PLANNING FOR FINANCIAL HARD TIMES
A shaky stock market, job layoffs and a weakening
economy are raising financial fears among many households that only a
year ago were flowing with optimism. Even in good times, bad things can
happen to families that cause a personal financial hardship. Here are
some ideas for how to prepare financially for tough times.
Hold realistic expectations. Before
high-tech stocks, and the stock market in general, took a nosedive in
2000, many people had come to believe that we had entered a “new
economy” in which the stock market only went up and the economy was no
longer subject to business cycles. How quickly reality threw cold water
on that viewpoint. Simply understanding that stocks have been returning
well above the historical average of around 11 percent, and that at some
point they would fall to or below those averages, goes a long way in
preparing for tougher times. Families who believe that stocks will
return 20 or 30 or 50 percent every year are less apt to curb their
personal spending and more apt to take chances on risky
investments—both patterns that can come back to haunt you when the
market drops and the economy sours.
Diversify, diversify, diversify. This is a
cliché, but nonetheless one that’s still true. Financial planners say
they cannot harp on this enough. People most frequently think of this
advice with regard to investing: spread your portfolio among a variety
of asset categories, and investments within those categories. Executives
heavy in company stocks and business owners whose wealth is mostly tied
up in their company are especially vulnerable. But diversification also
applies to other financial arenas. Spouses who both work for the same
company or in the same industry face greater financial risk in a
downturn. Diversifying job skills so that you can be more flexible,
should you lose your job, can help when hard times hit. Diversification
can apply to estate planning, where oftentimes it saves taxes to get
assets out of the estate through lifetime gifting or irrevocable trusts.
Know your financial worth. Most people
either don’t know their net worth (assets minus liabilities), or think
they know it and are wrong. Your net worth provides a useful benchmark
for how well you are doing, in good times and bad.
Keep emergency funds. Tying up all your money
in stocks and illiquid investments may force you to sell some of those
assets at fire-sale prices during hard times—in short, “locking in”
losses. Keeping adequate cash resources in money markets, short-term bond
funds and certificates of deposit gives you flexibility to see you through
a job layoff, down market or other financial crisis.
Minimize debt and establish budget. Even the
affluent often does a poor job of minimizing debt and budgeting. You might
get away with this in good times, but excessive debt and poor use of your
money become an albatross when financial times toughen. Reducing
high-interest debt, budgeting, strategic tax planning and buying smart
(from insurance to autos to groceries) frees up money to bank for those
emergencies.
Insure against tough times. You can’t insure
against layoffs, but you can insure for another common work disaster: a
disability. Yet disability (income-replacement) insurance is one of the
most overlooked types of insurance. Business owners also are commonly
underinsured. Consider an umbrella liability policy—lawsuits are a
common source of personal financial crisis these days.
Educate yourself financially. Perhaps there is
no better way to prepare for hard times than to educate yourself—and
your spouse—about how to wisely manage your money. It’s often not so
much the financial successes we have than the financial mistakes we avoid
that keep us financially healthy in difficult times.
Actively manage your money. People tend to let
circumstances dictate their financial decisions, not the other way around.
Taking charge of your finances, planning and saving for tomorrow, and
following through on the advice of your financial advisor or your own
planning usually make the difference between suffering through hard times
or riding through them with confidence.
June 2001— This column is produced by
the Financial Planning Association, the membership organization for the
financial planning community, and is provided by McGuire & Co., LLP, a local
member in good standing of the FPA.
