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Tuesday, 26 February 2008

Fighting the Financial Fear Factor

by Suze Orman

Declines of more than 10 percent in the major stock market indexes over the past few months, along with the growing expectation of a recession, have set off a massive investor call to action.

By action I mean the urge to flee stocks for the apparent safety of bonds or cash. For the vast majority of investors, that move can be a costly mistake.

There Will Be a Test

At the same time that many people are overreacting to the recent market volatility, they're underreacting to other facets of their financial lives. The same fear that causes someone to bail out of a stock fund when the markets slip causes them to not act when faced with bills they don't think they can pay.

Be it a credit card statement or an impending mortgage reset, the tendency is to do nothing, and that inaction ends up costing a ton in the long run. Fear is natural, but there's a right way and a wrong way to handle fear when it comes to finances. Knowing when to act and when not to act is one of the keys to financial security.

Right now, we're all being put to the test. The choices you make in today's volatile market environment and slowing economy are going to have a huge impact on your financial health years from now.

When to Stay Put

First things first: Those of you who are active day traders, stop reading right now. My advice is not, and never has been, geared to you. I'm concerned with the millions of Americans who invest for the long term via their 401(k) and IRAs, and are scared by the recent declines in their portfolios.

For these long-term investors, the best advice is to do nothing. Yes, nothing. If you have a well-diversified portfolio that's focused on building value over the next few decades, it doesn't make sense to overreact to a few months of volatility and bail out on stocks. It's no fun watching your portfolio fall, but you need to focus on a bigger problem: If you put all your money into super-low-risk investments such as money markets or stable value funds, you increase your risk, too -- the risk that your portfolio won't grow enough over time to build a hefty retirement account.

I know what you're thinking: When the market rebounds, I'll jump back in and ride the next bull run. Nice theory. But the truth is that it's ridiculously hard to be a consistently correct market timer. What tends to happen instead is that we react too late on both sides of the market by bailing out after our portfolios have already taken a sizable hit, then getting back in after we've seen the markets rebound -- in other words, well after the bull has started its run. That's a losing strategy.

Fear and Greed

If your investment time horizon is 10, 20, or 30 years, stay invested in your stock funds and ETFs. Over time (meaning decades, not weeks), stocks have consistently outperformed other types of investments. That includes periods when the stock markets fall. Doing nothing is going to net you better long-term results than doing something.

In fact, right now, sticking with your automatic 401(k) investments is a great move. Because prices are lower, your money buys more shares. When the markets rebound, the more shares you have the more money you make.

If you need some encouragement to stay the course, how about a little Warren Buffett wisdom? As Buffett has said, "Try to be fearful when others are greedy and greedy when others are fearful." Right now, there's a whole lot of fear. Keep adding to your stock investments rather than bailing out and you'll position yourself well for the next upturn.

When to Get Moving

As quick as people are to react when their investments start to slide, they do just the opposite when dealing with debt. When faced with bad news about debt, the typical reaction is to freeze and want to do nothing.

I'm talking about ignoring your credit card bill because you know you can't afford to pay it off, or ignoring a big interest rate jump on your card balance. Or, when you know your mortgage rate is going to reset, and you know it's going to be too expensive to handle, you don't get proactive before the lender starts breathing down your neck.

Inaction is inexcusable when dealing with cash flow issues. You need to do something right away -- the longer you let the situation fester, the worse off your finances will be. Inaction just leads to big problems down the line.

Now, Not Later

If your problem is credit card debt, the best first step is to simply pay the minimum amount due on time. By paying just the minimum, you'll keep the credit card company off your back and have a good chance of not hurting your credit score. That's important, because the next step is to see how you can reduce your credit card costs.

If you have a record of on-time payments and a FICO credit score of 700 or so, you've got a good shot at getting your interest rate reduced simply by calling up the card issuer and asking. If that doesn't work, your next step is to shop around for a balance transfer to a card that gives you a better rate deal; just be sure you understand the transfer costs. You can learn more about transfers and better card management here.

Those of you facing an unaffordable mortgage reset also need to take action; sitting tight is just not going to cut it. I'm not going to sugarcoat this -- the odds of your lender working out some sort of deal with you aren't exactly great, but to have any chance you need to be proactive. That means contacting the lender to talk about any restructuring options long before the reset hits. If you wait until your situation is dire -- that is, when the reset kicks in and you fall behind on your payments -- the lender has lost a whole lot of motivation to work with you.

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