Economics: Your Personal Finance Weather Forecast

Isn’t it interesting that the same people who laugh at science fiction listen to weather forecasts and economists?

~ Kelvin Throop III

Update: This article was included in the Money Hacks Carnival #105 at Live Real Now. Thanks!

Weather forecasters and economists have a lot in common. Both are routinely found in the punch lines of jokes that make fun of their predictive prowess (or lack thereof). How many times have we prepared for storms – meteorological or economic – that were either more or less severe than predicted? Almost every release of economic data is accompanied by some comment that it is either much better or worse than economists had predicted. So what are these folks good for anyway?

I think our expectations may be too high. They may not get the predictions exactly right all the time, but they can be close enough to help us avert catastrophe. The problem, especially with economists, is that they often disagree on what the salient issues should be. Is inflation or deflation a problem? Are interest rates going higher or lower? Where will unemployment levels be next year?

I have often been frustrated trying to figure out how to manage our money according to the prevailing conditions. We receive mixed messages daily. There are even some who dismiss economics as irrelevant to personal finance. What do the bond markets and interest rates have to do with your everyday money management? In my humble opinion, a lot.

With so many different ideas on what’s really going on in the economy, how are we as average investors and consumers supposed to know who’s right? Over the past decade or so that I’ve been following this stuff, I’ve taken the approach that I’ll listen to almost anyone, but I take what everyone has to say with a grain of salt. No one really knows what the future holds, but some have been closer than others in their predictions. I tend to give more weight to what those people have to say. Either way, it’s always good to know about both sides of any debate if you want to avoid nasty surprises.

Economics & Personal Finance are Interdependent

As I’ve previously written, I think that a basic understanding of the economic climate in which we’re operating is essential to your personal financial success. It’s very similar to the concept of momentum in trading. Doctor Stock recently addressed momentum in a great series over at Invest in the Markets that inspired me to write this post. The stock prices of even the very best companies can get clobbered if the overall momentum of the market is to the downside. If you choose to trade against that momentum, you are more likely to lose money. It’s better to wait for the weather to clear.

It’s the same with economics. You can never go wrong following personal finance commandments like spend less than you earn, live debt free, and pay yourself first. But you also need to be aware of the big picture. If you put your head in the sand and ignore gathering storm clouds in the economy, you will either suffocate or get struck by lightning in unflattering places.

This became abundantly clear in 2008 when so many people claimed that the economic crisis came out of nowhere. It didn’t. Many analysts and economists had been warning of the inflating leverage bubble and lax lending standards for years. They were dismissed as a bunch of Chicken Littles. To be fair, the whole thing did blow up a lot later than many (including myself) expected. But if you weren’t expecting it at all, I would think it was a lot more painful.

Always Check the Forecast First

Managing your spending, saving, investing, and debt without any idea about the general economic climate is like embarking on a trip without checking the weather forecast for your travel route and destination. If stormy weather is in the forecast, it may be more or less severe than predicted, but it’s still safer to alter your plans to try to avoid it altogether.

Although none of us can know exactly how the economy will play out, there are times when risks are elevated and it pays to be more careful. I believe that this is one of those times. I’ll elaborate on that a bit more tomorrow with my own economic weather forecast. (It’s to be taken with the same grain of salt as everyone else’s, but I’ll throw in my 2 cents anyway.)

How closely do you monitor the economic climate? Have you ever changed your personal financial decisions as a result of economic factors?