“There are two times in a man’s life when he shouldn’t speculate: When he can’t afford it and when he can.” – Mark Twain
What is the lingering impact of the recent recession? How has the average household been affected? And where are we headed from here?
To look for answers, we’ll examine the latest Survey of Consumer Finances (SCF) conducted by the Federal Reserve,a periodic in-depth assessment of changes in consumers’ net worth and income across the country. The findings from the latest survey, covering 2007 to 2010, were released in June 2012. The time frame is significant, as it provides a before-and-after financial snapshot of American households in relation to the recent economic downturn.
For most Americans, it isn’t a pretty picture. As the Washington Post summarized, “The Federal Reserve said the median net worth of families plunged by 39% in just three years, from $126,400 in 2007 to $77,300 in 2010. That puts Americans roughly on a par with where they were in 1992.”
Gary Halbert, writing in the June 19, 2012, Forecast and Trends newsletter, was more blunt: “Put another way, two decades of accumulated prosperity simply vaporized in 2007-2010.”
The SCF net worth calculation considers all assets such as a home, savings, investments and other items. In this context, it’s easy to explain the steep decline in Americans’ net worth: a double-whammy of a real estate bubble and stock market crash.
Hulbert notes that “We had the worst housing bubble on record, with home values plunging by 60% in some areas of the country.” During the same period, “The Dow Jones Industrial Average peaked at 14,164 on Oct. 9, 2007, and then plunged by more than half, to 6,547 on March 9, 2009. While the stock markets have recovered much of the lost ground over the last three years, many Americans bailed out during the recession and never got back in.”
So while the markets appear to have made a recovery, many investors have not. The numbers are sobering; and become even more so when you begin to calculate how long it might take to recover from these losses. Consider the following:
If the 2010 median net worth of $77,300 is equivalent to the median net worth of 1992, it is possible to calculate the average annual rate of growth in median net worth from 1992 to 2007, when the amount reached $126,400 before the recession. For this 15-year period, the average annual growth in net worth was slightly less than 3.35%. (See Fig.1)
If a 3.35% rate from 1992-2007 were to persist in the future, it would take 15 years(until 2027) for the average American household to simply return to their 2007 level of wealth. And with unemployment high, interest rates and consumer confidence low, and economies worldwide in crisis, that rate may not be conservative at all.
Of course, there have been periods where net worth has increased at a much faster rate. What if the annual rate was 5%? (Fig. 2)
At 5%, the return to the 2007 baseline is reached in slightly more than 10 years, which is better, but still a long time. If the projection was optimistic, with an annual rate of growth of 8%, the recovery time would be a bit past 6 years.
But these calculations are nothing more than math exercises. For the projections to be relevant, they must reflect reasonable real-world expectations. What is a “realistic” rate of growth for Americans’ net worth?
Factors Affecting Net Worth
For a swift recovery in net worth to occur, three real-world factors must be favorable:
- Incomes must be high enough for families to save significant amounts.
- Since housing is a relatively illiquid asset (homeowners can’t quickly sell their homes to reallocate their portfolio or minimize losses), market values must rebound.
- Investment returns must improve.
Right now, none of these factors can be viewed as trending positive. (“more” = truncate article)
First, adjusted for inflation, Hulbert reports that families’ incomes have continued to decline, a trend that predated the financial crises in 2007: “Median family income fell from $49,600 in 2007 (adjusted for inflation) to $45,800 in 2010. Note that these numbers are already 18 months old, and conditions could actually be worse today.” Furthermore, the percentage of American families saving anything fell to 52% in 2010, down from 56.4% in 2007.
If Americans aren’t saving, the only way their net worth can increase is if existing assets grow in value. For many Americans, one of their biggest existing assets is a home. While some areas of the country have shown a bounce-back in residential values, a February 2012 report from Zillow Real Estate Research forecasts the overall market will not bottom out until 2013. And upward trends will likely be slow, matching GDP growth of perhaps two and three percent annually.
If real estate isn’t anticipating a quick bounce-back, that leaves investments. Conservative, guaranteed accumulation vehicles are currently yielding record-low interest rates. Bank savings pay less than 1%, and even longer-term Certificates of Deposit are barely at 2% annual return.
The U.S. stock market, as represented by the S&P 500, has been quite volatile since its October 2007 peak, experiencing several run-ups and sell-offs; as of June 21, 2012, it remained 11% below the 2007 high watermark. And, as economist Kenneth Goldstein told the Huffington Post on February 13, “The economy that we had before the recession is gone. It’s not coming back.”
Given the status of these real-life factors, projecting an annual net worth growth rate of 2% isn’t unreasonable or pessimistic. It just makes recovery a lot longer. (Fig. 3):
The Lessons of the Recession
The possibility of taking 25 years to just break even for three years of losses is staggering. Which makes the following point: Some of the best financial strategies are those that avoid losses. Steady progress, even with a lower rate of return, often provides the greatest chance of long-term financial success, simply because you avoid the devastating impact of investment loss – in both time and money.
The conventional mantra for real estate or stock market investing has been to ride out the roller-coaster of gains and losses and benefit from the overall upward trend. Historically, the numbers bear out this approach – over the very long-term. But recent events may compel American households to have a greater appreciation for the advantages of balancing their portfolios with asset classes that emphasize steady growth over spectacular possibilities.
Whole life insurance provides better returns with more flexibility and tax advantages than banks, and bridge loan and life settlement investments do not suffer the ups and downs of market whims.
Perhaps, if there is a silver lining, it is this: those with ears to hear and eyes to see will be guided towards more predictable investments and sustainable strategies.
Do you need to re-evaluate your financial strategies in light of the new economy? Review our recent article about the differences between Prosperity Economics™ and “typical” financial planning. The silver lining is that there are financial strategies that still work, and it’s never too late to abandon the advice that never could ensure prosperity in the first place.