Broker Check

Financial Prudence

December 14, 2018

One of Warren Buffett’s many notable quotes seems particularly timely at the moment. Buffet once said: “The less prudence with which others conduct their affairs, the more prudence with which we should conduct our own affairs.” The idea is that we are all participants in the same economy. Therefore, the actions of others are likely to have an impact on our financial prospects even if we act more prudently.

For example, during the housing boom and bust even those who did not engage in risky financing activity still suffered when the value of their home equity declined due largely to the undisciplined borrowing of others.

Therefore, when some economic participants are prone to excesses, such as high levels of borrowing, it may not be enough to simply spend prudently and avoid excess debt. When the cycle reverses it may be painful  for everyone  resulting in lost  income or reduced savings.

Currently, household debt in the US is at an all-time high having surpassed the previous high from 2008. Household sending has consistently outpaced the growth rate in household income showing that the average American house-hold has conducted its financial affairs with little prudence in recent years.

Therefore, as Warren Buffett recommends, the best path forward for those who wish to insulate themselves from the eventual reckoning is to increase the prudence with which they conduct their own financial affairs. This means maintaining an emergency savings fund, paying down debt, and avoiding overspending. When the debt cycle reverses such a conservative approach may be rewarded.