The Misery Index Circa 2011

Posted on May 26th, 2011 in Financial Abundance, Newsletter Articles by wayne

Those of us, who were adults in the 1970s, remember a concept called the misery index.  The misery index was easy to compute, being merely the sum of the unemployment rate and the CPI.  This index was so named because it was believed that this combination of government statistics was a good indicator of the US economic health and an especially good indicator of the “misery” that our citizens were experiencing.

The misery index hit an all time high in June of 1980 at 21.98, during the final year of the Carter administration.  After 1980, this index declined until December 1986, when it hit its modern day low of 7.7.  In April 2011, the misery index was 12.16, 4.46 points above its 1986 low, but 9.28 points below the all time high.  The current index is most similar to the index value in 1990 – 1991.

These comparisons beg the question: “If the misery index is relatively low, why does our current economic malaise feel more like the late 1970s than the early 1990s?”

One answer may be that high unemployment produces more “misery” than high inflation.  In the March 2001 American Economic Review, a research report presented data, compiled through interviews of both Americans and Europeans, concluding that:  “people would trade off a 1-percentage-point increase in the unemployment rate for a 1.7-percentage-point increase in the inflation rate.”

Another explanation can be found in the manner that the government has changed its measurement of CPI since the early 1980s.  Let’s look at these changes, and how they have modified the measurement of CPI over the past 30 years.

In 1983, CPI was changed to use homeowner’s equivalent rent instead of housing prices.  This change was made because it was felt that home prices combined both the “consumption” of a place to live with an investment component, whereas the rental equivalent ignored the investment component.

In 1998, the CPI was adjusted to allow for the lowering of prices due to product quality enhancements.  Thus, when a bigger TV came to market, its price was adjusted, using an estimate of what an older TV would have cost if it were that size. Approximately 1/3 of the CPIs basket of goods was affected by this change.

In 1999, the CPI was again adjusted to allow for product substitution.  This adjustment assumed that if the price of sirloin steak increased, the consumer would buy flank steak instead.

All three of these changes served to lower the amount shown as the annual CPI increase.   The changes also helped lower annual adjustments to the government sponsored entitlement payments whose increases were linked to the CPI.  In June, 2010, the Deutsche Bank Group published a paper that estimated that the changes to the CPI made after 1990 had effectively lowered the CPI by 3.25%.  The combined changes, made since 1980, were estimated to have lowered the CPI by an astounding 7.35%.

If the Deutsche Bank estimates are accurate, current CPI (as measured before 1983) is actually 10.51%.  Adding this to our current unemployment rate of 9.0%, one could make the argument that our “true” misery index, in comparison to the June 1980 high, is actually 19.51%, the highest it has been since December 1980.

Whether the “misery index” truly measures how well (or poorly) our economy is performing is a question I will leave for economists and politicians.  From my perspective, the current economic malaise feels more like the late 1970s than the early 1990s.  Perhaps the changes in the manner in which we measure the CPI component of this index may help explain this apparent disconnect.

On Memorial Day Celebrate Abundance

Posted on May 26th, 2011 in Financial Abundance, Newsletter Articles by wayne

Memorial Day is a time when we thank those members of our armed services, both present and past, for their service to our country and remember those who gave the ultimate gifts of their own lives in our country’s service.  As I picked up my paper this morning, I could not help but feel blessed with the abundance that we share as Americans.

When I founded Financial Abundance, LLC,  I wanted to help my clients learn to approach their financial lives from a sense of abundance instead of from a fear of scarcity.  In spite of all of the financial turmoil and the current atmosphere of destructive political dialogue, on this Memorial Day weekend, it is important to remember how truly blessed we are.

To maintain our sense of abundance, let’s look at some ways that we can help maintain and increase our financial abundance:

1) Pay yourself first.  The first of my seven steps toward financial abundance is to spend less than you earn.  The easiest way to accomplish this is to “pay yourself first.” Before spending your earnings on anything else, you should “pay” a portion of your income into a retirement or savings account.  This savings provides a cushion to protect you in case of a financial emergency and will ultimately help provide for a more financially abundant retirement.

2) Buy what you need and delay what you want. It is often very hard to differentiate our needs from our desires. If you are considering purchasing something that you want but don’t necessarily need, delay the purchase for a week and see if the urge to have it passes.  I have found that many things that I thought that I required, often become unimportant soon thereafter.

3) Invest for after tax returns. Often, investments that appear to have excellent returns, will leave you with a very high tax bill and a lower than anticipated after tax return.  If you are considering an investment using taxable funds (as opposed to tax deferred funds), determine the after tax return of each investment.  To provide a comparable after tax return, investments providing ordinary income will often need to have over twice the returns of investments taxed at long term capital gains rates.

4) Keep a well diversified investment portfolio. Many investors believe that if they have 20 different mutual funds, they are well diversified.  In most cases, the investor would have better returns and be just as diversified with the Russell 3000 stock index ETF.   Whether you manage your own portfolio or have an investment advisor, remember that diversification comes not from the number of funds that you own but from the diversity of investments that the funds represent.

5) Begin Social Security Payments when they will provide the most benefit. As baby boomers reach age 62, many retired boomers believe that they should begin taking Social Security payments.  Most people in good health will receive more in lifetime Social Security benefits if they wait until at least their full retirement age (FRA) to begin their benefits.  If you are not sure when to begin your benefits, consult a knowledgeable financial advisor to help you make this important decision.

6) Have at least $1 Million in “Umbrella” liability insurance. Most homeowner’s and auto liability insurance policies may not fully protect you if you are responsible for a serious accident or injury.  For approximately $200 per year, you can add $1Million in umbrella liability coverage to these policies.  While you will likely never need this insurance, if you do, it will be the best $200 you have ever spent.

The only guarantee that we have in life is that it will someday end.  Between now and then, we can choose whether to live in a constant fear of financial scarcity or from a sense of financial abundance.  I urge you to use whatever ideas will be helpful in finding your path to a more prosperous financial future.

Happy Memorial Day!