Have you heard of a double dip recession or a Black Swan? If either of these takes place, which is not out of the realm of possibly given current economic conditions, your financial future may be at serious risk. In order to avoid the effects of these two events, you must have your finances protected and diversified as much as possible. I am going to tell you how.
First, let’s take a brief look at these two adverse economic events. Remember the financial meltdown that started in late 2008 and has extended through 2010? This meltdown that later turned in to a recession was responsible for the loss of property values, 401K balances, and an unemployment rate of nearly 10%. The economy has improved but the double dip theory says that those times during 2009 when America was in a financial tailspin may return sooner than you think if housing and employment do now show material improvements. Can your bank account withstand another recession or more important, can your employers?
A Black Swan on the other hand isn’t actually one event. This type of event is based on the book, The Black Swan by Nassim Taleb, which has been getting a reasonable amount of press lately. The book contends that there are some events that will have a worldwide, local or national negative impact that cannot be planned for. These types of events can have a catastrophic impact on not just life and property but also on world financial markets. The most notable Black Swan event in recent history was the September 11th terrorist attacks. This event caused a financial impact that could not have been forecast.
Either of these events could affect you as early as tomorrow and if it did, statistics show that Americans are largely unprepared and vulnerable to large scale financial changes should something happen. What should you do to prepare for such events? After all, the world continues on and bills and taxes still need to be paid once things return to normal. You want to make sure that you have the financial resources in place to deal with these events.
Start an Emergency Fund
If you lost your job tomorrow due to an adverse financial event that affected your company, how much money would you need to have saved to continue paying all expenses for the foreseeable future? Financial advisors vary on how long you should have financial coverage for, but the consensus is for at least 6 to 12 months, and the more the better. Also, remember that the FDIC insurers up to $250,000 per account, so spread your savings in various high yield savings accounts to make sure your emergency (liquid) savings are adequately insured.
Fully Fund Your Retirement
Don’t count on your employer to take care of your retirement fund and social security could very well dry up before you reach the age of retirement so relying on anything other than your good saving habits may keep you working well beyond your retirement age. Retirement limits for 401K and IRA accounts are on the rise and those over 50 have the chance to make catch-up contributions on a pre-tax basis. So make sure you take full advantage of these accounts, which also effectively reduce your marginal tax rate.
Speaking of Retirement
Diversify your retirement fund. An employee sponsored IRA might seem like enough but what if the Black Swan event occurred 6 months before your retirement? If you’re close to retirement, your funds should be largely allocated towards fixed income instruments like treasury bonds or even a Certificate of Deposit. However, you don’t want 100% allocated towards such low paying investments but should the unthinkable happen, those parts of your funds that are in a CD or even a savings account will be the most well protected. On the other, if rising inflation is a fear during your retirement years then consider TIPS (Treasury Inflation Protection Securities) or a guaranteed annuity
Minimize (and later eliminate) Debt
Like the dentist telling you to floss, you’ve surely heard this repeatedly but it’s vitally important. That Black Swan event could take place more locally. What if it’s a sudden decline in your health that doesn’t allow you to work? If that happens, you don’t want to have to worry about how you will pay mountains of debt payments. The reason you don’t want to be in debt is because your future and the future of the global market is a variable that is unknown. Those who aren’t in debt always wake up with a clean slate.
Boring is Best
You may have heard about people who have made a lot of money in the stock market and some of those stories are true. What isn’t largely reported is the amount of time they spend researching and performing other legwork to make that money. They also have specialized knowledge about the stock market just as you do in your job. For the part time investor, boring is best. Purchase stock in high quality companies that pay a dividend. Make sure you have your money in a variety of sources. If one of our two events occurs, your stocks will be the first to be negatively affected. (See Morningstar’s free X-ray tool to review your portfolio)
Not all stocks pay a dividend and if you’re a part time investor you should stay away from those in most cases. A dividend pays you simply to hold on to the stock. Some companies pay 6% and more each year. Even if your stock temporarily loses value, you can count on the dividend. The other reason to stick with dividend paying stocks is due to the fact that when the stock market experiences a decline, these stocks are normally not as adversely affected as other stocks.
We always want to assume the best. We believe that tomorrow will be a better day but as we’ve seen in the past few years, being prepared for those darker financial days is vitally important. Thus, when the good times return (and they will) you will be in position to leverage of your solid financial base and build an even strong financial future.