Four more ways to stop a financial crisis derailing your money goals

So you’ve done your four financial crisis checks:

• Your savings are safe
• They’re earning more interest
• You’ve got a plan to pay off any debt
• Your mortgage is sorted for the foreseeable future.

Time to turn over and fall back to sleep?

Possibly. I’m serious! It’s often too late to Do Something once a financial crisis is underway. If you follow the daily advice of the financial TV channels and churn your portfolio, the only person who’ll get rich is your stockbroker.

It’s better to calmly consider where you’re at, financially, and where you’re going. It’s certain you’ll encounter several testing times during your investing lifetime, and a cool head could save you a fortune.

In this post I’ll look at four more ways to deal with a financial crisis:

• Don’t sell in a panic
• Consider buying when markets are down
• Earn more cash before the crisis spreads to the wider economy
• Be sure to have a solid plan you believe in so you’re not spooked next time

1. Check your portfolio… calmly

At times of financial crisis, stock markets fall

If you’ve investments in funds or shares, you’re likely well down:

• Most stocks are hit in a financial crisis, usually before any impact is apparent in the economy
• Often a specific sector hurts the most, as with the dotcom bust
• The only exceptions in this 2007/2008 crisis are investments related to commodities, and the markets of countries dominated by miners and other commodity producers
• Bear markets pull everything down, so don’t expect that out-performance to continue if we’re in a true bear market

Are these falls rational? Can a big supermarket retailer, a provider of networking technology, and a manufacturer of metal cans ALL really be worth 10/20/50% less than just a few months ago?

Of course not. They were either overvalued then, or they’re undervalued now. Remember, the markets are driven by sentiment – fear and greed:

• Company specific falls in bull markets indicate bad news about that company
• Across-the board falls in bear markets tell you little about the companies and everything about the market.

No crisis is all bad news, financially-speaking, since different asset types respond in different ways.

In this current credit crunch of 2007/2008:

• Gold has risen
• So have government bonds, such as US Treasuries and UK Gilts, due to their rock solid security
• Corporate bonds have wobbled on credit fears
• Interest rates on savings are up, even after central bank base rates have been cut
• House prices are falling

This varied performance is why we’re urged us to diversify our portfolios. One asset going up will ease the unpleasantness of something else going down, just like sugar in a child’s medicine.

What this means for our investments:

• Funds and index trackers are volatile when the stock market is unsettled
• Pensions linked to the stock market will be down
• Most investors’ current net worth will fall. If you’ve a big portfolio built up over many years, the numbers can seem frightening when compared to your salary
• Diversified investing can reduce the pain

Action plan

• Unless you’ve been silly (putting all your money into real estate or tech start-ups or some other overweight bet) the best plan may be to sit tight.
• Don’t sell just because the market falls. As Benjaman Graham said, just because a gloomy Mr Market has slouched up with a particular price on some particular day, that doesn’t mean you have to accept it. One day he’ll be generous again.
• If you sell whenever the market falls, you’ll destroy your long-term gains…
• … unless you sell before they fall further, of course. But very few investors can consistently time market drops, and in my experience those who can seem to have trouble buying back in.
• Few great investors are market timers. (For instance, Warren Buffet isn’t selling, and in fact he may be buying). Buying and holding over reasonable periods is a better strategy for nearly all of us.
• If after several good nights’ sleep you decide you really are too exposed to some particular market, consider slowly selling down your holdings. Do consider though how you’ll feel if markets bounce back after you’ve sold!
• With stock markets, it’s fairly easy to do reduce your exposure (which is exactly why you should only do so calmly). With some assets, such as property, you’ll need to plan your disposals more carefully.
• Read up on asset allocation so you’re better diversified against future downturns. One very simple rule of thumb is to subtract your age from 100: hold your age in various bonds and the rest in shares. Some advocate an even simpler 50/50 ‘lazy’ strategy.

2. Consider buying more shares while they’re cheap

At times of financial crisis, some shares look very cheap

Nobody really knows why or when exactly a bull run will turn into a bear market. Even with the current credit crisis, it’s hard to tell if say the sub-prime collapse is truly a cause or just a trigger. We’d been broadly going up since 2003, which is a long bull run in historical terms.

The common wisdom is that the credit crisis has spooked investors into reconsidering the risks they’re taking, yelping, and then selling out. Also some market players, such as banks and hedge funds, have sold certain assets just to maintain their liquidity. These sales may have little to do with the intrinsic value of their holdings.

What it means for us

• Some sectors will look cheap in a crisis. The trick is telling which fell because they were wildly overvalued before, and which have been dragged down by association. (If you bought into seemingly cheaper tech companies in 2001, for instance, you watched your shares fall further.)
• For most of us, the answer is to buy the market rather than trying to be too clever, by drip feeding money via a cheap index tracker or an ETF.
• If you’re feeling lucky, some banking, financial, and property companies have come down a very long way, and seem to be discounting the Great Depression. (But remember the techs!)
• Some entire markets look very cheap. The Japanese Nikkei, already down over nearly two decades, has plunged yet again, to the extent that a large number of its shares are trading at less than book value – something you rarely see in the West.

Action plan

• In the long-term, cheaper shares are good news, giving you an opportunity to load up at bargain prices.
• Read more on why I buy shares in bear markets.
• Think of a bear market as getting 50% off in the sales, provided you planned to buy more shares anyway and doing so fits your overall strategy.
• Naturally, shares could fall further. The gloomiest predictions are very gloomy. As ever, nobody really knows for sure.
• Dollar-cost averaging via monthly savings helps smooth out the highs and the lows of investing, and takes our faulty judgement out of the equation – good for your mental health as well as your wealth!

3. Get a pay rise, or start making cash on the side

At times of financial crisis, cash means security and opportunity

The US is probably already in recession. The rest of the world may follow. Nobody knows how hard or deep the economic hardship will be. For people losing their sub-prime homes, things are already very tough indeed.

The outlook could improve from here, or it could easily get a lot worse, fast. We can kid ourselves that we know better than the millions of other people out there, or else we can concentrate on being prepared for any eventuality.

What it means for us

• Having three to six months salary as cash savings should be your first priority at all times, let alone when jobs may soon be lost and incomes dry up.
• For the wealthy or the previously prudent, having extra cash will let you buy more shares, bonds, or property at depressed prices.
• Regarding the current crisis, if credit really is being drained out of the financial system, those with savings will be rewarded again in the years ahead, after years which favoured debt.
• We’re already seeing this with higher interest rates on savings, and better mortgages for those with a larger deposit.
• Always beware the return of inflation.

Action plan

• Don’t look for cash when you’re desperate. Build up your savings now.
• If you’re an employee, make your job indispensable. Try to tweak your role so your employer sees your positive impact on the company’s bottom line.
• If you’re an employer or you’re self-employed, diversify. I’ve deliberately sought out new clients since Christmas, just in case any of my existing ones don’t make it.
• Start earning money outside of work in your own time. Employ an unused talent, or do something you don’t enjoy but find easy. Examples: Building furniture, teaching Spanish, completing tax returns, cutting down trees in gardens.
• Ebay everything you own that is ugly or that you have no use for.
• Do all this before everyone else starts doing it. Save whatever cash you get.
• It’s been a long-time (nearly 20 years) since the US and UK suffered a bad recession. The above probably sounds very quaint if you don’t remember it. My fingers are crossed as well.

Note to the skeptical: I’m writing this in April 2008. If the wider economy doesn’t turn sour and deep recession threat is averted, by all means buy yourself a treat with the cash you saved. Then try and find something bad to say about me suggesting you prepared just in case. Toast my bad advice with champagne!

4. Revisit your long-term goals

At times of financial crisis, we’re reminded things change

Most people reading this post will hopefully enjoy a long and happy life, in which you’ll encounter every kind of economic climate.

My oldest living relation is 94. She walked geese to market as a young girl, lived through two World Wars, used ration books for years, thought TV dinners were marvelous, never owned a car, and gives sweets to children who get more pocket money than she gets in a week’s state pension.

In just the past 15 years we’ve seen inflation plunge, migrants flock to jobs in the West, the dotcom boom and bust, gold quadruple in price, China become the world’s factory and US property price falls for the first time in living memory.

What it means for us

• Nothing stays the same.
• Today’s No Money Down is tomorrow’s No Mercy Repossession
• If you believe we’ll never see inflation, mass unemployment, major stock market upheaval or more transformative technologies again, you’re a braver man or woman than I.
• A good long-term financial plan transcends this day-to-day detail (coups, wars, or revolutions aside).

Action plan

• Commit to a goal of financial freedom.
• Read a good book on personal finance or my modest eternally true 10 steps.
• Write yourself a plan.
• At the least, you want to know how much you can save each month and where to invest it
• Consider doing so via a pension or some other form of tax efficient wrapper.
• I favour targeting a monthly income as opposed to a net worth figure, since net worth fluctuates so much with the markets.
• If you do retire young, I’d suggest you try to stay exposed to the stock market. This gives you a stake in the global economy. You don’t want to retire on today’s salary, only to discover some day that due to wage inflation you’re relatively poor. A high-yield portfolio of dividend paying shares is one way to get a relatively stable overall income from shares.

Thanks very much for reading this far – I hope you’ve found it useful. To keep your finances up-to-date, subscribe to Monevator via email or RSS. It’s free!