5 lessons savvy savers can learn from the debt crisis
Congress has finally voted to raise the government’s debt ceiling so that Washington can now borrow enough money to pay its bills.
All of its bills. At least through 2012.
But the possibility that the federal government might default on its bonds, which have been considered the safest investments in the world for decades, was a shocking reminder of how hard it’s become to save for the future.
How are we supposed to build a nest egg large enough to pay for our retirement, or our kids’ education, if our investments are under constant assault by one economic crisis or financial calamity after another?
Perhaps we should start by considering these five lessons every saver should take away from the debt crisis.
Lesson 1. Stocks are still critical despite the rocky ride.
Washington’s debt crisis cost savers money.
Last week was the worst week in more than a year for the stock markets.
The Dow Jones Industrial Average was down nearly 4%, and it continued to fall even as Congress was voting on its deal to keep the government functioning.
It was tough to watch retirement accounts, many of which had just recovered from the 2008 financial crisis and recession caused by the banking industry, swoon again.
But we’ve got to endure that volatility, because there’s virtually no way to build wealth without the substantial, potential returns, only stocks can deliver.
We can’t guarantee that you’ll succeed no matter how much, or how wisely, you invest in equities. But we can guarantee that you won’t succeed if you don’t take that risk.
This is especially true if you’re young and have another 30 years before you retire.
You can’t worry about what happens this week, this month or even this year. Think decades.
Let’s say you currently have $30,000 in your 401(k) plan, sock away $4,000 per year and earn an average of 7% a year. In 30 years, you’ll have more than $620,000. (You can project how your retirement plan will grow with our 401(k) calculator.)
Now let's say you're scared of the market and decide you're only going to put your money in CDs and money markets.
Even if you put away $5,000 per year and earn an average of 2.5%, you'll have only $287,000 at the end of 30 years.
Lesson 2. We’ll never look at Treasuries the same way again.
Our deeply divided government came to a compromise this time.
But a shocking number of lawmakers -- primarily Republican lawmakers -- were willing to let the federal government run out of money and potentially default on its debt in pursuit of their political goals.
Negotiating a reduction in the federal deficit is one thing.
Threatening to cut off the money the Treasury Department needs to pay interest on the government’s debt and repay its loans as they come due is a sobering tactic to anyone who owns government bonds.
Thanks to this take-no-prisoners politics, it’s possible that one or more of the major credit rating agencies may downgrade the government’s debt.
If that happens, the market value of Treasury bonds will fall, including those in our retirement funds, and our net worth will take another hit.
If more than one debt rating agency downgrades Treasuries, the money market funds and institutional investors required to hold only AAA debt could be forced to a sell their substantial holdings, driving prices even lower.
It’s a trust thing, and our trust will never be the same.
Lesson 3. Cash is king.
Move over Treasuries. Bank deposits are now the safest investments.
The only holdings we didn’t have to worry about while the threat of a government default hung over our heads were our certificates of deposits, savings and money market accounts.
We may not make much off our federally insured bank accounts, but at least we know our principal is not at risk.
Even if you’re young and have a large portion of your assets in equities, you should also need enough cash to weather any of your own personal storms.
Have at least six to nine months’ worth of living expenses in your bank accounts so that you don’t have to sell stock or Treasury bills when their prices are depressed and you lose your job or have emergency expenses.
Lesson 4. You’ve got to know when to get out of volatile investments.
It seems one crisis after another is going to roil the financial markets for the foreseeable future.
That means you’ve got to know when to move your savings from volatile markets into cash as you get older.
A general rule of thumb is that you should have no more than 100 minus your age in stocks.
If you're 62, for example, you shouldn’t have more than 38% of your savings still in stocks.
It used to be you could fudge on that rule and risk more of your savings in equities as you got older without much concern. But no more.
Protecting your principal and making sure it’s readily available to cover your living expenses must be a top priority for anyone nearing retirement.
You don’t want to run short of cash and have to sell stocks or bonds during a big downturn.
Lesson 5. The next crisis is already on the way.
While the Great Recession ended in July 2009, the recovery has been tepid at best, and recent data indicate the economy might be stalling again.
There’s a growing concern that a "double-dip" recession may have already begun, which means we could be entering another period of stagnant growth and job losses.
Economists point to such harrowing signs as:
- Housing continues to be a huge drag on the economy. Home prices have fallen to 2002 levels, and 4.3 million homeowners are currently “seriously delinquent,” which means they are more than three months behind on their payments and probably headed for foreclosure.
- The economy has recovered only about 1.77 million of the 8.75 million jobs lost during the 18-month recession, and job creation seems to have stagnated this summer.
- Manufacturing, which had been rebounding more strongly than many parts of the economy, is now slowing. New orders contracted in July for the first time since June 2009, and car sales have sagged since May.
You're going to be on your own from here on out. Save your money, stay out of debt, sit tight on your investments and do the best you can do hang onto your job.
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