Meaningful Returns

Yesterday was the day the largest US banks found out whether they passed the Federal Reserve’s “Stress Test” under the Dodd-Frank act. If you aren’t already asleep after that sentence, please keep reading.

Other than creating a lot of work for analysts who cover banks and want to know how the stress test results will impact stock prices, etc. (a Barclay’s analyst postponed his 11-year old son’s birthday party for it, so you know, good to know the fam is on board with his job)–other than that, this is just another way the Feds are trying to make sure banks are prepared for a future financial crisis.

But this piece over at Bloomberg (highly recommend) got me thinking about this from a personal finance standpoint. Do you know whether you would pass a financial stress test?

The five basic measures the article brings up are:

1. Readiness. This includes things like having a cash emergency account with at least three months expenses.
2. Flexibility. How much of your income gets eaten up by debt payments each month?
3. Lifestyle. “Stop being such a creep,” the headline says. And of course I agree.
4. Liquidity. That is, loosely, how much of your assets are easily accessible? (i.e., not retirement accounts or home equity). This is similar to number 2 above, but is less about cash flow and more about the nature of your assets as they accumulate. This is where the emergency fund (number 1) comes in, in addition to being able to cover other short term non-emergency expenses.
5. Insurance. The purpose of good insurance is to transfer the risk of large, unexpected (has to be both) losses to the insurance company by paying them a much smaller and certainly recurring premium. At a minimum, get a term life insurance policy, because they meet those criteria and are therefore the cheapest and most effective. Disability insurance is also very important.

The point of all of this is just the same as the point of going to a doctor. Outward appearances, even to ourselves, can be deceiving. Maybe especially to ourselves. So, self diagnose as much as you can, but then look for someone in the secret society of real financial advisors.