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Surviving and Thriving in Difficult Economic Times

2008 has been a very difficult year, financially, for many people. Between the high number of home mortgage defaults and foreclosures, rising unemployment rates, declining stock market prices and home values, multiple bank and investment firm failures, a credit crunch, and increased costs for basic necessities such as food, heating oil, and gasoline, some would argue that we haven't been experiencing just a "perfect storm," but rather a "perfect tornado."

What should you do? Protect yourself and take cover, financially, just as you would in the event of a real tornado. Below are 10 "tried and true" financial planning and investing recommendations that are appropriate anytime, but especially now, to survive and thrive in today's difficult economic climate:

  1. Spend Less Than You Earn and Avoid Excessive Debt - If household income is reduced due to unemployment or reduced investment earnings, and as household expenses continue to rise, adjust your household spending plan (budget) accordingly or prepare one for the first time. Rutgers NJAES Cooperative Extension has several online resources.
  2. Be Future Minded - Research indicates that, at every income level, people who are "planners" are more successful financially and feel better about their financial situation than those who do not plan ahead. Planning for the future includes the following: 1. taking a long-term view of historical investment returns; 2. calculating the savings required to achieve future financial goals such as retirement; 3. saving and investing regularly to achieve financial goals; and 4. proactively addressing potential future challenges such as the cost of long-term care and estate planning.
  3. Follow Recommended Financial Practices - Studies from a number of sources indicate that many people do not put into practice the action steps that are frequently recommended by financial experts. These include preparing a will, making a written list of financial goals with a target date and dollar cost, setting aside three or more months of expenses for emergencies, calculating net worth periodically, and following a spending plan or budget. Beefing up emergency reserves and monitoring income and expenses are especially important during current uncertain times.
  4. Build Human Capital - One of the best defenses against unemployment is to be a productive worker with current job skills that are in demand by employers or as a consultant. Leadership skills and the ability to work well with others are also important. Another way to build human capital is to practice good health habits such as eating nutritious meals and getting adequate sleep and exercise.
  5. Make Compound Interest Your Friend - Invest early and often, particularly in tax-free (e.g., municipal bonds or bond funds) or tax-deferred (e.g., IRAs) investments, where income taxes are not owed or can be postponed until later life. Avoid tapping retirement savings before retirement unless absolutely necessary. Another thing to avoid is making minimum payments on credit cards. In this situation, compound interest works against you. For example, a $3,000 balance on an 18% APR credit card with minimum payments of 3% of the outstanding balance will take 14 years to repay and cost $2,625 in interest charges.
  6. Save and Invest Regularly - By making regular deposits to purchase stocks or mutual funds at regular time intervals, a strategy known as dollar-cost averaging, you'll buy more shares with your fixed deposit. Think of market declines as a "sale" at a department store and continue investing regardless of current market volatility. Also make deposits to savings plans such as 401(k)s that are available through your employer and earn the maximum available match. Rebalance your portfolio as the market changes percentages in stocks, bonds, and other asset classes.
  7. Develop a Personal Asset Allocation Strategy - Then, stick with it. Asset allocation is the way you divide your portfolio among various asset classes such as stock, bonds, real estate, and cash assets. Your asset allocation strategy should be based on your investment risk tolerance level and the time frame required for your financial goals. Generally, the longer the time horizon, the more risk you can afford to take, consistent with your risk tolerance level. The shorter the time horizon, the less risk you might want to take. Your asset allocation strategy is a guidepost when markets are uncertain. If you decide to work with a financial advisor, he or she may refer to your investment strategy as an "investment policy statement."
  8. Know Your Risk Tolerance Level - Risk tolerance is a key factor in building a suitable investment portfolio regardless of whether markets are up or down. Try our research-based investment risk tolerance assessment tool. Research conducted with this instrument has found that risk tolerance often varies with the direction of market indices. Ideally, risk tolerance should be somewhat stable regardless of market conditions.
  9. Keep Your Investment Portfolio Diversified - Diversification helps mitigate investment risk and can be achieved by including different asset classes within your portfolio and different types of investments within each one. For example, within the asset class of stocks, one could have large and small companies, growth and value stocks, and foreign and domestic stocks. A common way that investors diversify their portfolio is to buy investments, such as mutual funds and exchange-traded funds (ETFs), which are already diversified because they pool together many different securities. Without adequate diversification, investors are vulnerable to losses caused by declines in the value of a particular type of investment or industry sector.
  10. Buy Low and Sell High - While this is a fundamental principle of investing, many people do the exact opposite because their emotions cause them to sell in a panic during declining markets, particularly during extremely volatile downturns such as those seen in September 2008. A good way to "buy low" is to follow a dollar-cost averaging strategy, as described above. Dollar-cost averaging helps take the emotion out of investing because new investment deposits are made automatically regardless of market conditions.