Why your clients should base their investment decisions on the stock market.
September 20, 2007
by Neal Frankle, CFP
I told my neighbor not to do it, but he wouldn’t listen and now he’s singing the sub-prime mortgage blues.
You see, last year Jim bought a bigger, more beautiful house. He did this before selling his current home (next to me) and for the life of me, I never understood why he did it (I don’t think I’m that bad of a neighbor). Even though Jim was never a sub-prime borrower, he is now caught up in the housing mess. He now has two mortgages, a house he can’t sell and a budget that is hemorrhaging cash.
Of course your clients would have to be living on the moon to be unaware of the current turmoil in the housing market. But they may not be clear on how this current economic predicament may impact their financial situation.
First, let’s go over what is happening.
As you know, for the last several years, many people bought homes they really could not afford. This happened during a perfect storm of low interest rates and rising property values. Many folks were offered adjustable rate loans with extremely low interest rates. At the low starter rate, people could make the payments fairly painlessly, but when these rates adjusted up, those payments become a lot more painful. Some of these people stopped making their payments to the institutions that held the mortgages. Keep in mind that the company that created the loan really didn’t loan their own money. No ... Most of the mortgage companies make the loans and then sell them to investors on Wall Street. Experts have asserted that some of these mortgage companies did whatever they could to make these loans — even to people who could not afford them — because of the fat fees they earned when the loan was made.
Ultimately, the investors who bought the loans found that many had no value. As a result, these investors stopped making “risky” loans. Once bitten, twice shy.
Here is where my neighbor Jim’s problem gets worse; a whole lot worse.
Again, you know that loans are either conforming (under $417,000 in most states) or non-conforming (loans above $417,000). Conforming loans can be guaranteed by government-backed agencies such as Freddie Mac and Fannie Mae. Because investors are extremely gun shy at the moment, they only want to make conforming loans — and even then they are not too happy about it. As a result, it’s very difficult for borrowers to get loans above $417,000. And forget about high-risk borrowers getting even the time of day. So, as a result, fewer real estate buyers can get the financing they need to buy. To make matters worse, foreclosures are flooding many markets. According to RealtyTrac, July foreclosures were up 93 percent from a year ago.
When we add this up, we see a situation where more homes are available to purchase than there are buyers to buy the homes. Usually, the result of such circumstances is a reduction in home prices. But it doesn’t stop there.
In your communities, you are now seeing people who once made a nice living working in the real estate market now losing their jobs. People who once made loans have no loans to make. People who once built houses find few people who can obtain the financing to buy the homes.
Hmm … lower home prices and lower employment … who does that impact? Just about everybody you know. Cities, counties and school districts will have lower revenue. Business owners will experience the same phenomenon.
When business suffers, that can impact employment and (of course) the stock market.
Having said all this, what can your clients expect and what should they do?
First, under the “DUH” department, I think it would be reasonable to expect lower interest rates and a soft real estate market. If your clients are relocating, make sure they sell their existing home now but consider renting for awhile rather than rushing into a new home purchase. I think that time is on the buyer’s side at this point. In a year, home prices and interest rates could be lower.
Expect unemployment to rise. What this means is that if your client has a job — have them keep it! Tell them to cut out the Internet browsing at work and be nice to their boss. If they lose their current job, it may not be so easy to find the next one.
If they are investors, suggest that they pay extra careful attention to the stock market. I’m absolutely certain that the stock market will survive this turmoil but it’s impossible to know how or when this situation will rectify itself.
The stock market has survived everything that has been thrown at it. Pearl Harbor, hi-tech bubble burst, presidential assassinations, wars, Watergate, depressions, 9/11, the Asian market crisis, savings and loan scandals, etc.
But don’t let them become complacent. Remember, the NASDAQ is still about 50 percent below the level it was at seven years ago. As your clients get older, they become less and less able to sustain catastrophic losses.
Yes, it’s important for investors to watch the market. Allow the market to tell them what to do. Don’t assume that the stock market will continue to be terrible because of the current situation. Nobody would have imagined in March of 2003 that the market was about to take off. After all, the United States was about ready to invade Iraq, the stock market had been terrible for the prior three years, and the news was full of accounting fraud and scandals. But against all logic, 2003 was a banner year for stock market investors. The situation may be unsettling now but don’t allow that to blind your clients from what the market tells them.
Make sure that your clients base their investment decisions on the market. Watch for market strength or weakness by watching stock market leaders and the major indexes. Only invest when the market tells you it has weathered this storm. For more information, contact me below. I’ll be happy to e-mail you my free white paper about ways that your clients can protect themselves from catastrophic losses in the stock market.
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Neal Frankle is the author of Why Smart People Lose a Fortune: 5 Steps to Restoring Your Wealth and Sanity. He helps affluent clients establish and implement a safety-net strategy to protect their wealth. He also helps other professionals, such as CPAs, to do the same thing for their clients. Contact Neal to get a free copy of his white paper on how to take the market's temperature and avoid catastrophic losses.