Since the financial crisis erupted, consumers have been adapting to a “new normal” in their financial lives. The aftermath of severe financial crises typically results in three negative occurrences that impact consumer finances: deep and prolonged asset market collapses (e.g., housing prices and equity indexes), profound declines in output and employment, and an explosion in government debt as tax revenues decline.
Baby boomers born from 1946 to 1964, and older members of Generation X behind them, are especially adjusting to a financial “new normal.” These are Americans who fully experienced, not only one major asset bubble, but two, during long stretches of their working lives. First there was the extraordinary run of high double-digit annual returns in the U.S. stock market and the “tech bubble” during the late 1990s. This was followed by the “housing bubble” during much of the decade of the 2000s.
The term “new normal” has increasingly been used to describe what is predicted to be an extended period of slow U.S. economic growth, low single-digit annual stock returns, stubbornly high unemployment, increased frequency of consumer savings and debt repayment, and ultimately, when the financial crisis abates, higher inflation. In the “new normal,” frugal living is an important life skill. Two general approaches to expense reduction include reigning in small daily expenses, which author David Bach refers to as “The Latte Factor™,” and trimming large monthly expenses such as mortgage payments (e.g., by refinancing) and outstanding debt balances (e.g., transferring credit card debt to lower-rate credit cards or using debt acceleration Web sites such as www.powerpay.org).
The financial crisis taught investors valuable lessons such as the need to acknowledge their “true” (read: bear market) risk tolerance level and adjust expectations about future investment rates of return downward. The extreme volatility of the stock market during times of uncertainty and the limits of diversification as a short-term defensive strategy against market losses were also exposed. Even target-date mutual funds, which contain several asset classes and adjust their weightings to match the time remaining before a future date (e.g., 2020), suffered deep losses in 2008-2009.
With U.S. stock returns expected to remain in single digits during the “new normal,” new investment strategies may be in order. Strategies to consider include investing more money in stocks that pay steady dividends, purchasing some “alternative” (non-correlated) assets such as mutual funds that invest in precious metals and commodities, and increasing foreign stock investments, including “emerging markets” such as India, China, and Brazil. Investors looking for more certainty and less volatility following the financial crisis might also want to consider annuities as a potential source of lifetime income.
Lessons from the financial crisis include: avoid complex investment products and leveraged investments, be broadly diversified, seek low-cost and tax-efficient investments, rebalance portfolio asset class weightings periodically, and don’t try to time the market. In addition, time-tested investing strategies, such as tax-deferral, dollar-cost averaging, and automated investing are still recommended.
New economic patterns have been evolving in the aftermath of the U.S. financial crisis. GDP growth and household consumption are low, credit is tight, investment asset class returns are miniscule (e.g., cash equivalent asset returns) and/or volatile (e.g., stocks), frugality is “in,” job stability is increasingly scarce, and the threat of inflation looms on the horizon. Americans’ prior level of spending was unsustainable and has been replaced by lifestyles marked by decreased spending and rising savings rates.
The financial crisis and its aftermath have provided an opportunity to revisit basic financial tasks (e.g., budgeting and goal-setting) that are not new but may be of greater interest given recent economic events. The “New Normal” years ahead are a “teachable moment.” Make the most of them by making regular investment deposits and taking other positive actions to improve your personal finances. Your future depends on what you do in the present.
