Thursday, July 10, 2008

Financial Mistakes That Are Okay in Down Times

Almost all asset classes are stagnant or falling in value. Even oil is treading water. There don't seem to be any good investments. It's easy to step back from saving and investing when you think you'll lose money tomorrow, next week, next month and even next year. Add growing inflation to the equation and the mentality of the 1970s could set in, when it seemed smarter to spend immediately on consumer durables like cars, TVs, washing machines, air conditioners and so on because the price would only be higher in the future. Conventional investment wisdom teaches that you should continue to invest on a disciplined basis, dollar cost averaging as markets sink and thereby lowering your overall investment costs. But when investing in stocks feels like choking down fried liver and stewed beets, this is more easily said than done.

The worst financial planning mistake of all is to stop saving. If you don't save, you won't have much of a financial future. Life on only Social Security is dreary at best, especially after you run out of ketchup to put on the dog food you bought on sale. Unless you're laid off, the one thing you should always do is keep saving. If you're having trouble stepping up to the plate and buying more assets likely to sink in value, feel free to make a few investing "mistakes." These are things that you shouldn't normally do. But every rule has exceptions.

Keep it in cash. Put your savings in a money market fund, money market account or other short term investment. (See for short term investing ideas.) This insulates you from losses. You also won't get much in the way of returns, and could miss out on market gains. Don't keep the money in cash indefinitely. But if this is what it takes to let you save and sleep at the same time, do it for at least the time being.

Time the market. Ordinarily, investment gurus frown on market timing. It's impossible for almost all people to identify market trends accurately. If you feel better about saving with the idea that you'll keep your money in cash until the market appears to hit a bottom or turning point, give it a try. Your chances of success at market timing aren't high, but at least you're still saving.

Build up cash instead of paying down high interest rate debt. If your cash reserves are low or nonexistent, it makes sense to build them up in these times of recession. You don't know when you might be laid off, or your bonus cut. Cash is king when times are tough, because these are the times you won't be able to get a loan when you need it the most. Even if you have to maintain some high interest rate debt, building up a cash reserve of three to six months living expenses (including minimum payments on your debt) is a good idea.

Borrow, if you must, from your 401(k) account. Normally, borrowing from a retirement account is a big no-no. But if your back is to the wall, and you're permitted by your 401(k) plan to borrow from your account, it's a better loan than borrowing from a credit card at a very high interest rate and very possibly easier than wrangling with a bank over your rapidly evaporating home equity line of credit (which nowadays banks are yanking left and right with little notice). You'll lose investment gains on the borrowed amount while the loan is outstanding. But at least those funds will eventually return to the role of funding your retirement. If you withdraw them from your 401(k) account, you'll pay taxes, and a 10% penalty if you're less than 59 and 1/2 years old, and lose the potential investment gains on the money forever.

If you make these "mistakes," return to a habit of steady saving and investing as soon as possible. That's how to build wealth over the long term. Don't chase returns by investing in the latest "hot" investment. You'll end up being a sucker for every asset bubble just before it bursts. And don't give up on building wealth. This is one aspect of life where it's abundantly true that quitters aren't winners.

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