There's a rising anxiety about the U.S. economy. Fueling this is the news of major financial companies taking huge losses due to subprime mortgage defaults, slumping home values, and consumers' purchasing power being sapped by high energy and food prices. If you're concerned about a coming slowdown in the economy, you are in good company: Most economists surveyed are predicting a slowdown, at best, and a full-blown recession at worst. A growing chorus of Wall Street investment banks, including Goldman Sachs, Merrill Lynch and Morgan Stanley are stating that the slowdown in the U.S. economy will turn into a recession.
According to public opinion polls, almost six-out-of-ten people believe the economy is already in a recession. An interesting indicator, the "R-word" index" -- the number of stories appearing in the Washington Post and New York Times that use the word "recession" -- has spiked in early 2008. According to The Economist, this simple tool pinpointed the start of the recessions in 1981, 1990 and 2001.
You only have to go back to 2001 to remember the last recession that hit the U.S. economy -- marked by the collapse of the NASDAQ stock market bubble, 9/11, and job losses.
But what is a recession? What does it mean for the economy this time? How will a recession affect you and your money?
Generally, a recession is a prolonged period of time -- typically six-to-12 months -- when the economy is slowing down, or contracting. Recessions are nothing new: There have been 11 since 1945, and these are a natural part of the economic cycle.
Recessions are characterized by several trends, including a slowdown in consumer spending, a decrease in production at factories, rising unemployment, falling personal income, and a volatile and falling stock market.
Is the US economy in a recession? Well, consider this: Consumers spent less than expected during the recent hliday shopping season, recent job figures showed a rise in unemployment, person income has been diminished by higher prices of food and energy, and the U.S. stock market has fallen over 10 percent since October of last year. That's four-out-of-five of the above trends that signal a recession is coming, if not already upon us. People need to know that a recession can affect two things - job security and interest rates -- and they need to connect the dots between this and their money.
With evidence of a slowing economy and grumblings of job cuts in the financial sector, workers need to buckle up and check the strength of their financial safety net. Here are a few financial moves to soften the blow.
Build a Cash Cushion
The average length of a job search is five months. It could take even longer if you are employed in the financial sector that's in turmoil because you might need more time to shift your skills to a career with more opportunity. For this reason, it's important to have at least three-to-six months of cash on hand, or more if you are the sole income earner or self-employed.
Consider these moves to increase your cash cushion:
Here's why getting a tax refund every year is not a smart thing: When you get a large tax refund, this simply means that you are having too much in taxes deducted from your pay. Since you only settle this overpayment up with the IRS once each year, at tax time, you are letting the IRS keep this money as an interest-free loan. Would you overpay your cable bill or overpay your rent by several thousand dollars just to ask for it back a year later without any interest? Of course not!
If you could use the cash instead of giving the IRS a zero-percent interest loan, then reduce your tax withholding by increasing your withholding allowances, changing your withholding status, or both. Here is how to do this: Complete a new form W-4 and submit it with your employer's payroll department. Do it now, so that the change will be effective for the next pay period. You can then put the additional cash you'll get in your paycheck to work increasing your savings.
Lock into Higher Rates on your Savings
With interest rates low and likely to go lower, getting the best rate on your cash in savings and locking into that rate is even more important. Don't settle for the standard bank rate of 0.5 percent to two percent on your savings. Look instead to moving some of your cash to certificates of deposit, from which yields are higher. An added bonus right now: Many banks have not yet lowered the rates they pay on these, since they continue to be an attractive source of funds for them to obtain to back the loans they make. With a little research, you can find yields on FDIC-insured one-year certificates of deposit of more than four percent at places such as:
Countrywide Bank, FSB: 5.10 percent
E-Loan: 4.97 percent
Discover Bank: 4.6 percent
ING Direct: 4.55 percent
Pay Off 401(k) Loans
This can compete with the goal of building your cash cushion, but it is more important. If you have an outstanding loan from your 401(k) plan, consider paying it off. The reason is that if you leave your job, most plans require you to either repay the loan within 30 days of termination, or they will treat the loan amount as a taxable distribution. This creates a tax and penalty ambush for an unsuspecting and unfortunate worker, because income taxes and early withdrawal penalties will be assessed on the amount of your loan if you are under age 59-½. If possible, try to pay off these loans from other sources.
Recession-Ready Your Portfolio
Studies of stock market performance find the following:
That said, the past is not always a good indicator of the future. Long-term investors should follow a few simple housekeeping rules, such as rebalancing their portfolios -- last year, some funds, such as emerging market stock funds, posted outsized returns and could now be a larger portion of, and increase the risk of, your portfolio. Consider trimming these back to your target allocation and reinvesting the excess back into the funds that need to be increased to get your portfolio back into balance.
Also consider this: Falling interest rates and rising energy and food prices can create opportunities for investors such as:
Treasury Inflation Protected Securities: These are a special of Treasury bonds that can benefit two ways: Their values can rise as the Fed lowers interest rates, and they can generate higher yields as inflation increases. Consider this: The iShares Treasury TIPS exchanged traded fund (TIP) increased about 11.97 percent in 2007.
Utilities: Typically during recessions, one of the sectors that have grown is the residential electricity sector. One way to participate in this is to invest in the iShares Dow Jones U.S. Utility Index exchange traded fund (IDU), which seeks to provide the return of the Dow Jones U.S. Utility Index. In 2007, this fund returned 16.7 percent.
Energy: With prices for oil and gas at historical highs, it's hard to believe prices can rise from here. But with the growing consumer base in China and India, and global growth in general, it's hard to see a disruption in this secular trend. A simple and effective way for investors to get exposure to this sector has been through the iShares Dow Jones Energy exchange traded fund (IYE), which increased over 35 percent in 2007.
Commodities: Rising prices on food, fuel and other commodities can strain your cash flow, but they can also give a boost to your portfolio. Consider the Power Shares Deutsche Bank Commodity Index exchange traded fund (DBC). This fund seeks the return caused by rising futures prices of things like crude and heating oil, aluminum, gold, wheat and corn. In 2007, this fund returned over 31 percent.
A few other ways to play a bet on rising agriculture and commodities prices include the Market Vectors Agribusiness exchange traded fund (MOO), which seeks to replicate the performance of the DAXGlobal Agribusiness index and the Elements Rogers International Commodity Index exchange traded note (RJI), which seeks to provide the return of a basket of 35 commodity futures contracts.
Get Credit While You're Worthy
Remember the old expression that credit is easier to get when you don't need it? If you don't already have a credit card, get one. If you have one, request an increase in its limit. And shop around for a card with the lowest interest rate. Also, if you own a home worth more than your mortgage, establish a home-equity line of credit. Do so while you are employed, because the lender will want to verify your employment and pay.
Make Your Benefits Portable
The loss of a job also can mean the loss of important benefits. It can also mean the loss of your retirement savings and a nasty tax trap:
A job loss can disrupt critical health coverage. If your spouse is also employed, check with his or her employer's plan to see what is required to get covered under that plan. If this is not an option, look into your employer's policy for health insurance continuation coverage. Most employers are required by law to allow you to pay for and continue coverage in their plan for up to 18 months. Also, look into switching to a health plan with a high deductible -- these will usually be the lowest cost options.
Don't forget to replace any employer-provided life insurance that you rely upon. Low cost term life insurance is available and easy to get from sources such as Quotesmith.com and Insweb.com. In addition to being portable, getting a personal term life insurance policy is usually much less expensive than coverage under most employers' plans.
Make Yourself Portable
Update your resume and include a list of recent accomplishments and responsibilities. Do not simply list your positions; instead spell out your professional experience that highlights your range of talents and abilities. Also, update your list of contacts at other companies that you would use as a network if seeking employment.
Remember that the best offense can be a good defense. Being prepared financially will lessen the blow if a recession affects your money.