The Credit Crunchy Finances

The Labor Department release on consumer prices showed a 1% drop last month in the past month. The change was largest since 1947 and comes along with troublesome news, such as lowest home builder sentiment, markets trading at new lows, and a pending automaker bailout. With the financial crisis damaging the US economic foundation, you may wonder what’s in store for you. There are a few key strategies to employ while running your finances in a crisis mode. Which ones you use and to what degree they are used depends on your situation.1. Prepare a substantial emergency fund. An emergency fund is a pool of liquid assets that you allocate for emergency needs, such as loss of a job or sudden medical expenses. Normally, it should consist of three to six months’ salary. However, in today’s severe conditions, you should pack away the maximum – six months’ worth – and more if you can. Remember to keep your emergency fund easily available such as in a banking account, not in investments, because if you need to access money and your investments are down, you will be forced to take a loss. If you don’t have enough cash, consider buying a job-loss insurance policy for one year to protect yourself from the danger of increased layoffs around the country.2. Adjust risk. Adjust your portfolio risk to the ongoing reality of the economic times. Stocks and bonds, as well as mutual funds and ETFs are now more volatile than normal. If you did not adjust your portfolio previously, you might be exceeding your preferred risk level by owning too many equities compared to what you normally hold in a more stable market. In order to maintain your level of risk, you should counter the risk exposure by allocating less to stocks, and moving more into bonds. In present times, it’s best to reduce stock exposure 2-3 times lower than your normal level. For example, if your typical portfolio is 80% equity against 20% bonds, consider moving to 40% stocks and 60% bonds.3. Employ wise leverage. If your emergency fund is in place, and you’ve been thinking about using credit for a particular purpose, do it now. With the inflation rate nearing 5%, it’s now the best time leverage your good credit. By the time you pay off your debt, the credit will likely be worth less than it is now, and high inflation will effectively minimize your interest cost. But remember, using credit is advisable only if used for strategic purposes, such as making necessary renovations to your home or purchasing a more fuel efficient car. Credit shouldn’t be used as a source of funding extravagant purchases or as a way to build savings.4. Take advantage of tax breaks. Sell your worst performers before the year-end to offset any taxable gains. If you have been fortunate to hold gainers along with some losers, look at selling the losers. If your capital losses exceed your capital gains – a very likely outcome this year – up to $3,000 can be deducted against your taxable income per year (up to $1,500 each for a married person filing separately). Because this annual allowance runs out in a little more than a month you’ll want to act quickly to take advantage, and you will have funds to reinvest as the outlook becomes better. Wondering what stocks to sell first? The stocks that have fallen over 80% since the time you purchased them. It is typical for stocks that have fallen that much to not return to previous highs, so you don’t need to hold them.5. Ensure a better retirement. It is also the best time of the year to convert your traditional IRA into a Roth IRA – and pay lower taxes. Because the value of stocks and mutual funds has dropped so much, your tax burden at conversion will be much lighter. You can then take advantage of tax-deferred growth in your new Roth IRA, and tax-free distribution when retirement comes.

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