Every day we’re bombarded with headlines filled with buzzwords like tariffs and trade wars. Geopolitics and socioeconomics. Throw in the occasional wild cards of natural disasters and terrorist activity for good measure. All these uncertainties culminate to create a lot of shakiness and questions about our economic foundation.
We live in a world with a 24/7 news cycle that gets amplified by nonstop social commentary. In an instant, an off-the-cuff comment or “tweet” can send the markets tumbling or soaring (no political insinuation intended). It’s the ultimate butterfly effect.
The environment we’re operating in today has desensitized many of us to how these circumstances impact us at home.
How are we supposed to react? How do you decipher what’s real and what’s a facade? What’s rooted in fundamentals and what’s simply emotional fallout?
No doubt it’s tougher than ever to distinguish what we should pay attention to versus what we should ignore, but let’s explore for a moment how we can take more accurate inventory of what’s going on, and more importantly what corresponding action you can take to ensure you’re taking care of yourself and your family.
How the economic machine works:
You don’t need a degree in Economics to establish a basic understanding of how the economic machine works. And equipping yourself with some fundamental knowledge of the dynamics at play will put you in a better position to assess what’s going on and how it may influence your personal strategy to benefit from it.
Something as complex as the global economy can appear pretty daunting and overwhelming. No doubt it’s a sophisticated system with lots of moving parts, some more efficient than others. But at its core, the economy is like any other machine. It’s a series of inputs and outputs. When one thing happens, it triggers some sort of reaction. That reaction delivers feedback which helps to determine the next input and on and on we go.
A simple example is how your body acts when you’re hungry. Your stomach starts to identify that it’s running out of fuel. That feeling triggers a message to the brain that tells it “I’m hungry”. The reaction of the brain is to find food and feed the system until your stomach tells your brain, “Ok, I’m full”. The feeling of hunger opens the loop, and that loop remains open until you achieve the feeling of “being full”. Once you’ve satisfied the hunger, you close that loop. We don’t consciously think about these things, it’s just how the system is wired to function.
This is something simple and relatable to all of us but is representative of how all machines and systems operate.
To tie this back to the economy, consider your own personal economy. You have a job or some source of income. The income enters your economic system. From there, a series of outputs immediately occur. A percentage of your income immediately goes to the government in the form of taxes. An additional percentage goes to paying interest on any debt and liabilities you’ve got. Next, you have built-in expenses that cover your basic needs and wants. A portion of your budget goes to your home and bills, a portion to food, a portion to satisfying lifestyle, etc. And finally for most, if there’s anything left at the end of the month, that money goes into savings or some sort of investment account. Next month, you get another paycheck and the cycle repeats.
The health of your personal economic system is predicated on your ability to manage your money effectively. If you’re bringing in more than you spend, you have a surplus. The greater the surplus, the quicker you’re able to build your capital reserves and economic independence.
On the other hand, if you’re living paycheck to paycheck, you might be struggling to get ahead. As times get tougher, you might be forced to borrow money to keep up. The more debt you take on, the more of your income has to be allocated to paying interest on that debt. If the problem persists, you could end up spending more just to keep up on your debt than you bring in every month. You’re operating at a deficit, which makes it very difficult to get ahead financially.
For anyone trying to manage student loans, mortgages, car loans, personal loans, credit card debt, etc., this probably sounds all too familiar.
Your household economy offers useful insight into the mechanics of the broader economic system. Our economy’s health is predicated on the amount of income we have to rely on – how much we bring in – versus all of our expenses and obligations – how much we have going out.
As I write this, the U.S. has amassed over $22 trillion in debt, and 2018 marked the first fiscal year where we experienced a trillion dollar deficit, meaning we spend more than a trillion dollars more than we brought in in revenue. As a country, we’ve operated at a deficit every year since 2002. Bringing this back to your household economic system, this means you’ve been living off of credit cards to make ends meet for 17 straight years. Not exactly ideal, but to make matters worse, we have a demographic tidal wave building as we head into the next decade.
In 2008 the first baby-boomer turned 62 and claimed social security, marking the very leading edge of the most significant demographic shift in US history.
This was the first of 78 million baby-boomers who are set to turn 62 between 2008 and 2026. As those 78 million baby-boomers hit this benchmark, they shift from working to retirement, claiming both Social Security and Medicare benefits in the process. The problem is made worse by the fact that only 30% of these 78 million hit this mark between 2008 and 2018, so while debt has more than doubled over the last decade, we’ve really only just begun to see the impacts that this shift represents. The other 70% of boomers (roughly 55 million people) will turn 62 between now and 2026. This means that 70% of the largest demographic in the United States will simultaneously leave their peak spending years, resulting in less tax revenue, and enter their years where they get to begin claiming their benefits – resulting in more spending obligation for the government.
Add these two factors together and you get decreased inflows (income down) combined with dramatically increased outflows (expenses up). How does that equation work for you at home? Unfortunately, the math doesn’t work any better for us as a country.
And just as you’d have to address this issue at home, we only have two fundamental ways to improve the situation as a country. Decrease our spending or increase our revenue.
Decreasing spending means cutting expenses. Based on the demographic situation we face, and the obligations that our government is already committed to, do you think it’s likely that we’ll be able to cut spending?
So the second piece of the equation is to increase revenue. U.S. revenue is primarily generated from tax revenue. Taxes paid by you and me – income tax, sales tax, property tax, estate tax, and dozens more.
While it might feel like you already pay too much in taxes, the truth is we’re actually in the lowest tax environment in nearly 100 years. From the 1920s through the 1970s the average highest marginal tax rate was over 70%. Today, the highest marginal rate sits at 37%. Roughly half of the historical number. Knowing our formula, do you think it’s more likely that our taxes will go up, or go down in the future? You can come to your own conclusion, but simple math tells me it’s almost impossible for taxes to do anything but go up in the future – when and how much, who knows? But the facts are the facts. The Tax Cuts and Jobs act that President Trump put into place in 2018 actually reduced taxes as a whole, but those cuts are set to expire after 2025. What happens then?
It’s critical to get your arms around these dynamics because as our debt crisis has skyrocketed, the stock market and economy as a whole is still experiencing a 10+ year run that’s nearly unprecedented. It feels like the economy has been thriving, and hopefully, you’ve personally benefited from it, but the only certain thing about the economy is that we’ll always experience relative uncertainty. But this prosperity can lull us into a sense of false security too.
Understand, it isn’t a matter of if the economy will pull back and enter another possible recession, it’s a matter of when this will happen.
Since 1945, the year that marked the end of World War II, until today, there have been 12 recessions, and these recessions have happened within every 7 to 10 years consistently. In all, there have been about 47 recessions in the history of the United States. These defined chains of economic ups and downs are natural and inevitable, and as much as many people love to heap the blame of economic downturns on political and external forces, it is an established fact that recessions have nothing really to do with who was in a position of power when the event occurred. If the economy has peaked and needs to rebalance, nothing can stop it from running its course.
What to do next:
The purpose of this brief economic lesson isn’t to try and scare you or to serve as any sort of doomsday prophecy. It’s simply to point out the facts. In a world dominated by conflicting opinion, the best thing you can do is isolate the facts from the opinions and use them to formulate your own informed conclusions.
It’s my sense that we’re on the verge of a crisis. There are too many black and white facts conspiring simultaneously to convince me otherwise. That doesn’t mean that we’ll see this come to fruition in the next year, 3 years, or even 5 years. My crystal ball works no better than anyone else’s.
But what I do know is the longer the rubber band stretches, before it breaks, the harder it snaps back. So be conscious of the factors at play, and be conscious of which of those factors is within your control, and which ones are not. The factors that you can control are the ones you should focus your attention.
So what can you control?
You can control your own personal economy. How much you have coming in, and to a larger degree, how much you have going out.
If you’ve accumulated a lot of debt, the first thing to do is get your debt under control. Bad debt is the cholesterol of your financial plan. It clogs the arteries and robs you of cash flow. And cash flow is the saving grace when the economy goes south. If you know you have positive dependable cash flow regardless of economic condition, not only will you maintain a lot more confidence and peace of mind in your financial plan, you’ll reduce anxiety, and position yourself to actually benefit from a possible pullback.
Next, automate your savings and investing by paying yourself first. If saving and investing is a manual or incidental process for you at the moment, it’s time to rethink your strategy. We teach and encourage our clients to pay themselves first. For most Americans, saving money happens almost like a happy accident. If they happen to have a windfall or disposable income one month, maybe that money goes into savings, or maybe it’s just an extra indulgence they get to enjoy. Don’t let this be you.
Set up a “wealth capture” account that you automatically sweep a percentage of your income into every month, even before any bills are paid. Start with whatever is doable for you. Five to ten percent is a good start, but work up to 18-20%. When you automate the process of paying yourself first, you’ll be amazed at how much more resourceful you can become.
Once you’ve started the process of automating your savings, establish a clear target of what you want to set aside in a liquid account. We like to say cash flow is king, but cash is queen, so maintaining adequate savings that you can immediately access is critical. Build to a point where you have at least 6-12 months worth of expenses set aside in a liquid bank account that you can get access to within 24-48 hours if you had to. This is the next layer of peace of mind that affords opportunities to prosper when times get tough.
Once you’ve achieved your liquidity goals, the next step is to build up capital reserves that represent investment opportunities. Recessions can destroy wealth for people who are unprepared, but they’re also where the most wealth is created for those who are well positioned and prepared. They create opportunities to buy great assets on sale, only if you’ve established capital reserves to help you take advantage.
There are creative strategies that the wealthiest individuals, banks, and organizations use to put their liquid capital to work for them outside of the bank, without taking unnecessary risk. We work with our clients to take advantage of these opportunities to create savings vehicles that can return 3-6% long term tax-free interest on your money while creating opportunities to use your capital twice at the same time.
If you’d like to learn more about how to set yourself up for financial prosperity we have two ways we can immediately help.
First, you can request an advanced copy of our brand new book, “Survive the Crash – How to Position Yourself to Thrive in Any Economic Environment”.
Second, we offer a complimentary strategy call with one of our team members. Our strategy calls are designed to serve you. We’ll work with you to clarify how you want your money to serve you, how it’s currently positioned to help you accomplish that, and what opportunities exist to help you accelerate your progress. You can request your complimentary strategy call by viewing our calendar here.
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