Friday, October 31, 2008

How Did We Get Into this Mess?

In the spirit of the political season, I'm going to get up on my soapbox today and do a bit of lecturing. There has been an awful lot of finger pointing, rationalizing, and denial going around lately with regard to all of the economic turbulence we are experiencing. Even many experts seem genuinely at a loss to explain exactly what went wrong and how we have come to this. Lots of musicians and other ordinary folks are feeling like helpless victims of those who "control the system".

Well, this may not be a popular thing to say, but I personally feel that we all bear responsibility, collectively and individually, for the financial condition we find ourselves in at any given time. Most people reading this blog are living in capitalist democracies, with a great deal of freedom to engage in free enterprise as they please. But with such freedom comes the responsibility to educate oneself and stay informed on financial matters. If you don't basically understand how a capitalist economy works, how can you expect the system to work to your advantage?

The good news is that anybody with a junior high school education can easily learn the essential principles of responsible personal finance. It's really not as complicated as most people think. Yes, professional investors do use fancy statistical analysis tools to evaluate markets and investments, but the average investor can generally get by pretty well using just basic arithmetic. I've long felt that a basic personal finance course should be a required part of every high school curriculum. I have no idea why this is considered a taboo subject for public education, and I'm convinced that with such training, the average citizen would wind up in far better financial shape. And if each of us individually kept our financial house in order, the overall economy would function a lot better.

I'm also convinced that if ordinary citizens had a better grasp of responsible money management, we would be more likely to hold our elected leaders accountable to maintaining responsible government budgets, instead of the rampant deficit spending we currently see in governments around the world. Let's face it folks, we've been resistant to learning about money for too long, and that ignorance is now coming home to roost. Things will only get better when we all start getting smarter about personal finance.

Friday, October 24, 2008

Inflation: the Savings Killer

What a time to be writing a personal finance blog! I can't recall a time when there have been so few attractive investment options. As virtually everybody has heard by now, traditional investment vehicles such as stocks, bonds, real estate and commodities are all in very bad shape lately. Most of the people with money these days seem to be mainly concerned with safely hoarding whatever they have left, opting for ultra safe, low interest cash equivalents like U.S. Treasury bills.

But stuffing mattresses is really never a good investment plan. This discussion will get slightly technical, but it's important that you understand the concept. The problem with hoarding cash is inflation. Inflation is the investor's enemy, slowly but surely eroding the value of your hard-earned savings. I can remember when I started playing bass in the mid-80's, a set of bass strings cost $10 at the local music store. Nowadays, the same set of strings runs around $18. That's almost double what it used to be, but to tell the truth, I hardly noticed as the price incrementally edged up over the years. In the same way, a nest egg of X thousand dollars, which might seem impressive by today's standards, will surely go less far ten or twenty years from now.

In the United States, most economists consider a "normal" rate of inflation to be somewhere in the neighborhood of 2-4% annually, and the government manipulates interest rates and other monetary policy tools to try keeping it around that level. Actual inflation rates, however, can vary considerably. If I assume that the government will be effective in maintaining inflation at, say, a 3% level over my lifetime, then I must earn consistently at least 3% on my investments just to prevent my savings from eroding. And if I eventually plan to live off of those savings, I will need to earn even more.

The problem with cash equivalent investments is that interest rates often barely keep up, or actually fail to keep up with inflation. My money market account is currently paying only 2%. The way things are going, it doesn't look likely that interest rates will be going up significantly any time soon, but even under the best of circumstances, cash equivalent investments rarely exceed inflation by very much.

Historically, investments such as stocks and bonds, although they involve more risk than cash, tend to outpace inflation by sufficient margins to actually grow your nest egg over time. It is certainly scary to invest in such things at times like this, but the prospect of eventually retiring with a severely stunted cash nest egg is even scarier to me. I suggest taking another look at my previous blog entry on the related subject of compound interest. Then try playing around with some numbers using these online inflation and compound interest calculators.

There is another new source of good career advice for musicians online. Please have a look at the Musician Wages website.

Friday, October 17, 2008

Diversify Your Bad Self!

One popular misconception about the music business is that most musicians make their living exclusively from live performances, or exclusively from studio session work. I'm not sure why people tend to make that assumption, but I suppose it may stem from the fact that most people only see and interact with us on stage. In spite of this romantic myth, the reality is that virtually all full time musicians these days earn their income through multiple activities. In fact, I can't think of any players who limit themselves to gigs only, and I know hundreds of successful musicians all over the world!

There certainly must be exceptions to this generalization, but I would argue that even if you can make a good living through gigs alone, you will still be limiting the potential extra income and job security that greater diversification could offer you. Think about it. If you are playing a 4-hour steady gig 5 nights per week, that is still only a 20-hour work week -- why waste your daytime hours? Here is a list of less commonly considered money making ideas for musicians:

  • Doing music clinics at local schools
  • Instrument/equipment rental
  • Rehearsal space rental
  • Teaching music lessons
  • Playing on recording sessions
  • Producing recording sessions
  • Selling time in your home recording studio
  • Live sound engineering
  • DJ work (blasphemy!!!)
  • Licensing original music
  • Selling original CDs or band merchandise
  • Booking other bands
  • Cover band gigs (if you're an original artist)
  • Solo gigs (if you're already in a band)
  • Accompanist work
  • Music copying and arranging
  • Daytime gigs at churches, coffee houses, etc.

There are really countless ways to be compensated for your musical abilities. If you thoroughly researched and explored all of these opportunities, you could keep very busy making a good living, and you would also be better positioned to endure the loss of any one of your gigs. Let's keep our eyes open for unconventional or unexpected gigs, and please post a suggestion here if you think of any that I missed!

Thursday, October 9, 2008

Making the Most of It

Just a few quick thoughts today about how to handle an economic/market downturn. A recession is usually a great time to:

  • Hunt for bargains on goods (including used and new musical equipment)
  • Hunt for bargains on stocks and other investments
  • Offer a special sale on your CD or band merch
  • Reexamine your lifestyle to cut costs and eliminate inefficiencies
  • If gigs are slow, use spare time to practice/exercise/improve skills/learn to cook
  • Possibly increase insurance coverage (crime goes up during recessions)
  • Re-establish connection with former musical contacts
  • Volunteer/go to friends' gigs/vote/host a jam session/build goodwill
  • Simply enjoy life and do something to make a difference

A recession is generally a bad time to:

  • Quit or start complaining about your gig
  • Try selling off used gear or other goods
  • Panic and sell investments at market lows
  • Assume that the market has bottomed and rush into a big investment
  • Not face up to your personal financial circumstances (this is ALWAYS a bad idea!)
  • Budget based on overly optimistic assumptions about income
  • Give in to depression or fear

Hey, it's not so bad, you'll get through this. And remember, we musicians are actually kind of lucky in that most of us have multiple sources of income, leaving us less vulnerable than someone who depends on a single employer for his entire livelihood. Feel any better? :-)

Thursday, October 2, 2008

Dollar Cost Averaging

In my first few blog entries, I introduced some of the basic, common principles of personal finance: keeping costs low, paying yourself first, taking advantage of compound interest, starting an emergency fund, and defining investment goals. I consider these to be the most essential concepts for any long-term financial plan.

Another commonly mentioned principle that I have not yet discussed is dollar cost averaging. This is the practice of investing a fixed dollar amount at regular (often monthly) time intervals. So, for example, if you have an annual investment goal of $5000, you would transfer $417 into your investment account on a fixed date every month, as opposed to writing one check for $5000 at the end of the year. Many consumer investment accounts, such as mutual funds, offer an option to set up these regular investment transfers for free.

The standard rationale for dollar cost averaging is that it reduces the risk of market timing on your investment return. Tradable assets (like stocks and bonds) go up and down in price daily, but if you put in the same dollar amount every month, you will automatically be buying more shares when prices are low, and fewer shares when prices are high.

Studies have shown that even sophisticated, professional money managers tend not to be very good at timing their investments ("buying low and selling high"), so why should Joe Musician expect to be any better at timing his purchases? Actually, the data is somewhat mixed regarding typical returns through dollar cost averaging as opposed to other investment schedules, but the fact that average investors should avoid the temptation to time the market is generally undisputed.

I would argue, however, that there is a more compelling reason to employ dollar cost averaging in your financial plan. It is the ultimate "pay yourself first" tool. If you know that $417 is going to be automatically deducted from your checking account on the 15th of every month, then you will view that as simply another bill to be paid and you'll be forced to budget accordingly. If, on the other hand, you put off investing and plan to just write a $5000 check at the end of the year with all of your anticipated lucrative holiday gig income, you might come up short. For this reason alone, I think dollar cost averaging is a great way to invest.