How to 'reboot' your American dream
Many American families are forging a new frugal lifestyle, shopping in second-hand stores, using coupons, and sharing housing. Concerns regarding job security, retirement shortfalls, and weak investment returns have left many feeling threatened that the American dream is no longer achievable.
As Americans "reboot" their dreams and reset financial priorities, it is important to adopt the attitudes and practices of both accountants and economists. Accountants base their projections of future revenues on actual income and earnings, while economists devise forecasts based upon sophisticated modeling tools and "what if" scenarios.
Wearing these two hats can help you to better evaluate your capital foundation: human capital (ability to earn income), financial capital (return on investments), and emotional capital (capacity to handle risk).
First, form a base estimate with the accountant's green eye shade. It should include today's bank account balances, employment income, investment returns, and liabilities (all outstanding credit-card bills, loans, and contractual commitments.)
Then create more optimistic projections with the outlook of an economist. Devise alternative scenarios with the assistance of online financial calculators. These tools can help you to vary spending estimates, income from new employment, housing expenses, and various asset allocation scenarios for your investments.
While retooling your finances, keep in mind the following seven rules for regaining financial security:
1. Manage risk. Identify your exposure to health problems, accidents, disability, unemployment, and long-term care – and consider insurance to avoid the financial losses that accompany such life experiences.
In terms of investing strategies, take your age into consideration. For investors above age 50, capital protection should be the focus. Younger investors should selectively use a dollar-cost averaging strategy to invest in longer-term equity markets, contributing the same amount periodically over time to smooth out the effect of swings in the stock market.
2. Secure your short-term financial stability. Fund a six- to eight-month reserve of your current monthly expenses and invest that money in an insured bank account for quick access.
3. Make time your ally. Maximize savings by starting early. Leverage the power of compounded interest. A 30-year-old investing $150 month at a 5 percent return will have $180,000 at age 65; a 40-year-old needs to invest $300 month to achieve a similar savings.
4. Create a net worth profile. Try to forecast where you might stand financially over time periods of 3, 5, 10, and 20 years. Setting intermediate time horizons for achieving financial goals – for example, paying off a mortgage, achieving savings of $250,000 – forces you to recognize slippages that can be corrected by modifying budgets.
Be tough in setting values for your home – assume single-digit appreciation over the next 10 years. Also set investment returns of 4-5 percent and calculate 10-12 percent increases in healthcare costs for at least the next five years.
5. Adopt an 'unretirement' mentality. The stock market's slump has led to expectations of working until age 70 or beyond. The "golden years" have gone the route of typewriters and black and white television, replaced with an attitude of phased retirement. Hold off on Social Security. Waiting until age 70 nets you a 132 percent retirement payment while retiring at 62 leaves you with only 75 percent.
6. Establish priorities to protect your retirement. Fund your retirement before your child's college education. The most generous gift you could bequeath a son or daughter is not an inheritance but a fully funded retirement.
7. Engage in a lifetime pursuit of financial knowledge. Use the vast online resources of financial information, study the changing global demographics that will determine our world economy, and research the healthcare and technological advances that may radically transform your future.
Most important, a positive attitude will dramatically improve your financial security. Despite recent financial reverses and possible employment disappointments, you own your future. Don't be a spectator in a volatile economy. It is essential to respond to life's challenges with energy, focus, and knowledge.
• Dr. Kathleen Connell is a professor at Haas Graduate Business School, University of California, Berkeley.
