An Inconvenient Truth: Personal Finance Edition

In a recent post I noted how once you are living beneath your current means its more important to increase your income than decrease your expenses while you are on your journey to financial freedom. Really it’s a combination of living beneath your means while also expanding them that I’m going for. In fact. as a somewhat cryptic article by Robert Kiyosaki for Yahoo! Finance states, when you’re purely saving your money you are probably actually losing value even though the price may be going up. Sound crazy? It’s been happening for the last few years.

It’s funny to me to read the comments following his article. I think people find what he’s saying too hard to swallow. After all, it’s far easier to discredit than to adjust behavior, especially when the entire financial planning industry has been telling people that investing for the long term, diversifying and paying down their mortgage is the right thing to do! I think a lot of people missed the point, which is the stock market may look good now but you have to take a bigger picture approach to your personal finance strategies… Especially if you don’t have a lot of time between now and retirement.

Allow me to illustrate Kiyosaki’s point. Let’s assume you are of the young, aggressive saver type. You had some market timing savvy and placed all of your retirement savings in a 401(k) / NASDAQ index fund January 1, 2002 thinking you found the bottom of the dot-com fallout. January 1 2007 shows a pretty nice gain over the past five years. The problem is that the value of your investment actually decreased when compared to gold and other currency markets. Using some figures for the NASDAQ, gold cost / ounce and the Euro, we see the following:

Year	NASDAQ in $	NASDAQ in EURO	NASDAQ  in Gold Ounces
1/1/2002	$1,979.08	2162.65 EUR	~7.00 Ounces
1/1/2007	$2,434.92	1840.29 EUR	~3.93 Ounces

At face value, the price of the NASDAQ has gone up quite a bit over the 5 year period. In a vacuum you may even be quite happy with your investment choices. On a global scale however, you’ve actually lost quite a bit of wealth in the process. Whether we realize it or not, our purchasing power has gone down even with recent increases in asset prices. With easy access to debt, Americans continue to borrow from a bank. As they make purchases their borrowed money gets deposited in another bank. As that money is deposited, it gets lent out 5-10 time’s over, creating new dollars out of nothing and making existing dollars have less value in the process.

America is an import economy. When our dollar buys us less overseas, eventually that comes back to hurt us. Luckily we’re as willing to go into debt as other countries are willing to finance our over-consumption – to the tune of ~$500,000,000,000 in 2006. This easy access to debt has allowed us to create phantom wealth in our homes and borrow against it to continue buying junk that we couldn’t afford on our actual income.

The complexities of why this happens are far to great for this little blog of mine, the implications are much easier. As the devaluation of the dollar continues to ripple through the US economy, people are going to find that the 401(k)’s that are increasing in price continue to lose purchasing power.

Running to “risk-free investment vehicles with historical returns of 10%” may actually prove to be much riskier than my new business venture. If it works the returns are infinite (no time, no money). I’ve printed money for myself. If it doesn’t work, I may have to pay back some debt which I’ll be sure is manageable. The funny thing is that at this rate I can actually make money by borrowing (a dollar 5 years ago is worth 25-50% of what it was today!)

How can you combat all this? That is the $500 billion question. Some may argue that I am comparing apples to oranges, but the real concern is that historically a country with huge amounts of debt has found themselves with a depression or prolonged recession, which is really worse than poor returns. Another argument can be made that we buy goods and services here with our $US so all that matters is that those dollars are increasing.

Starting a business that will work for you in times of noth recession and expansion is one way of keeping up with the devaluation of our currency. Theoretically as your costs rise, so do the prices people will need to pay for those goods. I’ll do great if the economy continues to expand and I’ll do just fine if the economy tanks. This is why I believe my business will give me a better chance at financial freedom than my retirement accounts alone!