How to Maintain Optimism in Tough Economic Times
Yesterday Mr. ToughMoneyLove suggested that ordinary Americans protest the credit and market meltdowns by burning their credit cards. Expressing your anger is helpful when channeled in a symbolic way.
But do not let your anger morph into feelings of hopelessness, helplessness and resignation. You can’t afford it. You must fight back.
But you know what? We have not given up hope. We can still see the light and are more determined than ever to finish the job we started, to reach the financial goals we set, and do it on our schedule. How is that possible after the all of the damage that has been inflicted upon our net worth? That’s a question that I am now asking myself because to be honest I am surprised at how calm I am at this point.
So let’s examine the reasons why Mr. ToughMoneyLove believes that optimism and determination can and should prevail over hopelessness.
Have a Firm Financial Foundation
A financial foundation in this context has two layers. The first layer of the foundation is no consumer debt. Debt is a dragging anchor at any point in a financial plan. It is a particularly acute problem during a recession. We are in good shape because we have no debt except mortgage debt that is fixed at a low rate. If you have consumer debt – car loans, credit card debt, etc. – you have a problem that has been exacerbated by current conditions. My opinion is that even though stock is “on sale” right now and a short term rally is at hand, markets are likely to be relatively flat overall for several years. This means that, except for 401(k) and 403(b) contributions that are matched by your employer, you should shift resources from investing to killing consumer debt. By doing so, you are getting a tax-free return on your money equal to the interest rate of the debt you are killing. Not a bad deal at all. If you are closer to retirement as we are, attacking the mortgage debt is equally important. Living in a paid-off home will provide huge tax advantages for those who are entering a period of flat or declining incomes.
The second part of a financial foundation would be a financial cushion, i.e., liquid assets that you can use to avoid having to sell investments that have been hammered down by declining market conditions. I am referring not only to an emergency fund but to secure investments that can be tapped for retirement or other needed spending in lieu of liquidating other assets that have been temporarily devalued. In our case, we have cash and government bonds that would allow us to survive for at least three years even if I were to become unemployed. There would be no need to sell other long term holdings in this current down market.
Having a three to five year financial cushion should be a goal of anyone who is actively preparing for retirement. You may not be at that point yet. Even so, you must acknowledge the possibility that unemployment may rise substantially in the next 6-12 months and it could affect your family. Get to work immediately in building a cushion against such a blow. If it means greater sacrifice in the spending department, here are some spending categories where you can start. Start now.
Have a Financial Plan
Nothing eases the mind under stress better than planning and preparation. If you have a financial plan that is designed to sustain you through tough economic times, you can relax somewhat, knowing that you have done and are doing everything that can be done.
In today’s crisis, proper planning is needed in two areas: budgeting and investment allocation.
Much has been written in books and around the blogosphere about budgeting your money. Different budgeting techniques work better for different people. These techniques start with the crudely effective envelope system favored by Dave Ramsey. Because we have many different accounts to track, I prefer using more sophisticated budgeting tools that are software-based. Many of these are free and are usable online. You can read what I have said about online budgeting tools. The key is to pay yourself first – food and shelter, followed by debt reduction, and then continuing to build your financial foundation. Discretionary expenses are last and, in the simplest of budgets, are ignored because all of the important categories are covered. (More about the Mr. ToughMoneyLove “simple but effective budget” in a future post.)
The second component of a financial plan that will calm you through stressful economic times is a properly designed investment asset allocation. More specifically, you should have an allocation that defines an “all weather” portfolio. I have written of how we have not altered our investment strategy in response to the current crisis, except to sell Bank of America stock because of its dividend cut. That is the kind of investment asset allocation that you want.
What is the consequence of not having an asset allocation in which you are confident? Panic selling. Imagine if you were a seller last week, as millions of panicked investors were. You would have locked in your losses and missed the biggest one-day market gain in history that occurred on the very next trading day. The confident investors were those who had prepared in advance and knew that even though they were taking losses, they had assets properly allocated to ride through the storm and come out fighting on the other side. Confident investors think about what they have, not about what they have lost.
Asset allocation can be complex or simple. I prefer simple. Simple does not mean unsophisticated. Simple means following an allocation where someone else has done the work for you. I suggest one of the couch potato portfolios designed and tested by Scott Burns. We use the ten-speed portfolio. Check it out for yourself. But do the work and implement an allocation that gives you the confidence to stick with it.
Put Your Human Capital to Work
When all indicators went south last month, I sent email messages to each of our three sons. The two oldest are working in good jobs. I told them that their biggest economic asset right now is their job. Their mission for survival is to keep that job at almost any cost to them. For anyone who is employed now, you must keep that job, even if you have to hold your nose while doing it. Having a steady income during a recession is both a necessity and, compared to millions who will be unemployed, a luxury. Do not make waves in the workplace except to excel. Be affordable. Be productive. Be indispensable.
Our third son is still in college. My message to him was to encourage him to put his human capital to work by excelling in the classroom. That is his full time job. It is possible that when he graduates, jobs will be tough to find. He needs to have credentials that separate him from other new job seekers. For everyone working or looking now, everything you do should be a resume builder. This does not mean going back to school while living on student loans. That would be a big mistake now. Learn new skills on the job. Learn new skills on your own time and as you can pay for it. Build value in your human capital while preserving your economic capital.
These are the Mr. ToughMoneyLove ideas for developing and maintaining optimism and avoiding hopelessness. I am sure I don’t have a monopoly on good ideas in this department. What are yours?