As we are about to engage in the American tradition of celebrating the labor movement and the prosperity that hard work can bring, it appears we have finally punched through the cloud of financial gloom that followed the great recession, at least when it comes to the state of personal finances.
According to the Q2 2017 AICPA Personal Financial Satisfaction Index (PFSi), Americans are experiencing their highest levels of personal financial satisfaction since the fourth quarter of 2006. The 10-year high was primarily driven by three factors:
- the PFS 750 Market Index maintaining a record-high
- job openings per capita climbing to a record-high, and
- a significant decrease in the inflation measure from the prior quarter.
The PFSi essentially determines the amount of personal financial pleasure Americans are feeling relative to their sense of personal financial pain. Technically, the index is calculated as the Personal Financial Pleasure Index minus the Personal Financial Pain Index. Positive readings indicate financial pleasure outweighs financial pain.
The Q2 PFSi measured 24.1, a 7.6 point increase from the prior quarter. The increase was due to the slight uptick in the Personal Financial Pleasure index (1.4 points) and a substantial 6.2 point decrease in the Personal Financial Pain index.
So how will this burgeoning sense of economic hopefulness impact the way Americans spend or invest their money? And how should CPAs/PFS’s advise their clients to navigate this new sense of buoyancy?
“In conversations with our clients, we’ve been telling them to be aware of the long-term trend. People naturally overweigh the current situation and forget that it is part of a cycle,” said David Stolz, CPA/PFS and member of the AICPA PFS Credential Committee. “Americans shouldn’t let their present situation allow them to drift from their plan of reducing debt and adding to their savings. It’s always wise to save some acorns in the summer, because we know eventually winter is coming.”
Clients might feel as though they can base their retirement income on above average market returns, or that they can buy a second home because their income is not likely to go down because at the moment it doesn’t feel like it will ever go down again, but they need to “beware of that thinking,” Stolz says.
“There is a saying that ‘if you can remember the bad times during the good times, then the next bad times won’t feel so bad’,” Stolz says. “We need to remind ourselves that both the good and the bad times are temporary.”
The Personal Financial Pleasure Index, at 66.0, is up 1.4 points from the previous quarter and has continued its steady increase, setting a record for the third quarter in a row. The PFS 750 Market Index has been the biggest contributor to the Pleasure Index for several years, a trend that continued in Q2.
Compared to the prior quarter, the information technology industry saw the strongest gains followed by consumer discretionary and health care, whereas energy and telecom experienced losses.
Of the four factors that make up the Pleasure Index, Job Openings per Capita Index experienced the largest increase over the previous quarter (5.3 points), reaching a record-high and moving into position as the second most important contributor to the Pleasure index.
The Personal Financial Pain Index, at 41.8, saw all four factors decrease from the previous quarter combining to drop the index 6.2 points which contributed to the overall improvement in the PFSi. The decrease from the preceding quarter was driven largely by a 16.5 point drop in the inflation index, the most volatile factor in the PFSi.
The U.S. economy has continued to show signs of strength as it leaves the great recession behind. The Q2 inflation index, which preceded the Federal Reserve’s June announcement that the target interest rate will rise, has been held down in recent months by a price war in the wireless cell phone industry and falling prescription drug prices.
With the market steadily climbing, advisors should discuss a client's asset allocation in light of their long term goals, says Mark Astrinos, CPA/PFS and member of the American Institute of CPAs PFS Credential Committee.
Many client accounts have recovered since the global financial crisis and it may be prudent to revisit whether or not it makes sense to maintain their current allocation, Astrinos says. One possible example: if a client nearing retirement has substantial equity holdings, but their financial plan indicates that they are already able to achieve their long-term retirement goals with their current asset level.
“This may be an opportune time to reduce the risk of their portfolio,” Astrinos says. “Assuming there are no other bequest goals, why continue to play the game if you've already won?”
Additionally, Astrinos believes, the recent bull market presents an opportunity for advisors to ensure that their client's portfolios are insulated if and when a correction occurs. “This means having a diversified mix of high quality, fixed income holdings that serve as the ballast for the portfolio when the waters get choppy.”
It is also important to remember, Astrinos says, that everyone's appetite for risk tends to increase when markets perform well. “This presents a great opportunity to educate clients on the history of market cycles and the importance of not over estimating your willingness to take risk,” he says.
Additional findings from the 2017 Q2 PFSi include:
- Real Home Equity per Capita is rising (7.1 percent above the prior year level, and 0.9 percent above the previous quarter level, but still 16.5 percent below its 2006 all-time high)
- Loan delinquencies have continued their downward trend.
- Personal taxes, still the leading overall contributor to financial pain for the fourth quarter in a row, showed a 1.2 point decrease from the previous quarter.
At first glance, all these factors may also seem to indicate cause for real optimism for Americans weary of dire economic news, but, Astrinos cautions, the positive trend of these factors could actually pose to be the greatest risk to clients behaviorally.
“Clients may be tempted to do things they normally wouldn't consider or loosen their personal financial standards because of these various signs of a healthy economy. For example, with the rise in home prices, many clients are sitting on substantial equity and may be tempted to tap into their home equity lines of credit to fund expenses that are outside of their means,” Astrinos says. “Advisors should be discussing cash flows with clients and look for signs of excessive spending levels. Additionally, advisors should be reviewing debt obligations for clients to ensure they're not over extended and are structured in the most optimal way from a cost, tax, and risk perspective.”
It's important remind your clients of the vacillating nature of the economy, to provide your clients with the long term perspective, and build a plan that models out various assumptions.
Things that clients can do proactively in light of this positive trend, Astrinos says, include establishing or replenishing emergency reserves for when times aren't as rosy. Additionally, if clients do have extra cash because of tax savings, they should look for opportunities to tax-efficiently fund goals such as education (through 529 plans) or retirement (through employers sponsored plans or IRA's).
Finally, Robert A. Westley, CPA/PFS, and member of the AICPA PFS Credential Committee, says one sobering note consumers should keep in mind is the fact that “the Fed will likely continue to boost interest rates, making it more expensive for banks and ultimately, the consumer to borrow money.”
In advance of future rate hikes, Americans should look to pay down their credit cards and other high-interest bearing debt as much as possible, Westley says because “any future interest rate increase will result in higher monthly payments and therefore less disposable income and less financial satisfaction.”
More information on the PFSi can be found at: www.aicpa.org/PFSi.