Making The Most Of Your Financial Capital: Financial Advisors' Daily Digest

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By SA For FAs :

The statistics that show large numbers of Americans struggling financially are alarming, but possibly overstate the problem. For example, last year's annual survey conducted by the Federal Reserve on Americans' financial well-being (the new 2018 survey should be out within a matter of days) found that if faced with an unexpected $400 emergency expense, 44 percent of adults either could not pay the expense or would borrow or sell something to do so; that 23 percent of adults did not expect to be able to pay all of their current month's bills in full; and that 25 percent reported skipping medical treatments because of cost.

Why might the problem be overstated? Let's take that first stat - that 44% of Americans could not meet a $400 emergency expense - as an example. Figure 12 in the above-linked Fed survey gets at how Americans would deal with such a concern. Forty-five percent would pay with a credit card and pay off the debt over time. That's not ideal, but it does reveal that these are people with an income, or else a bank would not extend credit. Another 29% would borrow from a friend or family member, indicating that at least these folks have social resources. A third segment, 18%, would "sell something" - again not ideal, but at least they have personal property. A fourth segment, 8%, would use money from a bank loan or line of credit, which suggests that these folks likely own more expensive collateral, such as real estate.

Except for three less fortunate categories of survey respondents - the 27% who wouldn't be able to pay, the 5% who would use a payday loan and the 3% who marked "other" (rob a bank?) - the responses show that Americans have resources - human capital, financial capital and social capital. This only makes sense: 44% of Americans do not appear to be down and out.

But one problem this frequently cited statistic may imply is that the modern consumer goes too far toward "making the most of" his money. The average savings account today has inched up to 0.17%; those who shop around can reach 2%, matching inflation. In such circumstances, many people figure they'd be better off holding zero cash, taking out an equity line of credit, using their home as collateral, thereby getting a mortgage interest tax deduction for interest they pay on any emergency funds used. For others without a home, the solution may be using their credit card (whose interest payments cannot be written off) if an emergency were to occur, hoping to pay it off within the grace period, and so on.

In theory, these strategies seem efficient. The problem, however, is that life is not efficient. In extremis, the optimal retirement strategy is to spend your last dollar on your last day of life. Those who try too hard to achieve this may end up consuming "social" resources - e.g., by moving in with their adult kids - or state resources for the indigent.

Hyper-efficient investment is not just an American phenomenon. Just like folks in the U.S. like to minimize their cash holdings or maximize their current spending opportunities using credit facilities, Chinese consumers have gamed China's credit system by pledging fraudulent collateral - say, a pile of steel that the owner sells behind the bank's back or keeps warehoused but uses the same steel as collateral for loans from 10 different banks. (I've written previously of my disinterest in investing in China; this phenomenon is Exhibit 1.)

And as with liquidity and property, so too with equity: Whether by shorting stocks or seeking 3x leverage on some sector through leveraged ETFs, gaming the stock market to make the most efficient use of your financial capital is not a game ordinary investors are not apt to win.

A finance professor friend once proudly told me he was an "optimizer," but I think "opportunist" might be a more apt term for someone trying to always get the highest possible return for his risk. Life, with all its unexpected changes, does not long provide solace for those trying to remain on the "efficient frontier." Too much risk and you've lost it all; not enough and you cannot attain your goals.

The opportunist, by striving to make maximum use of opportunities, inadvertently ends up foregoing or changing initial goals in favor of what appears more easily attainable. He owns a portfolio of stocks and ETFs that at one time seemed adequate to his needs, then as conditions change (as they always do), he changes his loyalties in accordance with the shifting likelihood of success. This may seem smart at the time, but is apt to crash against the boulder of reality.

A better approach to genuinely optimizing your financial capital would be to let your own individual goals drive your financial planning. Everyone needs a home to live in and a cash reserve for emergencies, and nearly everybody needs some degree of growth in their financial assets to meet long-term objectives. Whether alone or with a financial planner, you can set yourself on a path to meet your life goals without the indignity of not being able to handle a $400 emergency expense or grief of losing most of your net worth in a prolonged financial panic.


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See also Assessing Prospect Capital's Results For Fiscal Q3 2018 (Includes Updated Price Target) on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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