Saving and Debt to Income Ratios

My parents mailed me this Wall Street Journal article back in 2005: Ugly Math: Soaring Housing Costs Are Jeopardizing Retirement Savings.  I found it while cleaning out some old file folders.

It talks about how rising home prices of that time were keeping people from saving as they should while also ratcheting up their debt levels.  We're dealing with other economic problems these days, but the table in the article is still a great wake up call.

So, let's say you are 30 years old and making $50,000 a year.  You should have at least $5000 in savings, preferably in a IRA or other retirement tax shelter.  Meanwhile, your debt (including credit cards, student loans, car, and mortgage) should be no higher than $85,000.




Don't get too depressed; most of your friends aren't there either.  Just think about this when you get your next bonus or other windfall.  Perhaps you should split it between savings and student loans rather than buy a new TV.

The Market is More than Three Numbers

When you hear and read financial news, you likely get reports on the Dow, the S&P 500, and the NASDAQ.  These are indexes that track particular segments of the stock market.

They don't track the whole market, though.  More than 9,000 stocks are traded in the United States stock market.  The Dow Jones Industrial Average is limited to thirty very large companies.  The Standard & Poor's 500 tracks five hundred large cap companies.  The NASDAQ Composite tracks the stocks that trade on the NASDAQ stock exchange, but that only covers about a third of all the stocks and they are often more technology focused.

For a more complete picture, you should also pay attention to other indexes.  Check out the S&P 400 (a mid cap index) and the S&P 600 (a small cap index), for example.  The Russell Investment Group also has a set of indexes, as do other organizations.  Here is a good list of United States indexes.  You'll see on that Wikipedia page that many countries have their own indexes.

Insider Trading and your Elected Officials

Insider trading is a serious issue in our financial markets. It is hard to say how often it happens or how much money is involved, and it comes in many different flavors. The easiest example is that of the corporate executive who buys (sells) her own company's stock before the public release of good (bad) news. She then profits on her early access to information that can affect the stock price.

I heard this piece on Marketplace a while back:
Lawmaker's Inside Advantage to Trading September 17, 2009

This story brings to light a form of insider trading that is currently legal. Congresspeople can make stock trades using information from their private committee meetings. For example, if Barney Frank (Chairman of the House Financial Services Committee) was informed by the Consumer Credit sub-committee that they were going to recommend legislation that would potentially lower MasterCard's profits, he could sell his holdings in MasterCard (or sell short) before this news was publicly released. He, just like the executive in the example above, would profit from his early access to information that can affect the price of a stock.

Louise M. Slaughter (D-NY-28) and Brian Baird (D-WA-3) have introduced legislation that would create rules for congresspeople similar to those that exist already for corporate executives. They call it the STOCK Act, and you can read about it here and here.

Back on the Horse

I've been neglecting the blog for the past nine months, and it's time to attempt to revive it. It's amazing how busy unemployment can be. I've had some friendly encouragement lately, along with some advice from a marketing expert friend about how to post in a sustainable way. So, I'm going to attempt to post more often, but the posts will likely be shorter and involve more use of outside sources to get conversations started.

Today, I'll refocus the mission. I can't remember where I heard the theory about the three types of education needed to succeed, perhaps it was from Rich Dad Poor Dad (which I haven't read) or Why Smart People Make Big Money Mistakes & ... (which I have read and found to be good). Anyway, the general idea is that a person needs three types of knowledge to succeed in life:

• Book Smarts: factual knowledge, an employable skill, literacy, the ability to write a memo and do algebra, etc.
  
• Street Smarts: how to make friends, code switching language style based on audience, how to flirt, etc.
• Finance Smarts: understanding how your markets work, the ability to manage your money and other resources, etc.

Everybody has heard of the first two, but Finance Smarts is new to many. In fact, it seems that a lot of people think that finance and economics shouldn't be understood by all. "Economics is too complicated, leave it to the experts, and it wouldn't help me anyway," is the argument.

You don't need to be intimate with the orange futures market to succeed in life, true. You do need to understand how the prices of goods and services (e.g. gas, milk, housing, education) are set. You do need to know why a bank pays you 1% on your savings account, and charges 6% on your mortgage. You do need to understand what steps to take to successfully retire at age 65 and still have a place to live at age 105. You do need to understand how an investment in education affects you and your society in the long-run.

I hope Grokking Finance will help you learn about these things (and others) and build your Finance Smarts.