Are We in a Bubble?
In her last and most recent economic update as Federal Reserve Chair, Janet Yellen stated that she believes both stock and real estate prices are elevated. Although she stopped short of mentioning the word bubble, most investors can read between the lines and are concerned. With high valuations for stocks and real estate, savings accounts and CD's paying next to nothing in interest, bonds facing potential headwinds due to rising interest rates, and cryptocurrencies showing no signs of stability, what is a person to do?
The answer is really quite simple.
Forget the headlines, and focus on your own financials. Period.
Are you in a bubble? This is the more appropriate question to ask. The reason I say this is because I see a common occurrence play out over and over again: investors become so worried about external economic factors that they overlook -- and often flat out neglect -- their own personal economic factors, even when these factors are in bubble or dangerous territory. Why is this an issue?
The health of your own personal economy is entirely more important than the health of the U.S. or world economies in determining your odds of financial success.
This boils down to the fact that there are things you can control and things you can't, and it makes absolutely no sense to stress over those things you can't control. Also, they don't really matter. Will your retirement be in better shape if you develop a healthy savings rate, or if Apple reports a good quarter? Will your family be better protected if you have an emergency fund in place, or if Congress fails to reach a budget agreement? Will you be worse off if your personal spending is in bubble territory, or if your neighbor's house sold for more than it's likely worth? I think you get the point.
So instead of obsessing over the price-earning ratio of the stock market, the national home pricing index, the Federal Reserve's benchmark interest rate, GDP growth rates, and/or the rates of import tariffs, focus inward for a much better measure of what will truly impact your financial health.
Here are some key personal economic indicators that matter:
NET WORTH = (Total Assets - Total Liabilities)
- What it is: A measure of your financial standing, basically showing how much you (and/or your household) is worth. It's your equivalent to a company balance sheet.
- Why it's important: Your net worth is an important way to track the progress you are making in building wealth. You want to always be on a trending pattern where assets are growing faster than liabilities.
- Measure to target: A positive and growing number
SAVINGS RATE = (Annual Savings / Annual Gross Income)
- What it is: This shows the percentage of your gross income (before-tax) that you are putting away for your long-term financial objectives.
- Why it's important: Your savings rate is the bedrock measure in determining future financial success. There is no investment strategy, rewards program, or retirement plan match that can overcome a lack of savings discipline. A healthy savings rate combined with a solid long-term investment plan will get you through all market cycles in route to future financial success.
- Measure to target: At least 10% (or 0.1), aiming to get this to 20% or more
EMERGENCY FUND RATIO = (Cash / Monthly Living Expenses)
- What it is: This number shows how many months your household could get by should all of your income cease.
- Why it's important: Life has a funny way of throwing a consistent barrage of curve balls at you. An emergency fund will help protect you and your family should those curve balls prove to be monetary in nature. Having this cash cushion in place allows for a significant boost in peace of mind.
- Measure to target: 3-6 (months of liquid savings)
DEBT TO INCOME RATIO = (Monthly Fixed Debt Payments / Monthly Gross Income)
- What it is: A measure of how much you have going out each month (via fixed debt obligations) versus what you have coming in.
- Why it's important: Keeping your debt obligations in check will assist in expanding your savings and net worth. It will also reduce financial stress, and make you much more attractive to lenders should you be looking for that next cash-flowing investment property.
- Measure to target: Less than 40% (or 0.4)
Bonus: Download the Personal Financial Snapshot for an easy way to measure these items. Simply fill in the first tab and everything will calculate for you!
How do you measure up? Are there areas of your own personal economy that might be in bubble or troubling territory and need addressed? Focus on these improvements at the ground level and your financial future will be bright, no matter the actions of any government, firm or politician.