Saturday, August 1, 2009

Rebuilding Your Wealth: Could Savings Sink Us?

There is an old philosophy joke that goes something like this: A man catches his wife in bed with his best friend. As the husband asks “what’s going on here?” his friend replies “are you going to believe me or what your eyes tell you?”

That is about where we are in this economy. There are plenty of reasons to see things are beginning to improve and yet, it is still difficult to see these improvements. The recent rise in spending (0.3% with an earnings increase of 1.4%) is curiously coupled with the recent rise in savings. How can that be? Or better why can that be?

Even those of us who fall squarely on the side that disagrees about the Obama administration’s attempt to fix this economy with a government spending program so massive the numbers simply boggle the imagination can agree that if it works it will be good to be wrong. Those of us who think that this is exactly how you fix the problem that over six months ago belonged to another president, are hopeful that we will be right because it would be no fun to be wrong.

Seeing what you want to see is of course, nothing but a defensive posture we all are capable of assuming when things look bleak. In his 1993 book titled “How We Know What Isn't So”, Thomas Gilovich suggests the endowment effect might have something to with this. He writes, “ownership creates inertia that prevents people from completing many seemingly beneficial transactions.” For the economy to move in a direction that many considered beneficial, keeping your money close will not necessarily have the same desirable effect as if you began spending it.

Numerous reasons have been given as to why Americans have chosen to rebuild their depleted accounts rather than spending some of this cash. Beginning with building emergency accounts to offset any potential hazard that, if it hasn’t already happened (it probably won’t) from occurring. There is also some speculation that the growth in these accounts is the direct result of the poor performance of our retirement accounts.

Both of these reasons seem to be not only believable but also just plain old good sense. Just about everybody who writes about personal finance will tell you, the ability to tap back-up cash (the amounts vary from between three, six or twelve months of income) in times of crisis is the first rule of a healthy personal balance sheet. It is unrealistic for the majority of us but good advice nonetheless. The most troubling aspect is the shift from what made us feel good (our ballooning retirement balances) to what we think will make us feel good (our fledgling savings accounts) now.

When it came to investing, I can be relatively safe in suggesting that we all thought we knew what we were doing. Those of us that took the time to study our options, did a little research and chose the investment that we thought would best fit our tolerance for risk probably thought you were doing better than most. This phenomenon is based on one of the most well researched topics among psychologists.

Our retirement accounts were an extension of our assessment of our own abilities. Mr. Gilovich writes: “ the average person purports to believe extremely flattering things about him or herself – beliefs that do not stand up to objective analysis”. Our self-serving assessments as Mr. Gilovich calls them make it difficult to “apportion responsibility for our success and failures”. When the market performed well and by default our investments, we took full credit of our skillful strategy and savvy. When the market failed to perform, giving up years of gains, we were quick to blame external circumstances.

Now we look to savings to save us and help us feel endowed once again. There are three problems with this approach and why it will stigmatize this recovery. The first being our assessment of risk is somewhat askew. We have more or less rubber-banded from fully stretched to a restive state. We have removed out-sized risk in favor of none.

The second problem facing the economy is that savings and our logic for keeping it stashed away is not logical. Our motives at regaining self-esteem through building a savings account will have the exact opposite effect on who and how you perceive yourself. You look for retirement to happen one day and you reason, when I reach it, I will have six months savings stashed away in the event that I might need it. More troubling, what if that is all you have?

By rebuilding (or in many cases building) a savings now might jeopardize the economy in ways you haven’t considered. Although much of the income increases recently reported were due to increased overtime by skeletal staffs, there is far less opportunity to invest or even where to when you are out of work. Those that still are employed have not yet returned to the markets as employer incentives such as matching funds have dwindled. Many pension plans have been frozen. To reverse this trend, some one needs to buy something.

There are goods but few buyers. The nature of the transaction, which does not necessarily need to be motivated by credit, has not shown an equal recovery as compared to what we saved in the same period.

Third, the opinion makers, the people we listened to when we were investment geniuses are not making any sense to us anymore. This motivation makes us turn to those that tell us what we want to hear. Studies support the idea that we look for not only the kind of information we want to hear but how much we need to ingest. Things are bad and you hear: could get worse; could be you; you should prepare. Things are good and you listen to experts that advise you on the ways to keep it good. Even when we find information that doesn’t jive with our thinking, we will dig around until we find something that supports what we want to believe. We want to be comfortable that what we are doing is what we should be doing.

John O'Donohue, poet, philosopher, and scholar, looks at the Irish imagination in his book Anam Cara observing, “To the inferior eye, everyone else is greater. To the indifferent eye, nothing calls or awakens. To the resentful eye, everything is begrudged. To the judgmental eye, everything is closed in definitive frames. To the greedy eye, everything can be possessed. To the fearful eye, all is threatening.”

Without risk, what we see is what, better yet all we will get. John Burroughs wrote: “A man can fail many times, but he isn't a failure until he begins to blame somebody else.” And no one will want to take the blame for what the next year holds as his/her own because of it.

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