Disregard consumer confidence when making long-term financial decisions

Key Points

In all market downturns, the problem is part economic and part psychological.

There is no denying the economic problems. Oil reached a record $146 a barrel in July (the price had dropped to $109 by early September). The declining U.S. housing market has resulted in write-downs of $400 billion by financial institutions worldwide, with more to come. Inflation, as measured by the Consumer Price Index for the first half of 2008, has been more than 4 percent.

These problems are compounded by the credit crisis and meltdown of the U.S. financial system during the past year. A recent example is IndyMac, a bank in California that specialized in low-documentation loans, which was taken over by the Federal Deposit Insurance Corp. after depositors withdrew $1.3 billion. It was a classic case of a run on a bank.

The CCI is defined as the degree of optimism in the state of the economy that consumers are expressing through their activities of savings and spending.

The Conference Board, an independent research organization, issues the CCI monthly based on data from 5,000 households. The CCI uses 1985 as its benchmark, since it was considered a "normal year." Thus, 1985 received a value of 100. The CCI was at 50.4 in June, the lowest reading since February 1992 (47.3). The August reading was 56.9.

The MCSI questions 500 households each month on their financial conditions and attitudes about the economy. The index is normalized to have a value of 100 in December 1964. The most recent reading was 63.0 in August, substantially lower than the 83.4 score of August 2007.

What does all of this mean to you? Consumer confidence is important because if you are not confident in your own future, you tend not to spend money.

However, consumer confidence is typically more of a snapshot of the prevailing mood, and the statistics can change fairly quickly.

A careful look back at consumer sentiment shows that it has a poor record as a leading indicator of the economy and, in particular, the stock market. To the extent it does have any forecasting ability, it is precisely in the opposite direction than most people think, which is why many economists refer to it as a "lagging" indicator.

If you have any doubt, go back and look at consumer confidence in early 2000, when it was at one of its highest levels (just before the three-year market crash), and then in 2002, when it was at one of its lowest (just before the market went up for five years).

The bottom line is that consumer confidence is a good snapshot for how we feel today, but it is not a reliable factor in making sound long-term financial decisions. However, as evidenced by the actions of many investors pulling money out of stock funds, emotions and sentiment are a powerful force driving investor decision-making.

Many "experts" provide their opinion, but no one knows when the current turmoil will end, although history shows us that it will end. Research shows that successful investors are proactive in their decision-making, have a disciplined investment strategy, and focus on the long-term, while investors who get caught in the prevailing mood lag far behind.

The author is a fee-only certified financial planner with Preston & Cleveland Wealth Management LLC (http:// http://www.preston-cleveland.com) in Atlanta and Augusta, Georgia, and a member of the National Association of Personal Financial Advisors. The ideas expressed in this column are his alone and do not represent the views of Medical Economics . If you have a comment or a topic you'd like to see covered here, please e-mail meinvestment@advanstar.com
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