FINANCIAL FOCUS

The “Wealth Effect”

In this installation of Financial Focus, we will discuss the topic of “The Wealth Effect.” As always, we will provide some education and commentary for the inexperienced and/or uninformed.  

      In Chapter 6 of our publication When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), we discuss trading guidelines, including risk management, timing, profit taking, and age-appropriate investing. It is important for the health of your portfolio, and mind frame, to keep to a system you create for yourself, and use only funds you do not need in the short-term. 

     “The Wealth Effect” is basically the concept of thinking one is richer than they really are. Successful open investments are the main culprit in developing this “feeling” of prosperity, which often results in over-spending and indulgence.  

     It is extremely important to realize that any investment, especially in the equity markets, is ALWAYS vulnerable and can change at any moment. Though it is wise to allow your money to make money, tangible assets are more reliable than fluctuating assets, as their “value” normally changes at a much slower pace. Cash (though it has lost value over time), Real Estate (which changes slowly in cycles), and precious metals/art (a little more vulnerable, but still tangible), are easier to assess at any given time, rather than an always changing instrument like stocks, including 401k’s. 

     The easiest way to get in “trouble” with “The Wealth Effect” is to begin spending and living a life-style according to “paper gains.” Paper gains are not physical gains, and can disappear in a moment, unlike cash or other tangibles, which must be spent or sold to diminish. With stocks, the slightest negative sentiment or connotation can cause a large price decrease in minutes. If one were to buy a brand-new car based on their current “gains” in their portfolio, without liquidating any of those gains, they would be putting themselves in a very precarious position. Securing a loan, or using cash in their savings, does not guarantee any continued gains in their stock holdings. If one were to decide to buy that vehicle, it is much more advisable to sell the stock to provide the capital, as it maintains its “value” at the time. Sure, there would be a reduction in the shares held, and taxes would need to be considered, but it is a much safer practice to avoid potential disaster. 

      The Wealth Effect comes in different shapes and sizes of course, and should be treated accordingly. If an investor holds several pieces of property, with highly positive cash flow, excellent equity, all new mechanical systems and appliances, and a full 6-month maintenance budget savings account, a new vehicle may be affordable based on the likelihood that those assets would not all disappear at once. So long as an increase in property taxes or insurance, loss of tenant(s), or structural damage can be handled financially, the new car may be a nice reward. 

     Unnecessary debt can also become more of a burden in times of higher interest rates, inflation, and increasing regulations. Debt is the number 1 restrictor of wealth in current economic conditions, and it would be much wiser to reduce any debt, avoid additional interest payments, and not use “perceived” gains as a form of money. 

     Always keep in mind, whether planning to retire soon, running a successful small business, expecting to work and invest for the next several decades, and/or enjoying success with current investments, things can change rapidly. Injury, unexpected expenses, change in life status, loss of job/business, and “perceived” wealth are all factors that may not be under your total control. Don’t let The Wealth Effect get you!  

      For additional discussions and education, please continue to visit our BLOG section here on ASTRO-FIN, where we provide periodic updates on a variety of topics. 

***As always, this information is not intended to be financial advice, or any specific buy or sell recommendation, but rather a guide to assist the reader in some further understanding of current economic conditions.