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Saturday, 18 October 2008

How to survive the next depression?

Let me make it clear at the start: I don't think we're headed for another Great Depression.

Many of you disagree. More than half the people polled in a recent CNN survey believe an economic depression is either very likely (21%) or somewhat likely (38%).

I do believe that a recession is probable, that it may be severe and that many people will lose their jobs in the coming months.

But I don't think we'll return to a time when:

* The official unemployment rate was 25%, with many more people who either gave up looking for work or who involuntarily worked part time.



* Bank failures wiped out the life savings of millions of customers.



* One-third of the nation was, as President Franklin D. Roosevelt famously put it in his 1937 inaugural address, "ill-housed, ill-clad, ill-nourished."



This 12-year period of economic disruption and widespread poverty was unprecedented in our nation's history. From it sprang many of the safety nets -- including Federal Deposit Insurance Corp. coverage, Social Security, unemployment insurance and food stamps -- that, though overburdened now, will continue to keep our most vulnerable citizens from falling into the destitution that characterized the Great Depression.

Still, I think we're in for a rough ride. And the smart steps to take now are virtually the same whether you think what's coming is a run-of-the-mill downturn or a once-in-a-lifetime cataclysm.

Such as:
Implement your austerity budget
Pretend you just lost your job. Whatever expenses you'd cut in that situation, cut them now and use the savings to build up your emergency fund and pay off your toxic debt, such as credit cards.



"If you'd shut off the cable (after losing your job), shut it off now," says Sheryl Garrett, founder of the Garrett Planning Network, which represents fee-only financial planners who charge by the hour. "Only spend money on essentials."

If you need some inspiration, check out "Could you stop spending for a month?" Many people find they can save hundreds of dollars a month just by changing their food purchases: eating at home instead of dining out, cooking more meatless meals, reusing leftovers and shopping with coupons.
Erase that toxic debt
You know you should have done it long ago. Credit card debt is expensive and leaves you vulnerable to the ever-changing whims of credit card companies, which have been raising interest rates with abandon.



Now, though, shedding credit card balances may be critical. If you still have a job, Garrett says, use it to pay off this cancerous debt.

"Go ahead and get serious about it. Be a grown-up," Garrett says. "Realize you aren't going to get bailed out by a 0% credit card offer or another mortgage refinance."

If you're seriously behind -- if you can't pay the minimums or if you're getting collection calls -- make appointments with a legitimate credit counselor and a bankruptcy attorney. Between the two, you'll learn your options for dealing with truly difficult debt. Don't panic. Historical data show that, short of another Great Depression, investors who hold on for 5 years don't lose much money, even in a bear market, says MSN Money's Jim Jubak.
Keep your emergency exits open
Once you've paid off the cards, don't close them. Not only can closing accounts hurt your credit scores -- which have become all-important lately for getting loans -- but you may need access to that credit in an emergency.



The same holds true for other lines of credit, including home-equity lines. If you've got access to those, try to keep them open and unused so they're available in case of emergency.
Try to stay employed
No kidding, right? But here's exactly what that looks like: Volunteer for extra work, nab high-profile assignments, keep higher-ups apprised of your victories and value to the company.



Don't complain, and steer clear of people who do. And if you're on irredeemably rocky ground, tune up that resume now and start networking.
Pile up cash

In bad times, cash is king. Your emergency savings will pay the bills if you lose your job and will generally help you sleep better at night. Set up automatic transfers into a high-yield, FDIC-insured savings account and add any windfalls you get along the way.



If you've been prepaying any low-rate, tax-deductible debt -- such as a mortgage or a federal student loan -- consider suspending those extra payments and putting the money into your savings instead to boost your financial flexibility.
Prepare for inflation

The Federal Reserve and other central banks will flood our financial system with cash as they try to encourage lenders to lend. Once the economy starts to turn around, all that cash sloshing around in the system could spark inflation that might be tough to bring under control.



To protect clients, financial-planning firm Evensky & Katz of Coral Gables, Fla., has been adding TIPS (treasury income protected securities) to the fixed-income side of its portfolios, says Taylor Gang, the firm's vice president.

"We feel that the long-term risk is likely to be inflation," Gang said, "and we construct portfolios with this in mind."

But the firm isn't telling clients to abandon stocks. Far from it.

"Through exposure to equities, clients own securities that are likely to appreciate in value," Gang said, "and outpace inflation over time."

To repeat:
Stay invested in stocks

This advice is hard for many people to stomach. They feel that if only they'd gotten out of the market weeks or months ago, they'd feel so much better now.



That's probably why so many are raiding their retirement funds, cashing them out or refusing to contribute. A recent AARP survey found that 20% of workers 45 or older had stopped contributing to their retirement funds in the past year and that 13% are tapping their accounts to pay day-to-day expenses.

These are exactly the wrong moves. While the current market turmoil may mean a delayed retirement for many people (see "How to retire in bad times"), failing to fund your retirement accounts could mean no retirement at all.

And the problem with getting out of the market is that you won't know when to get back in. Markets usually turn around well before the actual economy starts improving, and they typically advance so rapidly that people who aren't already invested miss most of the gains.

Besides, it's not like most of us need the money right now. Many of us have decades to go before we'll tap our retirement funds. These losses we're seeing are purely theoretical unless we act to make them real, by selling in a panic.

And if inflation does kick in, it will be even more important to have the inflation-beating returns that only stocks can provide. Furthermore:
Don't ignore your asset allocation

It may feel like diversification hasn't worked, since all classes of U.S. and foreign stocks have taken it in the teeth lately. But this synchronized performance is temporary, says financial planner Ross Levin of Accredited Investors in Edina, Minn. Eventually, a rebound will begin, and some of the most-beaten-down sectors will bounce back the strongest.



"Rebalancing is critical during these periods," Levin recently told his clients in a quarterly newsletter. "By systematically rebalancing, you are forcing yourself to buy low."

Learn some old-school skills

Plant a garden. Plan your meals. Repair rather than toss. Barter or trade rather than buy. Throw a potluck.



You'll save money, help the planet and combat that feeling that you're the helpless pawn of economic forces greater than you.
Construct your Plan B

If the bottom does drop out of our economy, you probably won't wind up on the street. Maybe you'd move in with your in-laws or rent out rooms in your home (as many previously affluent families did during the Depression). Honing your backup plan can be surprisingly therapeutic, particularly for people who tend to get all catastrophic.



Instead of fearing the worst, in other words, you plan for it -- then hope to be surprised

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