A Clarification Worth Noting

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Ok, something came to my attention today and I think it merits a blog post. If you already know this, I apologize for boring you.

• Deposit-taking institutions are where you SAVE

• Technically, you INVEST with licensed securities dealers or in a business. Although the term "invest" is used with "alternative investments" and Ponzi schemes, they are completely different from licensed and regulated forms of investments.
  

• Deposit-taking institutions and licensed securities dealers are not the same. If you are unclear about what category a certain entity is, ask them or ask someone you trust

• Deposit-taking institutions have JDIC or FDIC insured deposits. What does that mean? That means that the institutions have paid a premium to the Government to insure your deposits. Deposit Insurance was introduced as a safety net measure - should the institution that has your deposits get into difficulties, the Government will ensure that you get back your deposit up to a certain limit. The FDIC has a limit of US$100,000 per depositor which was temporarily increased until December 31, 2009 to US$250,000 per depositor. The JDIC has a limit of J$600,000.
  

• Investments are risky and have no safety net. Some investments are riskier than others. Higher interest rates generally reflect higher risk premiums. Interest rates are determined by the base rate (determined by the Central Bank) plus a spread. If you notice, deposit-taking institutions have lower rates than all other "investment" entities - licensed or otherwise.

• Licensed securities dealers are licensed and regulated by the Government. That is why they are specifically called "licensed securities dealers"

• Licensed securities dealers do not offer insurance on your investments. Deposit insurance is for deposits in deposit-taking institutions. There are reasons why these terms are used.

• Investments in Government paper - any Government - are not equivalent to deposit insurance. Whether you make those investments through a money market fund, or buy Government paper directly, the fact is that investments operate differently from insurance. I have heard that people are of the view that since the Government has never defaulted - like Jamaica and the US - then that is the same as insurance. And therefore, the argument is that investments in Government paper is the same as saving. That is not true. Some could argue that Government paper is "as safe as saving", but it is technically not saving. Investments are not insured; savings are insured up to a limit. Deposit insurance exists for a certain purpose, and that purpose is specifically to provide a safety net for savings.
  

• Therefore, I urge you to think about your asset allocations. Save FIRST. Maximize the insured portion, even if you are not getting the high interest rates some other institutions are offering. Make sure you distinguish between deposit-taking and licensed securities dealers. When you have sufficient savings (insured), then think about how much you wish to invest, and what your risk/reward tolerance is.
  

Welcome To The Adjustment Club

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Many of us are used to a certain lifestyle. Quite frankly, we balk at the idea of certain products, services or even a change in the way we used to do things.

Generally, if one moves from limited resources to what some believe to be "unlimited" resources (although there is no such thing), it's so easy to adjust one's lifestyle from the "limited" to the "unlimited". Yet for some, it's not just hard, it's downright painful to adjust the other way - from what some thought was "unlimited" to moderation or budgeting.

Well, the world has changed. "Unlimited" does not exist. And "limited" is where it is at. So let me introduce you to the "Adjustment Club". Here's how it works.

First, all the people in the world are members. No one singled you out. The world underwent a radical shift. Like an earthquake, we are still feeling the aftershocks. Like a hurricane, some countries still continue to be hit, while others (like Jamaica) are feeling the outer bands hoping to be spared a direct hit. You get the picture. So we are all in this "Adjustment Club"

Second, we are all adjusting to the same relative place. That place is survival in the short term, and sustainability in the long term. As long as the markets remain volatile, and until the various global stimulus plans kick in all over the world to get the global economy growing again, all of us are living in a heightened state of uncertainty that was imposed on the majority of us. So, we are all heading to the same level of adjustment - survival in the short term, sustainability in the long term

Third, the amount of adjustment does depend on your particular circumstances. So, if you are super conservative like I am, I have relatively little adjustment to do. If you have always been seized with the importance of money management, then you have little adjustment to do. If you have always budgeted, and are fairly committed to your budget, then you have very little adjustments to do. However, if you are more of a risk taker, was never interested in money management, or have a generous budget for your expenses etc., you have more of an adjustment to do because you have to accept that all these factors are critical for the short term and the long term, and then you have to learn how to do them, and then you have to be committed to doing them. If money management and conservatism is not your thing, or does not come naturally to you, please remember that we are all in this adjustment club. It's just something we all must do.

Fourth, you can ease the pain of adjustment and speed up the time it takes to adjust. We know what the external environment is like, and how quickly things are changing. We know nothing is certain but uncertainty. To waste time being upset and frustrated about things you have no control over robs you of precious time to do more productive things to ease your adjustment.

A few adjustment basics:

• Priority 1: Develop a sizable Emergency Savings Fund (not with an Investment Product)

• Quickly develop a budget if you don't have one, and adjust your budget if you do have one. Be realistic - so reduce inflows and increase expenses for budgetary purposes. Don't forget contingencies. If budgeting is difficult for you, seek help if you need to.

• Commit to managing and reducing your expenses. What can you do with less of? What can you give up all together? All members of the Adjustment Club are sacrificing something. Some members are sacrificing much more than others. What are you willing to sacrifice?

• Avoid taking on debt if you can, manage what you have. If you can, pay down the higher interest rate debt first. But don't eliminate your savings or your retirement funds to pay down debt.
  

• Ensure you are as productive at work as you possibly can be. That way you are more likely to be viewed as a valuable member of the team which is likely to make management think twice if and when redundancies happen

• If you are made redundant, or volunteer for redundancies (like some programs offered by some companies), do not squander your redundancy payment. You do not know when you will have a steady flow of income again, and monthly obligations don't go on a holiday because you are unemployed. Take your redundancy payment and place it is a solid, conservative deposit-taking licensed JDIC insured (FDIC insured if you are in the US) financial institution - i.e. in a savings account not investment - until you find the best method to allocate it. It not not prudent to use all your redundancy for any investment - whether an investment product or a business. If you are being sold a financial product, and you are not sure if it is an investment, ask for clarification and get a second opinion. The absolute worst time to speculate or take risks is with your redundancy payment.
  

• Look for alternative means of supplementing your income - as long as it doesn't interfere with your full time job, conflict with your full time job, and importantly is not prohibited by your full time job. So perhaps you can tutor students, sell your amazing digital photographs, start a blog and monetize it etc. Your options depends on what talents, interests and skills you have.
  

Those are just a few ideas about the basics.

This is no time for any of us in the Adjustment Club to bury our heads in the sand.

It is time to make this adjustment as painless as possible. We didn't ask to be in the Adjustment Club, but here it is and it is not going away. So let's make the best of it.

There was a world before all the excess. It's not like we are adjusting to a completely different reality.

Likewise, there was a world of depression and war, and then war again. So it could be worse. Let's not help it get there. Like good club members, each of us needs to do our own adjustment, and help our fellow club members in theirs.

Guess What Americans Are Doing? Saving More!

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Today's news was interesting. In the last few months, there has been a steady increase in savings rate in the US. At one point in recent years, it had been negative. See an article here in the New York Times: Consumers Increase Savings While Spending Less

So, I'm thinking this is great news!

After the recent financial crisis and given the ongoing uncertainty, people are making sure that they are more conservative with their money, doing the absolute basic minimum of personal finance which is making sure that they have adequate savings, and really making substantial steps to get themselves back on their feet.

However, some economists argue that when people save "too much", the economy takes long to recover because businesses need the revenue to employ people etc. OK, I see the point. But, consider this:

There is nothing wrong with saving. Saving is the absolute basic minimum of personal finance. You don't have to invest (which is to take on risk with the hope or expectation of a return). You don't have to borrow (which is to take on debt). But you do have to have money to spend for the basic necessities of life and that comes from earning and saving.

If you want to get higher returns than what you can get from savings, and are willing to take the risk of losing all your money, then you invest.

Saving is not investing. I repeat, saving is not investing.

Saving is what you do when you place a deposit with a regulated financial institution at a stated interest rate applicable to that deposit and that deposit is insured up to a limit by a Government agency (such as the FDIC in the US and the JDIC in Jamaica)

If you want to buy things that cost more than your income, then you borrow and pay a premium for that money not being yours. That is what debt is - other people's money and you are using it. If you can wait, it is better to save for an item than go into debt to buy it. Why? Because debt costs money. That money is called interest and that debt interest will in most cases - unless it is concessionary debt - exceed your after tax interest on savings dollar for dollar. So after all your time spent saving, you would be effectively losing some of that interest every time you use any form of credit.

Now, back to this debate between savings and economic recovery.

Now, as I understand it, in the US people lost the ability to access credit - many of them through no fault of their own. If you don't have your own money - which is savings - and you don't have credit - either because of the banking crisis, the new lending standards of the bank, the credit rating system, or because you owe too much money - then what are you going to use to consume? You need savings.

Massive borrowing fueled unsustainable levels of consumption. Would some economists prefer that the economy "recover" by people borrowing which they might not be able to do anyway? Would some economists prefer that other people - who are fearing job losses - use up their savings to consume? Because when those savings are depleted, people will have no money to consume, and will have no savings and possibly employment income to qualify for credit to then consume. At some point, the economy will run out of people who have money to consume.

Why, in this time of record job losses, and market uncertainty should people not save more? Now, I love consumption as much as the next person but I have zero interest in unsustainable consumption. Unsustainable consumption, unsustainable debt with limited, zero or negative saving is how we ended up in this global mess.

No matter how you look at it, consumption gets a hit.

In order for an economy to be sustainable, there has to be a balance between consumption and saving.

We cannot continue to live in an interconnected global economy with such great information asymmetry - where so many people do not understand the basics of personal finance:

• that savings are absolutely mandatory;
  
• that savings are NOT investments;
  
• that you have to evaluate investments not just based on hot tips or recommendations but based on your individual risk profile, needs and age in life;
  
• that debt eats away at your hard earned interest and needs to be managed
• that you should only take on debt in accordance with your realistic ability to repay, and fully cognizant of the true cost of debt
  
• that expenses (and hence consumption) must be managed so that they can be paid from earnings without depleting savings, savings goals and ability to save. Remember the "Pay Yourself First" principle, you must save before you do anything else!
  

I could go on.

In order for anyone to prosper, as we have seen, everybody needs to be at a basic minimum level and it is up to education reform, advocacy, and helping each other that this financial literacy will be achieved. It has to start from a very young age.

If you spend money, you must know how to have money to spend - that is, to save.

It is said that those who weathered the Great Depression were the conservative spenders and the aggressive savers. Although we are not in a Depression, we would sure like to avoid one. The only thing we are certain of is that we are living with uncertainty. And if you don't know if and how much money you are likely to earn in the immediate near future, isn't it prudent to adopt some conservative spending and aggressive saving habits?