When it comes to money, the financial climate in which you grew up can have a life-long impact on your financial perceptions and behavior. The influence appears to be particularly strong if the financial events are extreme, such as those occurring in a boom or bust period and especially impactful for people who are between the ages of 18 and 25 when the major event occurs. A research paper published in September 2009 by Paola Guilano and Antonio Spolombergo (Growing up in a Recession: Beliefs and the Macro-Economy) reported that “recessions do alter perceptions,” and that these changes in perspective tend to persist throughout one’s life.
Looking back on 20thcentury American experiences, it is possible to see how significant financial events shaped the behavior of different generations. The generation that came of age in the Great Depression placed a high priority on frugality, steady employment, and saving. They had strong aversions to almost all debt (and unsecured credit in particular), and were reluctant to take risks in the stock market. Guilano and Spolombergo concluded that because “recession-influenced respondents…tended to believe that success in life was more a matter of luck than hard work,” they also displayed a greater preference for government intervention, in the form of entitlement programs and progressive tax rates.
In contrast, the authors found that “birth cohorts that experienced high stock market returns throughout their life report lower risk aversion.” They are “more likely to be stock market participants, and, if they participate, invest a higher fraction of liquid wealth in stocks.” This observation describes the Baby Boom generation that was born following World War II, as well as the Boomers’ children. In addition to taking greater investment risk, these generations embraced easy credit, longer mortgages, and became comfortable using financial leverage (credit) for almost every transaction.
Will there be prominent perception shifts as a result of the Great Recession (or as economist Paul Krugman likes to say, the “Lesser Depression”)? Based on previous experience, the past few years qualify as an extreme period in financial history, so it seems likely that major attitude shifts might follow. From a broad survey of current financial commentary, here are some possible perception changes that are in the making:
Eighty (80) is the new 65. For the generation that grew up during the Depression, the magic number for retirement was age 65, when fully vested pension payments and maximum Social Security benefits began. For awhile during the 1980s and 1990s, that magic number dropped into the 50s as a high-flying stock market led many to believe they could accumulate enough to retire early.
But today, age 65 has “become irrelevant,” according to a November 17, 2011, wire report from Moneynews.com. Longer life spans, rising healthcare costs, falling stock market values, and heavy debt loads have led many Americans to conclude that continuing to work as long as possible is their only retirement option. A November, 2011, Wells Fargo study showed almost one fourth of middle class Americans now see age 80 as “a good age to shoot for when it comes to retirement.”
A trend toward prolonged working lifetimes could result in a fundamental change to many financial dynamics, from accumulation and distribution strategies to the cost of employee benefits, required minimum distributions, tax credits, and eligibility for government programs like Social Security and Medicare.
“Sure things” aren’t sure things.Two financial clichés that were popularized in the late 20thcentury and persisted up to 2007: (1) “Stock markets may fluctuate, but the long-term trend is always up,” and (2) “Buying a home is the best long-term investment a person can make.”
For awhile, the numbers seemed to support these assertions.
And then the sub-prime bubble burst. The market for housing dried up, foreclosures skyrocketed, and prices plummeted. Now, as the November 10, 2011, headline from the Wall Street Journal states: “Home Prices Keep Dropping.” The actual numbers vary with the location, but a 30-40% decline in home prices since their 2007 peak is not uncommon. What’s worse, says Paul Dales, an economist for Capital Economics, it will take “years rather than days for a proper recovery to get going.”
Meanwhile, the past decade has not been good for stocks. While there have been significant ups and downs during this period, the net result over 10 years from most market indexes is slightly better than break-even. Even though many financial professionals continue to remind consumers that stock market investing is a long-term project, a 10-year period with almost no return (or a loss) is hardly reflective of an upward trend. What’s worse, markets have become more volatile – even if the overall return is flat, fluctuations are higher and more frequent.
Insurance matters. With fewer assets and lower returns, more Americans find themselves living on a thin financial margin where one unforeseen incident can unravel everything. Suddenly, it seems financial discussions – in the media and around the dinner table – are as much about protecting oneself from poverty as getting rich. People know they need insurance.
Right now, health insurance is the front-and-center topic, one that will apparently require a Supreme Court ruling to determine how the nation will address both affordability and protection. But other insurance issues need to be resolved as well. And much like health insurance, it will be interesting to see whether private or government programs will win the day.
As defined benefit pensions have been replaced by 401(k) accounts, retirees face the challenge of turning their accumulation into a steady income stream. In the marketplace, this concern has meant the revival of immediate annuity purchases, allowing individuals to exchange a lump-sum for a guaranteed stream of payments. From the government side, public policy advocates have floated several ideas to reshape Social Security or establish national retirement accounts.
Where once a popular strategy for life insurance was to buy cheap term insurance to cover one’s working years, increased life expectancies and a lack of retirement assets have prompted many Americans to take a second look at life insurance designed to stay in force for their whole lives. Additionally, hybrid financial products that combine either life insurance or an annuity with long-term care insurance are also attracting consumer interest. Going forward, insurance will play a larger role in individual finances.
Employment is a fluid condition. Once upon a time, the average American graduated from high school or college and settled into a lifetime of steady employment, often staying with the same employer until retirement. At least, that’s how we imagined the story went. The reality is much different, both then and now.
“For the great majority of American workers, so-called ‘career jobs’ never existed, and they certainly do not exist today,” says Craig Copeland, an Employee Benefit Research Institute senior research associate and author of the study “Job Tenure Trends, 1983-2010.” “A distinct minority of workers have ever spent their entire working career at just one employer.” The median job tenure for Americans is slightly more than five years, and considerably less for younger Americans, but this number hasn’t changed much over the past 20 years. What is different today are the reasons for job change.
In periods of high employment and prosperity, people changed jobs to pursue better opportunities. Today, job change is more likely the result of layoffs or downsizing. People aren’t moving from job to job, they are moving from employment to periods of unemployment. Furthermore, due to the high ancillary costs that come with hiring full-time employees, more businesses are meeting their labor needs with contract and temporary workers. As a result of the Recession and the subsequent changes in employment, census data released in September 2011 showed US households earned less in 2010 than they did 13 years ago (see chart).
Obviously, this on-again-off-again work format has the potential to disrupt or complicate efforts to achieve financial security.
Adjusted for inflation, real household income has dropped to 1997 levels. Outstanding debts must eventually be repaid. One of the reasons economic recovery has been so slow to take hold is because there has not been a bounce-back in consumer spending. Shaken by the events of the past few years, many Americans are coming to the conclusion that they can’t always outgrow, out-earn, defer or restructure their debts. Instead of borrowing for a new car, or refinancing the mortgage to add an addition, more Americans are paying off credit card balances, cleaning up their student loans, and trying to build cash reserves as a hedge against employment and investment uncertainties. Some observers wonder if those who have grown up in a culture of leverage – always borrowing today, and hoping to pay tomorrow – can truly embrace a new paradigm, but as was mentioned at the beginning of this article, recessions alter perceptions. And it appears many Americans have embraced an austerity program as a way to stabilize their financial status.
If only governments were so responsible. Whether it’s Greece or the United States, deficit spending cannot continue indefinitely. The optimists may still believe it is possible for a national economy to outgrow its obligations, but when debts get too large, a tipping point is reached, and the only solutions are decreased spending, higher taxes, or bankruptcy. None of these options are good ones. But somehow, the debts must be resolved.
Adjusting to Changing Perceptions: Recapitalize and Restructure. In the business cycle economic model, bust follows boom, which precipitates a recapitalization and restructuring that lays the foundation for the next boom. The events of the Great Recession certainly have the characteristics of a bust. The question is how best to recapitalize and restructure.
In the Great Depression, much of the restructuring came from government initiative. Employment programs like the Civilian Conservation Corps and the Works Progress Administration stepped in to put Americans to work. Social Security was established to assist with retirement. The funding for these programs came from higher taxes and deficit spending (i.e., borrowing). Today, it is an open question as to whether voters will accept either higher taxes or deficit spending as a way to facilitate government solutions to these financial issues.
There is a second problem with government intervention: Even if the electorate approves these steps, lenders may not. Look at Greece. While the Greek population seems strongly in favor of maintaining the country’s entitlement programs, the government is finding it can no longer borrow to pay for the programs. In effect, outside creditors are determining national economic policy; while the Greek government may want to provide for its citizens, its credit card is maxed out. When governments reach their spending limits, the only recourse is individual initiative to develop and implement individual solutions.
In any phase of the business cycle, people who are paying down debt and rebuilding their savings are recapitalizing, and better prepared to prosper in the future. But what is often overlooked is how efficiently this recapitalization is taking place. New perceptions may require changes in strategies as well. For example:
- If your future employment may be characterized by periods of unemployment, should you adjust how you contribute to a qualified retirement plan, such as a 401(k)?
- If your house isn’t the best investment you’ve ever made, are you sure you want to make extra principal payments to pay off the mortgage earlier?
- If you are ready to retire, should some of your accumulation be used to purchase a guaranteed stream of income?
- If it is likely your current employer will not be your employer 10 years from now, should you consider portable, personally-owned disability and/or life insurance benefits?
This discussion is a bare-bones overview of some projected long-term effects of a significant financial event. The challenge for individuals is determining how best to respond to these changing financial perceptions. Effective financial management has never been a set-it-and-forget-it program; even if you are well-positioned right now, some changes may be necessary in the future.
IN LIGHT OF RECENT EVENTS, COULD YOUR FINANCIAL PROGRAMS BENEFIT FROM RECAPITALIZING AND RESTRUCTURING?
ARE YOUR FINANCIAL PERCEPTIONS IN LINE WITH THE AFTERMATH OF THE GREAT RECESSION?