Prepare now for the next financial crisis
September marked the 10-year anniversary of the huge nosedive on Wall Street in the 2008 financial crisis. Last month’s article discussed what led to the 2008 crisis, and this month’s article encourages you to prepare for the next financial crisis.
Another financial crisis is inevitable, although we do not know when it will occur or how severe it will be. The U.S. stock market recently became volatile, with the S&P 500 declining over 5 percent during Oct. 10-11, 2018.
There are very few safeguards within the financial industry that would prevent another crisis, and corporations have been stocking up on debt due to the low interest rates in recent years.
According to S&P Global Ratings, U.S. companies (excluding banks) are now holding $6.3 trillion of debt. This may not be a problem in good times, but it can become a serious issue if corporate profits decline.
The U.S. economy appears strong, but the lower corporate income tax rates (effective Jan. 1, 2018) have led to significant share buybacks by corporations in 2018. According to journalist Matt Egan, “buybacks artificially inflate earnings per share by eliminating the number of shares outstanding.”
There are many warning signals that suggest the American economy is not rock-solid. Our federal debt is increasing rapidly. Tariffs are impacting international trade. Meanwhile, many countries are experiencing economic downturns, including much of Europe, China, Russia and parts of South America.
Preparing proactively for the next financial crisis will make your financial situation stronger and more resilient, which is always wise. I recommend the following five strategies:
1. LOOK OBJECTIVELY AT YOUR FINANCES. Create a net worth statement so you know what you own. (A form is provided on my website at thejoyoffinancialsecurity.com/net-worth.pdf.) A net worth statement is the first step in taking control of your finances.
2. IF YOU HAVE CREDIT CARD DEBT (carried over from month-to-month), commit to paying it off quickly. There are two ways to free up additional cash. One is to cut back on spending, and the other is to increase your income.
You may want to consider: 1) cutting back on spending for holiday gifts this year for relatives and friends, 2) looking for ways to reduce the cable or cellphone bill, or 3) stop buying impulse items or unhealthy snacks and soda when you go to the grocery store.
Many retailers are hiring part-time help for the holidays, so this is also a good time to pick up a second job.
3. IF YOU ARE LIVING BEYOND YOUR MEANS (and feel the stress of too many bills), consider downsizing. Move to a smaller house or rent an apartment. Get rid of the expensive car and buy one you can afford. These are not easy choices, but freeing yourself of the stress that debt causes will feel great.
4. IF YOU HAVE INVESTMENT ACCOUNTS, I recommend that you conduct a thorough review to determine if the investments are appropriate for you.
• Do you have the proper asset allocation (percentage of equities vs. fixed income) to match your tolerance for loss? A balanced or conservative asset allocation will leave you less exposed to losses during the next financial crisis. Rebalancing your accounts back to your target asset allocation is recommended every six months, and more often if the stock and bond markets become volatile.
• Do you know what fees you are paying within your investments? This includes commissions, fees to a financial adviser, and fees for owning mutual funds, annuities, etc. Keep this total as low as possible.
• Do you know what your investment performance has been for the past year, five years, etc.? Financial advisers and stock brokers should provide performance figures for your accounts, and many brokerage firms provide it also.
• Are your investments diversified between U.S. large-cap, mid-cap, and small-cap stocks or mutual funds? Do you have international mutual funds? Are your bond funds (or individual bonds) diversified? Are your investments tax-efficient if they are in a taxable account?
• Is your emergency fund earning money, or is it in a bank account earning virtually zero? CDs and money market funds (appropriate for emergency funds) offer attractive yields, while still providing safety.
5. DETERMINE HOW MUCH YOU CURRENTLY SAVE. A form to help you calculate your current savings is available at joyoffinancialsecurity.com/savings.pdf. If you currently save 5 percent, commit to increasing it to 8 percent. I recommend trying to save 15 percent to 20 percent of your gross income during your working years.
The above tips are designed to help you take control of your money. I strongly encourage you to prepare now, because your financial future will benefit from your efforts.
Financial security helps you sleep at night, knowing your financial future will be safe, regardless of what our economy throws your way. You will also experience the freedom that financial security provides – freedom to do many of the things that make you happy.