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February 18, 2009

Housing Stability and the Consumer Bailout

It was the collapse of the housing industry that kicked off the recession that has cascaded through the American economy. Home values have been on the decline, sales are in a severe slump and new housing starts have all but dried up. Economists are consistent in their opinion that the broader economic woes won't be reversed until there is stability in the housing market. Where does it stand now?

The National Association of Homebuilders offers a measure of builder confidence based on what they are seeing in the business. The good news is that the index rose one point to 9 this month. That's off the all-time low recorded in January. The bad news is a rating of 50 is neutral and anything below that reflects a negative outlook. The current rating of 9 doesn't suggest that homebuilders feel things are going to get better any time soon.

On the brighter side, Citibank and J.P. Morgan have decided to stop all new foreclosures for three weeks for properties which are the owner's primary residence. The government also sees the importance of getting the housing industry back on solid ground and is working toward a plan for buying up consumer mortgages. Once purchased, the government would be able to reduce the outstanding principle of the mortgage, presumably commensurate with the reduced value of the home. Consumers would be allowed to refinance at the new level and lower their monthly payments. While details remain to be worked out, the plan is intended to help consumers stay in their homes.

For those who bemoan the bank and auto industry bailouts saying "Where's my bailout?" Here it is. Of course, this is only one of several consumer bailouts being proposed or already approved. There are also plans to increase payments to the growing legions of unemployed in order to forestall mortgage defaults and other economic hardship in that group. Income tax credits are planned to increase the weekly take home pay of those who still do have jobs. The centerpiece of the economic stimulus plan, of course, is the provisions for new job creation across the country. The plan would save or create millions of jobs largely through infrastructure improvement and repairs jobs in all 50 states.

All this is designed to keep the American consumer in their homes and buying goods that support the overall economy. In January alone, according to industry group RealtyTrac, 275,000 new foreclosures were filed. With unemployment still rising, that number could get even worse. A glut of foreclosed homes being auctioned off will continue to depress home prices nationwide, but particularly in those areas that are seeing the worst unemployment rates due to large factory closings.

It's clear that the government recognizes the problem and realizes that something must be done and done quickly. That, at least, is a good sign.

Author: Brad Sylvester

February 17, 2009

Financial Road Map

Are you making progress toward your financial goals? Are your finances in order? Are you prepared for a financial emergency? If you're not sure, take time to thoroughly assess your finances so you have a road map for your financial life:

Assess your financial situation.

Evaluating where you currently stand financially will help you determine how much progress you are making toward your financial goals. There are several items to consider:

Your net worth -- Prepare a net worth statement, which basically lists your assets and liabilities, with the difference representing your net worth. Prepared at least annually, it can help you assess how much financial progress you are making. Ideally, your net worth should be growing by several percentage points over inflation.

Your spending -- Next, prepare a cash flow statement, detailing your income and expenditures for the past year. Are you happy with the way you spent your income? You may be surprised by the amount spent on nonessential items like dining out, entertainment, clothing, and vacations. This awareness may be enough to change your spending patterns. But more likely, you will need to prepare a budget to help guide your future spending.

Your debt -- Debt can be a serious impediment to achieving your financial goals. To assess how burdensome your debt is, divide your monthly debt payment, excluding your mortgage, by your monthly net income. This debt ratio should not exceed 10% to 15% of your net income, with many lenders viewing 20% as the maximum. If you are in the upper limits or are uncomfortable with your debt level, take active steps to reduce your debt or at least lower the interest rates on that debt.

Increase your savings.

Calculate how much you are saving as a percentage of your income. Is it enough to fund your future financial goals? If not, go back to your spending analysis and look for ways to reduce expenditures. That may mean reassessing your lifestyle choices, since you need to live below your means to find money to save. Commit to saving more immediately, and then take steps to make that commitment a reality. For instance, you may decide to increase your saving by $25 per week through your 401(k) plan at work. To do that, you may need to forego your daily stop for coffee and a doughnut, cut back on how often you dine out for dinner, and reduce your monthly clothing allowance. Not sure it's worth that much sacrifice to save $25 a week? After 20 years, that weekly $25 savings could grow to $63,811 at an 8% annual rate of return, before the payment of any income taxes. (This example is provided for illustrative purposes only and is not intended to project the performance of a specific investment.)

Rebalance your investments.

At least annually, thoroughly analyze your investment portfolio:

• Review each investment in your portfolio, ensuring that it is still appropriate for your situation.

• Calculate what percentage of your total portfolio each asset type represents, compare this allocation to your target allocation, and then decide if changes are needed.

• Compare the performance of each component to an appropriate benchmark to identify investments that may need to be changed or monitored closely.

• Finally, calculate your overall rate of return and compare it to the return you estimated when setting up your investment program. If your actual return is less than your targeted return, you may need to increase the amount you are saving, invest in alternatives with higher return potential, or settle for less money in the future.

Prepare for financial emergencies.

To make sure you and your family are protected in case of an emergency, set up:

• A reserve fund covering several months of living expenses. The exact amount you'll need depends on your age, health, job outlook, and borrowing capacity.

• Insurance to cover catastrophes. At a minimum, review your coverage for life insurance, medical insurance, homeowners insurance, auto insurance, disability income insurance, and personal liability insurance. Over time, your insurance needs are likely to change, so you may find yourself with too much or too little insurance.

Review your estate plan.

The estate tax laws have been changing substantially over the past few years. Take a fresh look at your estate planning documents and review them every couple of years during this transition period. Even if the increases in exemption amounts mean that your estate won't be subject to estate taxes, there are still reasons to plan your estate. You probably still need a will to provide for the distribution of your estate and to name guardians for minor children. You should also consider a durable power of attorney, which designates someone to control your financial affairs if you become incapacitated, and a health care proxy, which delegates health care decisions to someone else when you are unable to make those decisions.

February 13, 2009

Raising Financially Responsible Children

It's not unusual to have concerns about the impact money may have on your children's lifestyles. Even beyond basic financial responsibility, you want to make sure that wealth does not remove your children's incentives to work hard, to pursue meaningful careers, or to care about other people. How do you help your children obtain the values you'd like them to have? Consider these five tips:

Lead by example. Of course, you want to have many discussions with your children about the values you consider important, including the value of hard work, caring about others, and preserving their legacy. But it is equally important to ensure that your behavior supports these values, since children watch their parents' actions closely. Make sure your handling of spending, debt, asset purchases, investments, and charitable donations support the behaviors you are trying to instill in your children.

Teach financial basics. Encourage your children to take finance courses in high school and college that help explain the basics of investments and personal finance. Include your children in discussions about significant financial decisions, such as which investments to select, which charitable organizations to support, and which major assets to purchase.

Allow your children to make their own financial decisions. Don't just give them money every time they want to make a purchase. Give your children an allowance that increases as they get older to cover certain expenses, such as entertainment, lunches, clothing, and gasoline for their car. Let them learn how to spend the money, but don't give them extra money if they make bad choices. It is important for your children to learn from their mistakes. You can discuss options with them, but the final decisions should be theirs.

Encourage philanthropic values. If charitable causes are important to you, require your children to contribute a certain percentage of their allowance to a charity of their choice. Get children involved with charitable organizations that you are involved with. If you have a charitable foundation, find a role for your children in the foundation. Include children in discussions of how family funds will be used for charitable causes.

Counsel your children on continuing your financial legacy. You should have plans in place to help ensure your financial legacy lasts for an extended period of time. That could include setting up trusts that will distribute funds to your children gradually, such as in thirds when each child reaches age 25, 30, and 35. Or, you may want to structure distributions to promote behavior that is important to you. Once your plans are in place, explain them in detail to your children so they understand what you are trying to accomplish.

February 12, 2009

How to Protect Your Retirement Nest Egg

While stock market fluctuations are painful for all investors, they are even more so for those nearing or in retirement. Investors who won't be retiring for many years have plenty of time for their investments to grow. Current and prospective retirees, however, may be concerned about how market fluctuations will affect their retirement plans. If you're looking for ways to help protect your retirement nest egg, consider the following:

Try to withdraw as little as possible from your investments. If your investments have declined in value, reevaluate your current withdrawal amounts. Withdrawing the same amount from a substantially smaller portfolio means that you will deplete the balance much sooner. If you must make the same withdrawals, at least calculate what impact that will have on your current portfolio.

Consider postponing retirement or going back to work. If you haven't retired yet, you may want to postpone retirement until you are sure your investments will provide enough income for retirement. Those who are already retired may want to consider going back to work on at least a part-time basis to avoid withdrawing too much from investments.

Build up a reserve of investments not tied to the stock market. This reservie should total three or four years of retirement expenses. With this reserve, you won't have to sell your stock investments during market declines.

Withdraw funds in a tax-efficient manner so they last longer. In general, you should withdraw taxable investments first so that your tax-deferred investments can continue their tax-deferred growth. In most cases, however, you will need to start taking minimum required distributions from your tax-deferred investments by age 70 ½.

Reassess your asset allocation. The recent stock market fluctuations may have made you realize that your portfolio contains too much risk. While you may not want to make major asset allocation changes immediately, you can take steps to gradually add diversification to your portfolio.

Decide whether you want a professional to manage your investments. In volatile markets, you may feel more comfortable allowing an investment professional to make investment decisions for you.

February 11, 2009

Market Slides after Geithner's Plan is Announced

Stock markets around the world were down sharply after incoming Treasury Secretary Tim Geithner announced his plan to revive the ailing credit markets on Tuesday. The negative reaction by the markets is widely blamed on the lack of specifics in Geithners plan. Geithner himself called the plan a framework and stressed the need to continue working out the details in order to make sure everything is done right.

The essence of the plan involves using both government and private funds to help segregate the huge pile of bad mortgage debt from the rest of the banking system by buying it, presumably at a discount. A step that most financial experts agree is needed to restore the health of the system. If private money is to be enticed into buying this bad debt, then that discount is likely to be steep. It was not clear whether the government funds would be used to subsidize a portion of the purchases for the private buyers, or whether the government would become partial owner of the debt. Geithner also promised $50 billion in federal funds to help reduce home foreclosures, keeping people in their homes where possible, and keeping the mortgages for those homes from moving into the default column.

Geithner could not say for certain whether the remaining $350 billion of the already approved $700 billion bailout package would be enough to get the job done. He indicated that much would depend on how quickly market confidence could be restored. No sooner had he uttered those words, however, than the market dropped, with the Dow closing down more than 4.5% on the day. That represents the biggest one day drop since Obama took office.

Another of the plan's provisions calls for what Geithner termed a "stress test" of financial institutions to see if they really need government assistance. This would lay bare the true state of their balance sheets and the level of risk to which the bonus collecting CEOs of Wall Street allowed their companies to be exposed. The common expectation is that, so far, banks have been shielding visibility to the true depth of their problems and that laying all the cards on the table will show the system to be much weaker than has been admitted to date. That, of course, would have a strongly negative effect on market and consumer confidence and might even exacerbate the problem. On the other hand, continuing to sweep the dirt under the rug is not going to clean up the situation either.

All in all, Geithner's framework looks good. It isn't the silver bullet that will make the problem disappear in week or month, as some investors would like, but the window of opportunity for that passed about two years ago. In most market crashes or severe downturns, experienced investors look for a signal called capitulation. Capitulation occurs when the average investor essentially gives up on the market and pulls out their money. This generally makes for a sudden, severe, and painful drop after a protracted downturn. However, it often signals a return to stability or upward movement. Geithner's stress test may provide a capitulation of sorts for the banking industry. Instead of hiding the magnitude of their problem, everything will be out in the open and we can all stop waiting for the other shoe to fall.

Author: Brad Sylvester

February 9, 2009

Identity Theft Incidents on the Rise

A new report released by Javelin Strategy and Research shows that identity theft was on the rise in 2008, but many consumers may be surprised to learn that the number one source of stolen information had nothing to do with the internet. In a press release, Javelin revealed that 9.9 million consumers were victimized by identity fraud during the year just ended, 22 percent more than in 2007. Yet the company says, despite the average take for thieves being $4,896, the average cost that was born by the consumer for having their identity stolen has fallen dramatically from $718 per incident to $496. This is likely because people are paying more attention to their financial transaction records and are catching the fraudulent charges earlier.

People think of identity fraud as someone impersonating them for an extended period of time, getting new credit cards and taking out loans in their name. This is actually a rare situation. In 2008, say Javelin researchers, when the source of the stolen information was known, 43% of the time it was due to lost or stolen checkbooks, wallets, or credit cards, by far the largest single source of access to information for identity thieves. Information stolen through online access accounted for only 11% of identity thefts.

When identity thieves do get your information, the most common way to take your money is through the use of your ATM PIN number from any handy ATM machine. Although these machines do have cameras that record the picture of the thief, a well positioned hat can hide the face well enough to prevent identification and, of course, the cash is untraceable.

To lower the chances of becoming a victim of identity theft, consumers should take the following very simple steps:

1) Do not write down your PIN number and keep it in the same location as your ATM card. Many people even write their PIN number on their ATM card, making it easy for thieves to take their money should the card be lost or physically stolen. Be careful to avoid anyone observing you as you enter your PIN number as identity thieves will often place themselves in a location to observe or overhear sensitive personal information during legitimate transactions.

2) Never reply to an email asking you to give your social security number or other sensitive personal or financial information, even if it claims to be from a bank or company with whom you regularly do business. Instead, go directly to the company's website or call their customer service number that you obtain from a source other than the email itself. Ask them if they sent such a request and tell them you prefer not give out such information by email. Of course, if you initiated the transaction, that's a different story. Sending payments over the internet using a secure payment system is actually safer according to Javelin's research report than mailing your payments. There is a much higher likelihood of your mail being intercepted than having an encrypted online transaction hacked.

3) Check the policies of your own credit cards, says Javelin, to understand who is liable in the event the card is stolen or charged without your authorization. Look for cards that offer you zero fraud liability. Whichever credit card you have, check your monthly statements carefully to make sure that all the charges that appear are legitimate. If you see a charge which you did not make, call the credit card issuer immediately to dispute the charge, no matter how small. Sophisticated thieves sometimes make a small charge to a credit card to verify that it is active before really running up the numbers. Some of these test charges can be as small as 25 cents, an amount they hope is too small for you to take action until it's too late.

Author: Brad Sylvester

February 7, 2009

A Government Bailout for the Average American

As the Senate dickers over the economic stimulus package, another nearly 600,000 Americans lost their jobs in January. A total of 11.6 million are unemployed in total, a rate of 7.6 percent. January's job losses were spread out among manufacturing, service, and construction sectors indicating continued broad based weakness in the US economy. Only health care and education showed employment gains for the month.

Unfortunately, education is headed for a downturn in the coming months. With almost every state and many municipalities running severe budget deficits, school budgets are under strong pressure. Boston alone, says the Boston's Globe, is planning to cut 900 education jobs to deal with the city's expected deficit of as much as $140 million for the coming year. Expect that scenario to be repeated around the country as city after city is forced to make cuts. With taxpayers unable and unwilling to pay higher taxes on property that is falling in value, and income taxes falling as the unemployment numbers rise, there are few alternatives.

Most economists agree that unemployment will continue to rise throughout most, if not all of 2009. Not even quick passage of the President's economic stimulus can forestall the job losses completely at this point. Perhaps if it had been enacted earlier, but that's water under the bridge. Now, those same economists agree that the stimulus plan can only limit the damage and save a few million of the many jobs that will go away this year.

For a few million Americans, and the companies that make the goods they will still be able to buy, or the companies that loaned them money that they will still be able to pay back, that's a very good reason for Congress to stop their political gamesmanship and pass the bill. The bill has hundreds of billions in tax cuts that will put more cash into the pockets of the working Americans who need it. It has hundreds of billions designated for programs like infrastructure improvements that will create or save those extra 3 million or so jobs. And it has a relatively small percentage of the usual add-ons that get attached to every bill that been passed through congress in the last 30 years or more. The economic stimulus plan is the government bailout for the average citizen. Yet, it receives more opposition than bailouts of roughly the same size that were intended for Wall Street banks, and failed corporate giants.

Author: Brad Sylvester

February 6, 2009

Be Prepared for a Layoff

In these economic times, job security is a notion from the past. All workers should be prepared financially for the possibility of a job layoff. Here are a few tips to help with that process:

Stay on the lookout for signs of potential cutbacks. Those signs could include layoffs at competitors, declining financial performance, top management changes, or a major tightening of expenditures. Under federal law, only companies with more than 100 employees are required to give 60 days notice of layoffs or plant closures.

Set up a cash reserve of at least three to six months of living expenses. It typically takes at least that long to find a new job. It may take even longer in this economic environment or if you are middle-age or older.

Apply for a home-equity line of credit or other type of loan. It is usually easier to obtain credit when you are employed, so get borrowing options in place to help during a layoff.

Look for ways to cut your living expenses. Avoid nonessential expenses like extravagant vacations, clothing, and entertainment. Even if you aren't laid off, you can use those savings to increase your retirement savings.

Keep your resume up to date. While you may not want to actively start looking for another job, be aware of the current job market and expand your professional contacts.

If faced with a layoff, don't just accept your employer's severance package. Try to negotiate for more severance pay or for an extension of your health insurance benefits. Also check whether the company offers services to help you find another job.

February 3, 2009

The Basics of Asset Allocation

The theory behind diversification, or asset allocation, is to spread your investments across different asset classes to help protect your portfolio from downturns in any one asset. Diversification is a defensive strategy -- it is meant to protect your portfolio during market downturns and to reduce your portfolio's volatility.

Your asset allocation strategy will depend on your risk tolerance, return needs, and time horizon for investing. While each person's asset allocation strategy will be unique, you should consider these tips:

To moderate your portfolio's risk, invest in both stocks and bonds. Stocks tend to have a low positive correlation with corporate and government bonds, meaning that on average, movements in stock prices will only moderately match movements in bond prices. Thus, owning both reduces your portfolio's risk.

With a long time horizon, you can increase your allocation to stocks. By staying in the market through different market cycles, you reduce the risk that volatility will adversely affect your equity performance. Those with a time horizon of less than five years should not be invested in stocks. Look at cash and bonds for those short-term needs.

Diversify within as well as among investment classes. For instance, in the stock category, consider value and growth stocks, small- and large-capitalization stocks, and international stocks. Bonds could include long-term bonds, intermediate-term bonds, high-quality bonds, lower-quality bonds, Treasury securities, municipal bonds, and international bonds.

Make sure you have reasonable return expectations for various investment categories. Basing your investment program on return estimates that are too high could cause you to increase the risk in your portfolio in an attempt to obtain higher returns.

Once you develop an asset allocation strategy, rebalance it at least annually. Since your strategy is designed to provide a stable risk exposure, you need to periodically rebalance so your allocation does not get out of line.

Make sure you have enough cash to handle short-term needs. That way, you won't have to sell investments at an inappropriate time, such as immediately following a market downturn.

Evaluate new investments carefully, ensuring they add diversification benefits to your portfolio. Don't keep adding similar investments, such as several stocks in the same industry. Not only does this not add much in the way of diversification, but it makes your portfolio more difficult to monitor.

Avoid following the market too closely. Your asset allocation strategy is designed to guide your portfolio's long-term makeup. Don't rethink that strategy simply as a result of a market downturn.

Should You be Worried about Deflation?

During the Great Depression in the United States, we saw a period of deflation. Now some economists are expressing fears that we may be in for a deflationary period again. Does this mean another Depression? What exactly is deflation and what causes it? Here is a brief beginner's tutorial on the subject.

Deflation is the net result of prices that fall for a protracted period of time. In other words during a period of deflation, your money buys more than it used to. Furthermore, the longer you wait, the more your money is worth and consequently, the more you can buy with it. This provides a strong incentive for consumers to hoard cash and wait to make purchases. After all, if prices are dropping you'll be spending less if you just wait. What's wrong with our money buying more? So far it sounds like a good thing.

To see the down side of deflation you have to look at it from a company's perspective. A manufacturer buys raw materials at a certain price and converts them into a finished good. The company then tries to sell those finished goods at a profit based on its real costs. However, the inventory that the company holds drops in value every week during a period of deflation until often they have difficulty making a profit. Furthermore since customers are wise to the game, they are holding off making any purchase and the inventory sits on a store shelf with its value dropping and dropping... and dropping. As the inventory builds up, companies see that they have to cut production due to declining demand and falling profits.

That's where it starts to hit home. Companies cut production by laying off workers en masse. Since deflation affects nearly every company across the board, unemployment can reach staggering levels. Now, in addition to those customers who are simply waiting for lower prices, there is a growing segment of the population without a job and without enough income to buy even if they wanted to. Demand falls further, which makes prices drop more, and even more workers are let go.

Borrowing during a period of deflation can be a painful experience as well. Whether it is a consumer borrowing on a credit card or a business borrowing for expansion or replacing capital equipment, in just a few months, they know they will likely still owe more on the loan than the items are worth. With each passing month, this difference between the real value and borrowed amount grows worse. Think of this in terms of today's declining home values. Nobody wants to buy a house that may be worth $50,000 less than they paid for it in a year or two.

Deflation, by definition, only occurs when inflation is less than zero. We are not there yet. Although oil prices and many commodity prices have fallen, overall, we are still paying more for goods and services as time goes by. Goldman Sachs has released an estimate that, by the end of 2010, inflation will still be at 0.25%. While that is extraordinarily low, it is still a positive number and doesn't give consumers any price incentive to wait before making purchases.

For now, then, it doesn't look like we are in for any significant deflationary period, but if unemployment continues to rise and consumer demand continues to fall, the danger does exist. It is something we need to watch out for at this point. There is also the danger of things swinging in the other direction. Runaway inflation makes your money worth less and less every day. If the government expands the money supply too much to get us through this period of recession and tight credit, we may find that once we start climbing out of the current economic woes, inflation takes holds and we could see sky-rocketing prices, but that's a discussion for another day.

Author: Brad Sylvester


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