Wall Street seems far away for most Americans. Not just geographically, but in terms of how it affects their lives. Although surveys show 55% of Americans own stocks, it only takes simple arithmetic to know that 45% of Americans do not.
However, even for Americans who do not own stocks, Wall Street news can affect their daily lives and, more importantly, their personal finances. Some of these effects are direct. For example, if your retirement account is entirely invested in stocks, a market crash could upend your retirement plans.
Other effects are indirect. For example, your finances are not destroyed if your bank shuts down, but you will incur costs in time, money, and opportunity as you move all your accounts to different financial institutions.
Take, for example, the effects of the stock market on most valuable asset that most Americans will own — their house. Here are ten ways Wall Street finances can affect personal finances, particularly as it relates to your home:
Many people raise money for buying a house and home maintenance, repair, or remodeling by selling stock. For these people, stock market prices have a direct effect on their personal finances. As stock market prices rise and fall, the funds you raise from the sale of stock will rise and fall. And this will directly set the budget you have to buy, maintain, repair, or remodel your home.
There is very little you can do about stock prices. However, you can do a few things to weather a stock market downturn and gain during a stock market upswing:
- Diversify your portfolio. As the old saying goes, do not place all your eggs in one basket. By having many different stocks, and combining those with other investments like bonds and cash, you will be less likely to be ruined by a downturn.
- Do not try to time the market. Rather than making big sales when you think the market has hit a peak and big purchases when you think the market has hit a trough, use dollar cost averaging to make small trades over time. You may not make a killing, but you will have a portfolio built for the long term.
- Do not be afraid to sit on the sidelines. If the market is volatile, there is no shame in holding onto cash or buying other types of assets like commodities or bonds, until the market settles down.
- Do not panic. Panic sellers usually get killed. When the market is going down, consider it an opportunity to get a bargain price on some stocks that you otherwise could not afford.
Borrowing Against Stock
Liquidity is a term that refers to assets that can be spent. Most people feel they need to make a choice between investing and liquidity. But you never see big investors driving old beat up cars and selling their stock for leak repair in their home. What is the secret to investing and staying liquid?
Simply put, they do not sell their stock. They borrow against the value of their stock portfolio. This gives them the best of both worlds. They maintain their stock portfolio while gaining liquidity.
The amazing part of this is that as long as the stock market grows at a higher rate than the loan’s interest rate, the investor makes money on this loan. This allows the investor to leverage the investment portfolio and his or her income to make purchases much greater than he or she would otherwise have the liquidity to afford. This is the reason hedge fund managers have multi-million dollar homes and can still remain invested in the stock market.
During a business downturn, the labor market usually becomes soft. That is, as demand for goods and services dries up, fewer workers are needed to meet that reduced demand. Unfortunately, this usually means layoffs. This is the main way that people who do not own stock are affected by negative Wall Street news. When the stock market goes down, people get laid off.
Unfortunately, this can force homeowners to put off necessary home maintenance like concrete crack repair. Without their paycheck, even necessities may have to wait. This is the time that many laid off workers will need to collect unemployment benefits and dig into savings while looking for another job. As a result, the only way to prepare for layoffs is to save when you can.
As a result of stock market downturns, a tightening labor market, and increased savings, consumers spend less. This is how recessions can become self-fulfilling prophesies. As consumers spend less, the stock market slows down even more, people save even more, and spending goes down even more.
On the plus side, however, a slowing economy often signals lower prices. Because businesses are eager to generate as much work as possible, you may be able to find bargain electricians for any necessary repairs or even remodeling projects.
Availability of Credit
Business confidence also goes down during stock market downturns, but for a different reason. Publicly traded companies rely on stock to raise working capital. That is, as investors buy stock, the value of the company increases and the company has more capital for investment, hiring, and purchases. When the stock price goes down, however, the business has less working capital to spend.
This can have a direct effect on the availability of credit to ordinary consumers. Or, more accurately, it can affect the cost of credit for ordinary consumers. Banks only have so much money to lend. As businesses shift to using credit rather than working capital for its spending, credit becomes more costly for consumers. This means that even if your finances are not directly affected by negative Wall Street news, you may still feel a crunch as it becomes more difficult, and more costly, to obtain credit.
Most ordinary consumers do not have several thousand dollars saved for roof replacement from a commercial roofing contractor. Rather, most people either use home equity loans or credit cards to finance the project. During the early stages of an economic downturn, it may be difficult to obtain loan approvals or loans may be associated with higher interest rates as banks try to manage the risk of loaning money during a down economy.
As risk for banks increases, bank stability decreases. As most people who lived through the Great Recession of 2008 recall, several banks failed or were bailed out as their balance sheets turned negative. Although deposits, for the most part, were protected through deposit insurance programs managed by the U.S. government, bank failures led surviving banks to tighten their practices that nearly strangled the economy.
As previously mentioned, credit became difficult to obtain or very expensive to service. This strangled business spending and made it difficult for the businesses to pull out of the downward spiral.
Imagine, for example, running a plumbing business during a major recession. As your bank’s stability teeters, you still have to run your business and manage its day-to-day finances. However, the bank is aware that homeowners do not hire plumbers during a recession, except for emergency plumbing. Under the circumstances, it may be reluctant to extend a line of business credit to your plumbing business because it fears not being repaid and it is aware that just a few bad decisions could push it over the edge. This one decision could directly affect your plumbing business’s finances by forcing you to forego investing in new tools, training, employees, or facilities.
In 2008, the instability of the banks required a de-leveraging that forced banks to get rid of their worst assets, like risky mortgages. These mortgages went into default and worsened the downturn as people were left homeless on top of being unemployed.
This causes a crash in prices as a glut of foreclosed homes came onto the market. For home buyers, this glut was like a gift from heaven. Cheap homes came onto the market which allowed investors with strong finances to buy and hold homes to be flipped later. Although some of the homes might require some work before being sold after the housing market recovered, some of these deals were such bargains that even an wholesale kitchen remodeling project was possible using the money saved when buying the foreclosed home.
This same strategy can be used now, although on a smaller scale. As homes come onto the market in distressed neighborhoods, they can be purchased at a low price. At the right price, the buyer can invest in a home remodeling project before flipping the remodeled house at a profit.
One fact that makes the business of flipping homes during a down-market is that commodities prices often drop when the stock market drops. The reason for this is logical. As the economy slows down, business and consumer spending drops. The demand for raw materials drops, which causes their prices to drop. This means that wood, steel, copper, and all those other raw material used to make and build things become cheap.
As a result, a down market is sometimes the best time to invest in a major renovation like a whole home remodeling project if your finances allow it. Amazingly, 35% of remodeling jobs involve the whole home. Doing a whole home remodel while commodities prices are low could save several thousand dollars on materials alone. Once you add in the savings on labor due to a soft labor market, and you may realize that the best time for a major remodel is during an economic downturn.
Moreover, working on your home during an economic downturn can increase its value for when the economy recovers. If you are in the market to sell your home, improving it during the down part of the cycle will help you to sell it at a higher price during the up part of the cycle.
The textbook definition of a recession is an economic contraction that lasts at least two fiscal quarters. For the average person, however, this is usually seen as a drop in economic activity including hiring, income, retail sales, and manufacturing. In other words, during a recession, you can see all around you that less money is being spent, fewer products are being made, and fewer jobs can be found.
During an economic recession, you can prepare yourself to come out of the other end in better shape.
- Manage your money so you can pay your bills. If at all possible, do not fall behind on your bills. Your credit score means everything and if you come out of the recession with a good credit score, you will be able to afford major remodeling projects like professional window and door installation.
- Save what you can. As mentioned previously, bargains can be found during a recession for people with cash who do not need to acquire credit. Avoiding frivolous purchases and saving up for a valuable investment, such as home remodeling, will put your money to work for you while everyone else is on the sidelines.
- Pay down your credit card bills. Credit is hard to come by during a recession. If you have extra money, pay down your credit card bills so you are not lining the bank’s pockets with high interest payments. You deserve your money more than your credit card issuer.
- Develop a financial plan. If you still have money left over, you can get into the stock market before it recovers. Financial planners can help you develop a budget and investment plan to improve your personal finances even while everyone else is struggling.
Most people invest in the stock market for the long term through retirement plans like a 401(k) or IRA. While changes in the stock market can cause your portfolio to jump and drop, over a 30 or 40 year period, a well-managed mutual fund or investment portfolio will almost certainly grow.
This means that unless you are managing your own account, you do not really need to follow every headline out of Wall Street. Rather, understand that economic downturns are inevitable over the long term and that the economy always recovers and expands. In other words, recessions are not a reason to pull the handle on your fire alarm system.
Once you have retired, you need to protect your nest egg. You can shift your finances to favor more income generating and interest bearing assets. You may invest in more concrete assets, no pun intended, like real estate. In short, you may come to favor less risky and more stable investments as you come to rely on your retirement accounts for your day-to-day expenses.
Wall Street news can be stomach churning. A stock market correction is defined as a 10% drop in stock values. A typical recession can see a 30% drop in stock values. This means that your $100,000 retirement fund could lose $30,000 in a matter of a few months. However, if you are in the stock market for the long haul, you can not only weather these storms, but come out ahead. This is particularly true if you invest in your greatest asset — your home — during an economic downturn. You will not only find great bargains, but you will also increase the value of your home.