At any given time in your life you may find yourself in a financial situation not of your making. The recent credit crisis in America is a prime example. It is a uniquely perfect storm to be sure, the kind of economic crisis that comes along once every 50 -100 years perhaps, but that doesn’t lesson the impact on your well being.
Economic hardships come and go, and are largely beyond our control as individuals but there are things we can do to prepare for such times. Severe economic downturns have some factors in common, and this current credit crisis is no different in this regard. Some effects we can expect include:
No more “Free Money”
It will become harder to get loans and the loans you do get will likely have higher interest rates. Banks will continue to keep lending money, just not with the exuberance they have in the past decade. Lenders have been bitten by risky loans they made to sub-primer borrowers, and the investments that were based upon those loans as collateral. As a result, lenders are more conservative in whom the lend money to and the conditions of those loans. This means your chances of qualifying for a no money down home loan are slim, if they exist at all. In short, you’ll likely need a down payment and be charged a higher interest rate on the money you borrow. Not just for homes, but in general. Credit card rates will likely go up.
When companies can’t borrow money easily, it becomes harder to continue high rates of growth. Decreased growth means layoffs. In the case of some small business, this may even me closing the doors permanently.
Lower returns and poor performance on Investments
Expect your 401(k), IRA, 403(b), etc… to take a hit. With the economy slowing and a general uncertainty of how bad the crisis will be there will be a lot of volatility in the stock market. Companies will likely hoard any cash they have, reducing the likelihood of dividend increases, which are a large part of stock market returns over the long haul.
Essentially, we’re looking at the recession the media has been trying to convince us we’ve been in for the past 12 months actually becoming a reality.
So, what can you do? How can the little guy avoid the financial fall out? Hunker down in your financial bunker and get back to basics. Here are a few steps to build and manage your financial bunker:
Build a strong foundation
This economic crisis is a stark reminder that an emergency fund is a necessity. An emergency fund is the foundation of any financial bunker. If you have 3-6 months of expenses saved in a high yield, FDIC insured, bank account or CD then you have a much better chance of surviving any layoffs headed your way. The more in your fund, the longer you can hold out. Think of this as your stash of non-perishable food.
Remove the dead weight
As mentioned above, money will be harder to come by and adjustable rates are likely to rise. So, it’s a great reason to avoid debt wherever possible and eliminate as much of the debt you have now as you can. Those with the most debt will be hardest hit in economic slow downs.
Buy only what you need
If you’re trying to fluff up that emergency fund, or eliminate the dead weight debt, now is not the time for that new car or plasma screen T. V.. Adopt (continue) a frugal lifestyle. If you’re thinking of buying a home, plan on owning it long term. I just bought a new house. Some people think that’s insane in the current economic conditions and falling house prices. Flippers got flipped, but I don’t care about falling home prices now because I bought much more house for a lot less money, and I don’t need the equity for at least 10+ years.
Invest in Stocks
Returns will likely be a lot lower in the short term, but there is no better way to out pace inflation in the long term than investing in the stock market. If you don’t have the time or inclination for investing, pick a broad based index fund and diversify. I’m 25+ years away from retirement, so the recent market turmoil is an excellent buying opportunity for me. Stocks are having a big sale, and if you don’t need the money for 10 years or more it would be foolish not to take part.
Big drops like this in the stock market really only hurt people if they take their money out while stocks are low. Retirees and soon to be retirees are hardest hit. Use this crisis as a lesson: keep an eye on your allocations. If you’re 10 years or less away from retirement you should have much more money in bonds and cash. Be properly diversified and have a year’s worth of living expenses in cash or CDs in the run up to your retirement date. That way, you can still retire when planned even if the market tanks just as you’re about to pull the plug on your working income.
As I said, these are really basic concepts. The trick is to keep your head, don’t lose heart and stay focused on the big picture. Keep a long term outlook, and you can ride out any economic storm.
Image courtesy of MotherPie