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Thursday, 14 February 2008

A Down Market Has Its Upsides for Young People

by Anya Kamenetz

Sometimes what seems like bad news can be turned into good.

All the recent talk about the faltering economy certainly seems to fall into the bad-news category. Housing prices had the biggest decline ever, the U.S. and international stock markets had some very dark days, 17,000 U.S. jobs unexpectedly "disappeared," and many experts feel that we're heading into a recession.

But there's reason for young people to look on the bright side. In fact, beginning your financial life during an economic correction or downturn can be a preferable thing in many ways. Here are a few of the positives:

1.) We won't expect to get rich quick.

Economic dramas shape an entire generation's beliefs about the nature of the economy and the risks involved. Just ask your grandmother, who experienced the Depression and is probably still saving rubber bands.

If you're in your 20s or early 30s, your living memory consists of a nearly unprecedented runup in stock market values -- the tech bubble of the 1990s. Bubbles by definition get people excited about making lots of money, fast. Thanks to the Internet, millions of people were able for the first time to pick, follow, and trade stocks for themselves. Unfortunately, the common outcome could be summed up by the title of film critic David Denby's book: "American Sucker." An affluent, well-connected New Yorker with ties to top stock analysts, Denby lost over one million dollars gambling on tech stocks.

Investors like Denby, who try to get rich quick by picking individual stocks, exemplify what is known in the investment world as "dumb money."

It's nearly impossible for you and me to beat the market consistently. And commissions, as well as trading and research costs, tend to eat up your returns if you try. It's a great lesson to learn by example -- not by experience.

You can also learn some lessons from the downturn of the housing market. In the past decade, it became much more common for first-time homebuyers to borrow big and hope to flip within a few years for huge appreciation -- 50 percent and up. But if you buy a house these days, you'd better love that city and that neighborhood, not buy more than you can afford, and be prepared to hold onto it for a long, long time.

2.) We'll get real about consumption.

Think about this: Consumer spending increased every year for the past 16 years. That's the longest buying binge Americans have ever gone on.

This spending increase was largely fueled by the runup in house prices, which allowed home-owning Americans to borrow against the cost of their homes. Consumer credit also expanded markedly over the past decade and a half.

For those of us in our 20s, this may mean that our parents borrowed against their home to send us to college or to pay for vacations or other luxuries while we were growing up. It also means that credit cards have always been there to fill the gap when we wanted a pair of shoes or a restaurant meal. Young people have been spending 16 percent more than they earn in recent years -- not a sustainable situation.

Well, now the credit market is tightening. As long as house prices are falling, not rising, home-equity loans will be harder to get. And in the general atmosphere of a recession, out-of-control spending tends to slow down as everybody tightens their belts. For example, this past holiday shopping season was the weakest in five years.

But did it really hurt your celebration with friends and family if the presents were a little less lavish?

3.) We'll buy on the cheap.

The current scary economic environment should not cause you to stuff your money under a mattress. The stock market may not be the best way to make a fast buck, but it is still the best long-term investment for your money; market returns average 7 percent to 10 percent over the long term (although your mileage may vary based on investment costs.)

And the "long term" means decades, not a few years.

Even with the recession in 2001-02, stock prices never really corrected to historical norms, which means they may still have a ways to fall. According to David Leonhardt of "The New York Times," the stock market is currently "overvalued" by 10 percent, relative to historical norms. And in a recession, the market sometimes plunges more than it should because of the mood of the investors, rather than because of underlying economic indicators.

That's bad news for people who are retiring now or in the near future. Your grandfather might have had a million dollars if he cashed out last year, and only $800,000 today. But it's good news for the average 25-year-old. You have most of your stock-buying ahead of you. You'll ideally be putting 10 percent to 15 percent of your salary each year into a retirement savings account that's invested in stocks. If stock prices go from "overvalued" to "undervalued", you're essentially buying in at a discount -- and you have plenty of time to see your investments appreciate.

As for the housing market, some are predicting prices will sink 25 percent to 30 percent in the next few years. At best, prices could remain flat while they catch up with rents. (Before the bubble, the monthly costs to rent a home were roughly comparable with the monthly costs to carry a mortgage. These days, in New York City at least, the same apartment that rents for $2,500 may sell for $650,000 -- $3,800 a month after a 10 percent down payment.)

So my advice (which I'm following myself) to would-be homebuyers is to watch and wait and keep your eye out for a bargain. Make a lowball offer and, again, you'll leave plenty of room for appreciation.

The next few years are going to be a real economic education for us all. In my next column, I'll talk about the two cardinal rules for the cautious slowdown investor: hold down costs and diversify.

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