I’ve been reading a lot of reports in the news that consumers are “feeling” richer, and as a result, they are increasing consumption and spending more. What the hell does that mean? What is it like to feel rich, but not actually be rich?
There are supposedly two factors that are making people feel richer. The first is the rise in the stock market. The Dow Jones Industrial Average and the S&P 500 recently broke records by hitting all-time highs. A rapidly increasing stock market always brings money back from the sidelines, drawing in “investors” (read: speculators) who apparently like to sell at lows and buy at highs. But that’s not the point. The point is, how exactly does a rising stock market make you feel richer? Do you have so much money in strong performing investments that you can sell them at any given moment to go live in luxury for the rest of your life?
I’m going to guess the answer is no. Most of us common folk who are actually investing are pouring our hard earned money into tax sheltered retirement accounts that won’t let us withdraw our money until we’re at least 59 1/2 years old. Even if you started investing early in these types of accounts and have an unusually high balance (I’m talking hundreds of thousands or more), withdrawing early and eating the the tax penalty for doing so wouldn’t be worth it.
Remember, if you’re investing using a buy and hold strategy in low cost index funds, increased prices in the stock market only represent paper gains. You don’t make any money until the day you actually need the money, and can sell shares in your holdings to withdraw funds.
The second factor that is making people feel richer is the rise in home prices. Interest rates for mortgages are still low, inventory of existing homes has reduced, and investors are hungry to buy up single family homes. The result is a meteoric rise in real estate, driving power once again, into the hands of sellers. If you don’t have a huge amount of cash and an excellent credit score, expect difficulty shopping for a home in the current environment.
So what does that mean for homeowners who now have some equity? Nothing. Does your new found equity mean that you can now become debt free and completely financially sound? Don’t count on it. That’s right, equity means that you can take more debt that is secured with your property. However you want to spin it, it’s debt and it means that you will continue to slave away working for someone else making them richer and you poorer. Sure, you’ll have some nice stuff or nice renovations to live in – I hope that makes you happy.
On the other hand, rising home prices means your house is worth more right? Your house isn’t worth anything unless you can sell it and someone wants to buy it. Until those two events happen at the same time, your house is only worth what its function is – a place to live. Realize that a home is, and will continue to be a money sink for its lifetime. Not only will you be paying property taxes and insurance (sometimes HOA dues) every year, you will be constantly spending money on repairs and maintenance. If you add in all the interest you pay over the life of a mortgage, how much would you have sell your house for to make a “profit?”
So, what’s the moral of the story? Stop using “mental accounting” to think that you’re richer when you’re not. The behavior of spending more, or taking on more debt, because you feel like you have more money to spend will only lead to trouble the next time the economy takes a dive. Believe me, you’re not richer. If all of a sudden the commotion in the mainstream media is making you feel richer, pay down debt or save more. Saving money is the only way to actually be richer.
Talk to me, Goose.