If the U.S. economy were a medical patient, the attending doctor might conclude that some of its vitals are strong, and some are definitely improving. But experts generally agree that it’s too early to discharge the patient. There are just too many unknowns to predict when the patient will recover.
So, as the nation watches and waits, even the most forward-thinking investors are looking back and wondering: “What caused The Great Recession of 2009?” and “What can we do to ease the pain, and begin our own economic recovery?”
These are truly unprecedented times in our nation’s economic history. What happened? One problem that has become apparent is that there was too much risk in the financial markets. Wall Street and investors all over the world mispriced the risk associated with real estate lending. When the market collapsed, investors who were leveraged at ratios as high as 35 to 1 just couldn’t sustain the losses.
Regulatory oversight also failed on a number of fronts. Regulators were either not aware of excessive leverage, or they chose to turn a blind eye. In either case, such inattention has come back to haunt us, and is likely to result in even stricter government oversight in the future. The collapse of Bernard Madoff’s massive Ponzi scheme is a perfect example of what happens when the “good old boy” network on Wall Street looks the other way.
In the near-term, the fallout from all of this turmoil will be greater risk aversion, less leverage and more regulation. A drop in global trade will mean lower profits and slower growth. In spite of recent improvements, there will generally be less wealth, as many portfolios still show painful declines from market highs.
What are the consequences?
It’s never easy paying for the nation’s financial messes, and this mess is no exception. The billions of dollars the government has been pumping into the economy are going to have to come from somewhere. Those fortunate enough to earn a high income are going to find part of the payback coming out of their pockets in the form of higher taxes.
Many economists also believe that massive stimulus spending is going to lead to inflation. Higher inflation may take time to develop, but from a financial planning and investment standpoint, it means planning for a higher cost of living, and the detrimental effect higher inflation has on investment assets.
What should you do right now?
Slower economic growth and lower profits will likely result in lower returns in both the stock and the bond markets. Lower returns over an extended period will require many to either increase their level of funding to accomplish their financial goals, or re-evaluate their goals in light of current realities. Goals that have defined you for years—a retirement condo, an education for your children, the ability to retire early—may need to be adjusted downward and time frames may need to be increased. For example, you may have to settle for funding just 50 percent of your child’s college education instead of 100 percent. Postponing retirement for a couple more years may have changed from a possibility to necessity.
Although it may seem radical, the best advice may be to throw out your old financial plan, if you have one, and start over. Take a fresh look at your objectives. Challenge the value and quality of your investment portfolio, including the earnings assumptions and tax impact. Run the numbers on your rate of contribution. Chances are, additions of new money to your financial plan are going to have to increase to keep you on target for your pre-recession goals.
Keep the following in mind as you take stock of your finances:
- Assume lower investment earnings. Estimates that once were conservative may now be far too optimistic.
- Assume higher taxes. Someone has to pay for the economic stimulus; those with higher incomes need to be prepared for higher taxes.
- Save more. Aside from your long-term investments, you should have funds set aside for short-term cash flow needs as well as an emergency or unexpected hardship. A minimum of six months of cash flow needs is recommended.
- Increase diversification. The future course of financial market fluctuation is unpredictable, so don’t “put all of your eggs in one basket.” Diversify your investments among different types of assets (e.g. cash, bonds, stocks, gold and real estate, etc.).
- Develop an effective spending plan. Without an understanding of your spending habits, it will be difficult to make adjustments to the changing times. Project your current spending into the future to estimate your current and post-retirement needs.
- Educate your family on prudent financial discipline. Communicate your experience and what you have learned with those you care about. Financial planning principles are not taught in school; all too often they are learned the hard way. Ask your advisory team to host a family meeting.
- Update your estate planning documents. Meet with your attorney and advisory team. Consider the legacy you want to leave for your family and your community. What will happen to your business interests? Always consider the impact of taxes and strategies to reduce their bite.
- Update beneficiary designations. Beneficiary designations on IRAs and qualified retirement plans must consider the long-term tax consequences to your heirs, and must tie together with your estate planning documents. Consult your advisory team as new legislation unfolds.
As you plan for the future, you need to be able and willing to make adjustments to your plans. By taking time to understand where you are headed, you will be better able to make these adjustments. It is also important to be willing to make the necessary adjustments when rough waters are encountered. Sometimes you will stay the course, other times you will have to make tough choices in order to chart a new course.
Every financial advisor would like to be able to tell you exactly when the recession will be declared over. It doesn’t really matter! A positive attitude and proactive planning are your best plan of action. iBi
Jeff Secord is managing director and Jeff Huizenga is a senior manager for Clifton Gunderson Wealth Management in Downstate Illinois.