By Alan J. Davis
Capital Investment Advisers
If 2008 felt like one of the most challenging years that the financial markets have ever had, it’s because it was. The U.S stock market suffered its third worst year in more than a century. Specifically, it was the Dow’s worst year since 1931 the worst year for the Standard & Poor’s 500-stock index since 1937. We saw the failure of banks and financial institutions along with the most costly bailout of a private company in U.S. history. And then, to finally top the year off, we hear of what might be the largest ponzi scheme ever uncovered.
I’m sure most of you have asked yourself, “What caused us to be in this financial mess?” Many in the financial press have stated that new products, such as credit default swaps, collateralized debt obligations and special investment vehicles, were the cause. While they may have been part of the problem, the root cause is on a more basic level. In his year-end letter to shareholders, James Rothenberg, chairman of Capital Research and Management, explains this basic cause as follows:
“I think we got into this mess because the market fundamentally mispriced risk. Too many financial firms and corporations either mismanaged their risks or simply did not understand how much risk they were taking. Too many institutions ended up with too many obligations that they couldn’t meet.”
The reason I share this with you is to remind each of us as individual investors that if we do not adhere to the basics or fundamentals, we too will find ourselves in financial ruins. So going forward, what can each of us do to avoid the financial pitfalls that have trapped so many of us this past year? The answers are simple, it’s the doing that is the hard part. These seven basic tips were given to me years ago from my father:
1. Put savings first
2. Save at least 10% of your income
3. Make it easy to save
4. Make it difficult to withdraw savings
5. Invest your savings wisely
6. Control your spending
7. Control your credit
I do not know where my father got these rules from, nor does he, but when anyone follows these seven simple rules, they can become financially successful. The inverse is also true: anyone who has gotten into financial trouble has failed to follow at least one of these rules. If you are wondering how well we as a country are doing at following these rules, the average personal savings rate in 1984 was over 10%. In 2007 it was only 0.6%. If there is one common message in these seven rules, it is that we need to live within our means. And living within our means requires discipline, which is the hard part.