| LIKE MOST AMERICANS, I've always been a
much more enthusiastic spender than saver. And so, when President
Bush told us to spend our tax rebates this summer, I had no
problem fulfilling my patriotic duty. (A new MP3 player.) And
when Mayor Giuliani told us to go back to our normal lives here
in New York City after the terrorist attacks — do some
shopping, go out to dinner — I did that, too.
But I have to admit, I'm starting to look
at my finances with a more conservative eye. Fact is, propping
up the U.S. economy has become an increasingly heavy burden
for the American consumer. And with layoffs rising, the stock
market falling and recession all but a certainty, it suddenly
seems that what may be good for our economy could be bad for
our own pocketbooks.
The problem: The stiff winds of the coming
economic storm promise to wreak havoc on the house of cards
Americans have been happily building in recent years. That's
cards as in credit cards. While revolving debt (i.e., credit-card
debt) has been flat this summer at $700.3 billion (as of July,
seasonally adjusted), consider that just five years earlier
the total was $480.6 billion, according to Economy.com. In other
words, since 1996 the amount of outstanding credit-card debt
has increased approximately 46%. On top of that, our savings
habits are anything but impressive. Our savings rate, as a percentage
of disposable income, dropped from an average of 7.8% in 1990,
to 1.0% during 2000, according to the Bureau of Economic Analysis,
although it has been rising over the past two months. (It's
also worth noting that these figures don't include investment
gains.)
Bottom line? A lot of people have been using
debt to finance the American dream, says Richardo Kilpatrick,
president of the American Bankruptcy Institute. And while that
might have worked fine in the late 1990s, it could cause problems
now. "My projection is for a financial Armageddon,"
says Steve Rhode, co-founder of Myvesta.org, an online debt-management
service.
Now's clearly the time to do some hard thinking:
Are you financially prepared for a recession? How long would
you be able to live comfortably if you lost your job? "People
need to build a financial bunker — not with cans of Spam
but with dollars placed in a savings account," Rhode says.
Creating Your Financial Bunker
When it comes to buttoning up your finances,
we all know what we're supposed to be doing. We should pay off
unsecured debt (like credit cards). And we should have an emergency
stash of cash readily available. For many of us, this is going
to require squeezing some additional dollars out of our current
income. And in order to do that, you need to know where your
money is currently going — which most of us don't.
All of this leads us to a rather silly corner
of the financial-planning world that's full of earnest tips
on how to save money. One of my favorite sources, Cate Williams,
president of the Consumer Credit Counseling Service of Greater
Chicago, or CCCS, recently gave me her list of the top three
goofiest ideas she's come across during her career. They are:
- Learn to cut your own hair.
- Trade clothes with a friend.
- Get rid of your pets.
You get the picture. I'm going to assume that
only you can decide the best way to save some extra money. For
the rest of this column, I'm simply going to suggest some goals
and point out some tools that might make reaching them a bit
easier.
Shoring Up Your Emergency Stash
Rule No. 1 of solid financial planning: Everyone
should have an emergency fund. That's true regardless of whether
you earn $30,000 a year or $300,000. Your fund should consist
of somewhere between three and six months' worth of living expenses.
If you and your spouse both work, three months is probably sufficient,
says certified financial planner Rich Chambers of Palo Alto,
Calif. But if your family is dependent on your income alone,
you should try to stash away as much as six — particularly
if you're worried about the stability of your job. How to figure
your expenses? That takes a budget, about which more in a moment.
The point of an emergency fund is that it
will keep you from having to dip into your other investments
(including your 401(k)) if you need some cash. And in times
like these — when the market has fallen significantly —
it keeps you from selling low. That's why your emergency stash
needs to be held in something very conservative, like a money-market
fund. Unfortunately, these days even the best money-market funds
are earning less than 3.4%, but again, the object here is safety,
not return.
Having an emergency fund is such a priority
that most financial advisers recommend that you build your stash
even before you pay down your credit-card debt. "It's always
easier to eat macaroni than plastic," says Rhode.
Tightening the Budget
The word "budget" might as well
be a four-letter word. In fact, it causes such a visceral reaction
in people that some financial planners try to avoid using it
altogether. CFP Robert Tull of Norfolk, Va., for example, uses
the phase "money-spending plan."
But whatever you call it, you have to have
a decent idea of where your money is going. If you already use
a personal-finance program like Microsoft Money or Quicken,
those tools should be at your fingertips. If you don't, you
can start by using our cash-flow worksheet, and while you're
at it, you might also want to fill out our net-worth worksheet.
So where should your money be going? Here's
a suggested budget provided by CCCS of Greater Chicago. Personally,
I think the amount allocated to savings (5% to 9%) is somewhat
low, so if you have extra left over from another area, it should
be put into the savings and investment area. This includes investing
for retirement: As important as it is to pay down your debt
and build up some cash, don't forget to feed that IRA or 401(k).
Reducing Debt
It's true in good economic times — and
even truer in tough ones: You need to take a disciplined approach
to debt, particularly credit-card debt. Sad to say, there's
no magic wand you can wave to make debt vanish, but there are
a few things you can do to make it shrink more quickly.
First off, if you have a decent credit rating,
you shouldn't be paying more than 14% on your debt. That's the
average interest rate on standard credit cards these days, according
to Bankrate.com — although if you've ever sent in a late
payment, gone over your credit limit or broken pretty much any
other rule of your credit provider, chances are you're paying
well over that. If that's the case, then it's time to shop for
a new card. You can do that at Bankrate.com, or you can simply
collect the endless stash of offers that clog up your mailbox
— and after a few weeks, apply for the best of the bunch.
Pick a card with no annual fee, and the lowest permanent rate.
Don't kid yourself about those low introductory offers —
if you've got a bunch of debt to pay off, you're still going
to have it when the introductory rate expires. For more on finding
the best credit card, see our story.
It may also be tempting to get rid of your
debt by either borrowing from your 401(k) or consolidating your
debt into a home-equity line of credit. Both of these maneuvers
would indeed save you money on interest, but in this environment,
they're highly risky. For starters, if you're laid off, chances
are you would have to repay your 401(k) loan immediately, or
pay taxes plus a 10% penalty on what the Internal Revenue Service
would view as an early withdrawal (assuming you're under age
59 1/2). And while converting debt into a home-equity loan has
tax advantages, increasing the leverage on your home may not
be a smart move if you're already worried about your financial
stability.
So you're probably better off keeping the
credit-card debt and simply paying it down. If you have more
than one card, you should either pay off the one with the highest
interest rate first, or start on the card with the smallest
debt (paying it off will give you a sense that you're making
some progress). For more ideas, check out our Debt Management
section.
One final bit of advice: Between all of your
extra saving and debt-fighting, don't stretch yourself so thin
that all of your financial do-gooding has left you broke at
the end of each month. Keep some extra money aside for at least
a little bit of fun. Consider it your patriotic duty.
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