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Battening Down Your Budget

By Stephanie AuWerter

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 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, 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 — 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, 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.