Prosperity Depends on
The Most Dismal Part of the Dismal Science
Henry K. Hebeler
The most dreaded part of our economic life is developing and following a budget. It doesnít matter whether you are a member of the presidentís administration, congress, an employer, or working with household finances. The budget is king and leads to eventual success or failure. Industry can play games hoping that cash outflows in excess of cash income will ultimately lead to more growth. Government also plays budget games consistent with politically oriented policies not only with regard to current deficits but also with promises of future social payments that may far exceed tax revenues in periods beyond current politiciansí terms in office.
Economics is often called the dismal science. It has many facets such as microeconomics and macroeconomics that attract brilliant people who get Nobel prizes for their work. Alan Greenspan rightly gets credit for helping us maintain some economic stability even though we are living in a time of record debts at every level: international trade deficits, national debt, state debt, industrial debt, and personal debt with each facet of personal debt at its own record from credit cards to home mortgages. Security firms tout their economic forecasts, largely biased towards selling their most profitable products. Financial magazines attract buyers with covers that flash choices of securities or tax reduction methods that they believe will do better in the economic future they foresee.
While the Nobel economics prize winners may be at the forefront of the more exciting part of economics, the common household budget is at exactly the opposite pole. It is truly the most dismal part of the dismal science. It doesnít matter whether you opt to use programs like Quicken, Money, or analyzenow.com to develop and track your budget or whether you hand tabulate last yearís expenses and try to determine the actions for next year, the job is ugly. It takes records, time, and a willingness to sacrifice certain expenses and limit life styles so as to increase savings and/or reduce debt. Aggregating expenses in gross categories may make this easier. These categories might be income taxes, savings, debt payments, insurance, utilities, essential living expenses and discretionary expenses. Ideally, young people should budget more than 10% of their gross income to savings, and older people nearing retirement might save two or three times that, but people need a customized financial projection to achieve personal goals.
Those who can use automatic savings programs sponsored by their employers have a distinct advantage for many reasons. First, these programs take the money out of their hands so that it canít be spent frivolously. Next, these programs require some kind of informed decision how to invest the money for its future growth. Such regular savings benefit from dollar-cost-averaging, a phenomenon that gives higher long-term returns from buying more shares when the market is down and less when it is up. And, finally, such programs often benefit from some employer matching funds which effectively provide a return on investment that make any speculator envious.
Unfortunately, not all employed people have easy access to automatic savings programs, and even those who do usually do not put away enough money to build adequate funds for retirement. This means that the vast majority of people have to save more on their own, and that requires a budget for the amount that needs to be saved--hopefully from each paycheck to gain the benefits of dollar-cost-averaging. Inevitably, this means reducing spending in other areas, which unfortunately is very hard to do for the vast majority of people in this consumer driven economy where people just have to own the latest in technical gadgets or keep pace with their neighbors. The national savings rate is nearly zero after two decades of declines from historical savings rates of about nine to ten percent of after-tax income.
Some dismal scientists say that the national savings rate is not a good measure of savings. Thatís because they say it does not include the great increase in wealth from capital appreciation. They said this during the bull market of the late nineties when portfolios grew without new savings deposits, but they became very quiet when the market plummeted thereafter. Now they are repeating themselves but using home appreciation as the reason. At least the stock market would have been a source of cash. A home is quite another matter for the majority of people who already consider that they donít want to sell their homes and rent an apartment or otherwise further increase their mortgage load to get cash from their home. And, what happens when this housing bubble bursts? This brand of dismal scientist will again crawl into the woodwork.
Retired people have to rely even more heavily on a tight budget. It is not possible to recover from a year of overspending when you canít or wonít go back to work. Unfortunately we too often see the effects of spending too much too early in retirement. The national statistics show that people in retirement continue to spend less as they get older. Some dismal scientists believe thatís because retirees decide that they have less need of money as they get older. Baloney! I spend lots of time with retired people, and most of them would spend more if they had more to spend. If they had fully satisfied their own needs, theyíd give more to their children or grand children or charities. Perhaps this brand of dismal scientist is trying to justify past recommendations for retiree spending that have taken too large a toll on retireeís nest eggs in recent years.
So face it folks! Whether you are employed or retired, youíve got to budget carefully. Workers have to budget to get adequate savings for retirement. Retirees have to budget to make sure that they donít overspend early in retirement. Both workers and retirees have to decide what they need for the future, develop a detailed budget, and then hunker down and get into a line item by line item analysis of what they have to do to achieve their long-term objectives.
Budgeting doesnít end with development of a good plan. It has to include controls and measurements. These donít have to track every individual purchase, but there has to be a way to catch all things in some measurable categories. In months when there isnít enough for savings, itís time to get back to the details again and take some action to improve budget performance.
This is the essence of financial success. Set goals, then budget, then measure performance and take corrective actions. Of course the other element the financial success is wise investing, but, without savings, itís completely academic how you would invest. And those who have saved too little, even with good investment choices, will certainly see a dismal retirement future as any dismal scientist must confess. Except for the very lucky, most of us will succeed by adhering to a budget consistent with an annual financial projection that fulfills our image of the future.