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5 lessons from the crisis
Five things to try now to help improve your personal economy.
The financial crisis that began five years ago triggered a recession and dramatic drop in stock and housing prices that hit Americans hard. The unemployment level reached its highest mark in nearly 30 years, foreclosure rates quadrupled, and many investors suffered significant setbacks to their savings plans.1 It’s no wonder that in a recent Fidelity survey more than 64% of respondents said they felt scared or confused at that time.2
Five years later, however, one benefit may have emerged from the downturn: Many Americans have become more focused on their financial lives—more than 56% told us that instead of “scared or confused,” they now feel “confident and prepared.” “From the depths of the recession and volatile market conditions, many investors found resolve and started making very positive changes to their personal economy,” says Kathleen Murphy, president of Personal Investing at Fidelity. “Whether it’s increasing contribution rates to a 401(k) or IRA, adjusting asset allocation, or increasing the frequency of financial discussions with family, the silver lining of this recession was that it spurred investors to reassess and improve their finances.”
How did they do it? The short answer: They took control.
While our respondents were split between blaming the crisis on banks and lenders and blaming it on Americans getting overextended financially, 56% of respondents said they now believe that it’s solely their responsibility to prepare for retirement. And they have already begun to take action. About two-thirds told us they have become more knowledgeable about their finances, and about three-quarters are monitoring their investments more carefully.
How can you learn from them? Consider these five steps to take control and help strengthen your personal economy.
1. Save more—and smarter—for retirement.
You can’t control the markets, but you can save more—and doing so can pay off. Among investors who went from feeling scared to prepared, 42% said they increased their contributions to their workplace savings plans—401(k)s, 403(b)s, 457s, health savings accounts (HSAs)—as well as to individual retirement accounts (IRAs).
Why is it so important to save in these accounts? The combination of tax-deferred investments and disciplined savings mean even small changes can have a big impact on your future lifestyle. Take an individual who now makes $70,000 a year. Let’s say he increases his workplace savings rate from 5% to 7%, and that money grows tax deferred at a hypothetical average annual rate of 6%. After 20 years, his balance would be 15% higher (see the graph to the right for additional assumptions).
So, take advantage of your workplace savings plans. For most people, the top priority should be contributing enough to capture any company match. Not doing so could be leaving money on the table. Also, try to take full advantage of other tax-advantaged savings vehicles, like HSAs, IRAs, and annuities.
How much is enough? We think a good starting point is to have saved at least eight times your ending income by the time you retire, though your number can be significantly higher or lower, depending on your situation and some key choices you make. Among those choices are the age at which you plan to retire and the amount of your income you want to use in retirement.
2. Prepare for the unexpected.
Talk of risk management at the market top was the proverbial skunk at the picnic. But staring into the financial abyss was a hearty reminder of the value of preparedness. In our survey, about half of respondents said they had reduced their personal debt, reflecting a nationwide shift to thrift. In aggregate, U.S. household debt as a percentage of GDP dropped from a high of 14% in 2007 to slightly above 10% at the end of 2012, the lowest level since the government began collecting the data in 1980. Of those respondents who now feel confident and prepared, nearly three-quarters said they have less personal debt than they did before the crisis.
If you have high interest credit card debt, try to pay it down as soon as possible, starting with the cards with the highest rates. If you can’t pay it all off, consider consolidating the debt in a low interest rate home equity loan or line of credit. Also consider these important strategies:
3. Rethink risk.
Even the most seasoned investors may have felt weak in the knees as they watched the financial crisis evaporate stock and housing wealth. Among those in our survey, 21% shifted to a more conservative investment mix, but more than 50% stuck with their plan. Five years later, those who stayed in the markets may have reason to celebrate. Although they lost more in the early years, they benefited from the 125% rise in the S&P 500® Index since March 2, 2009. Those investors who fled the stocks for the apparent safety of bonds and cash may have missed that recovery. An earlier Fidelity research study showed that 401(k) savers who continued making contributions and stuck with their asset allocation had higher balances than investors who tried to time the markets (see charts below for results and important information about methodology).
So what if you were rattled by the volatility and increased your investment in bonds, beyond your long-term plan, in an effort to reduce risk? You may need to rethink what is risky. In recent years, bonds have been investor favorites, and assets in taxable-bond funds have more than doubled since the end of 2008, climbing from $1.1 trillion to $2.5 trillion, according to Morningstar. But, bonds have been beneficiaries of 30 years of generally falling interest rates, and thanks to investor demand and central bank policy, today rates are historically low. There is no guarantee that rates will go up soon, but if they do, bonds may suffer price losses. Those will be partially offset by climbing income on funds, but interest rate risk may make bond investments more risky than some investors may realize.
Bottom line: Get a plan you can stick with for the long term that has a realistic chance of meeting your needs. Consider making regular monthly investments—no matter what the market is doing. If the market moves strongly, considering rebalancing at least annually or when your portfolio is more than 5% away from your target asset mix. Those practices could help give you the discipline to try to buy low and sell high.
4. Manage your tax and inflation exposure.
Five years ago, deflation was the big economic fear. But today, massive deficits and unprecedented central bank asset purchases have turned the tables and pushed taxes and inflation to the top of investors’ worry list. More than half of the investors we surveyed said that tax and inflation strategy had become more of a focus during the last five years. If you want to build your portfolio for the next five years and beyond, you need to consider these risks.
5. Don’t go it alone.
One last lesson from the downturn is that you don’t have to go it alone. As the financial crisis started to unfold, 30% of our respondents said they turned to a financial adviser for help, while 26% chose a spouse or family members. But reaching out to others can help strengthen families financially and personally in good times as well as bad.
A new day
Five years after the financial crisis, the world looks different, with new risks and challenges. The good news is that many people are responding with a new commitment to taking control of their financial lives.
For help, consider:
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