's line of work requires that he live in one of the most expensive areas of the country. If "good" companies could diversify where they locate themselves that would help because people would not have live in in the extremes of high living cost. If one tends more towards a government solution, encourage the government to help develop mid-sized cities. Even if the cost of living goes up, it won't approach New York or San Francisco.

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  6. I think it was the combination of living in NYC and sending his two daughters to private school that really doomed his family. I understand the need to have your kids go to a good school, but did he have to live in NYC? What about living in Jersey and commuting while sending your kids to a good public school? And how much of a commute does he have anyway -- he's a writer, couldn't he do that anywhere? Or, as a proper and upstanding member of the so-called "creative class", he has to have the urban lifestyle for the credibility with all his friends or something. I never understood that mentality. But, of course, I'm a terminally uncool dork who lives in the suburbs.

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  7. Wow, he even makes it to the third paragraph before taking a swipe at Trump! For a 'creative class' type that's practically rabid conservatism.

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  8. "Emptying out your 401(k) for a party (no matter how important the party) is not a wise decision."

    So very true. That anyone would do this (and I'm guessing many many do) makes me shudder at the prospect of self-directed social security accounts. No idea, beyond brokerage houses that would love the trading fees, who this possibly benefits.

    When did 401Ks, in place of real pensions, start to become popular? My recollection was 80s. If so, we should soon be getting to the first wave of people retiring and being surprised how little money they have---now that's gonna be a good time to short the ES!

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  9. I remember seeing Neal Gabler occasionally on TV, doing movie reviews, etc.

    From reading the article, another serious issue is lack of communication with his wife about their financial health. He says she hasn't worked since the kids were little, which really puts a lot of stress on their finances. He also appears to have hidden the depth of their money problems from her as well.

    My ex-husband (who I'm still on good terms with) is in almost the exact same position as Gabler, but at least he's not in NYC. His wife hasn't worked in over 20 years, his two daughters want all the stuff their friends have, the recession really hit his business hard, his older daughter is going to an expensive private university, he had to take out a second mortgage, his car is 14 years old, etc. His family wants a comfortable middle class life style, but on only one income, which varies with the health of the economy. 40 years ago this would have been doable, but not nowadays. I feel really sorry for him.

    Back to Gabler - if his wife was working, their finances would be in much better shape. And they should have stayed in the Brooklyn coop, and never moved to the Hamptons.

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  10. Tap that home equity.

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  11. From the article: "You wouldn’t know any of that to look at me. I like to think I appear reasonably prosperous."

    As has been pointed out on this blog, real income hasn't gone up for most industries in thirty years. However, what is considered a middle-class lifestyle has gotten much more expensive, with cable, internet, cell phone plans, etc. Most people just get these things without realizing what a huge chunk of their income it represents.

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  12. Life is like football. If you get behind (financially) early in the game, it's very difficult to catch up and there's a limited time to do so. Save regularly. Money will accumulate even with very low interest rates. There's a difference between needing something and wanting something. Minimize the acquisition of the latter. Follow the advice of Ben Franklin.
    http://www.frugal-cafe.com/frugal-op-ed/articles/ben-franklin-quotes1.html

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  13. "Life is like football. If you get behind (financially) early in the game, it's very difficult to catch up and there's a limited time to do so"

    Now, isn't that a great argument about doing that Grad School/Postoc in chemistry? Just to bring it back to the normal programming and all.

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