Making Sense of the Financial Crisis and What to Do With Your Money

By: Jonathan D. Pond | Source: AARP.org | September 30, 2008

The news about the travails of financial giants Bear Stearns, Fannie Mae, Freddie Mac, Merrill Lynch, AIG, and others is frightening indeed. The initial failure of the House of Representatives to pass the bailout legislation sent the U.S. stock markets into a tailspin.
 
The objectives of the legislation that failed in Congress were to prevent the financial crisis from deepening and to help the overall economy get back on a firmer footing. The backbone of the plan was a requirement that the federal government buy distressed mortgage investments, or so-called “toxic loans,” from financial institutions at discounted prices. The hope was that helping the beleaguered institutions would restore some confidence in the investment markets and enable lenders to reopen their loan windows. Without access to loans, businesses in all industries would be threatened. Were the crisis to continue, the credit squeeze would also hamper the ability of homebuyers to obtain mortgages.
 
In order for the plan to benefit the taxpayers, who will foot the bill, the housing market will have to bottom out and prices begin to rise. A strengthening housing market, along with some help for homeowners who are having trouble keeping their homes, would go a long way toward restoring confidence in the investment markets. 
 
 
What’s an Investor to Do?
 
There angst in the United States and in overseas investment markets will continue. Whatever rescue plan is devised, many will have lingering doubts as to whether it will work. One concern is that the credit crisis will extend overseas, where governments may be less inclined or unable to afford to help companies in their countries.
 
It’s tough to lose money on your investments, and the temptation to seek the comfort of no-risk investments, such as savings accounts, may be strong at this juncture. But the best thing to do is to remain cool; this is no time to make big changes in your investments.
 
You might want to review your holdings and weed out any weaklings. But rather than dwelling on the losses in your investments so far this year, keep a longer-term perspective. Historically, the stock markets have declined about one out of every five years, and stocks gained in each year from 2003 to 2007. Despite your losses so far in 2008, if you’ve been investing in stocks and stock funds over the past several years, you’re still ahead.
 
Avoid falling prey to the drumbeat of negativism of the Chicken Littles that populate Wall Street and the media. All of the news isn’t terrible. Energy prices have declined from their highs and inflation fears are subsiding. The decline in stock prices has not been any worse than most previous bear markets.
 
But the most important “contrary indicator” in my mind is that Warren Buffett is on a buying spree. Buffett is arguably the savviest investor alive today. He not only sees an end to our travails, but also sees now as a good time to add to downtrodden stocks. 
 
 
How to Protect Your Investments
 
First, there’s no way to protect all of your stock, bond, and mutual fund investments from losses short of selling everything and putting the money into low-interest accounts like CDs and money-market funds. While this may appear to be a smart move if the stock market keeps declining, the challenge will be deciding when to get back into the market. Many times in the past, when the stock market rebounds, it does so very quickly.
 
There is a middle ground between staying put and heading for the hills—or in this instance, for savings accounts. Here are three strategies that have in the past helped investors protect their money and reduce their losses. 
 
Dividend-paying stocks: Stocks that pay dividends usually fare better in declining stock markets compared with stocks that don’t. You can either buy individual dividend-paying stocks or a so-called “growth and income” stock mutual fund that typically invests in dividend-paying stocks.
 
TIPS: While inflation seems under control, there’s a lot of concern that it may rise in the near future. One way to protect some of your money is to invest in Treasury Inflation-Protected Securities (TIPS), the interest rates of which rise with inflation. It’s easy to own TIPS through a TIPS mutual fund or through an exchange-traded fund.
 
Rebalancing your investments. While repositioning your investments to add to stocks may seem like a crazy way to protect your investments, this has proved to be a smart move in past bear markets. If you have a target percentage of stocks that you want to maintain, chances are that your portfolio now has a lower percentage of stocks than your target. Rebalancing back to your target percentage will involve adding a bit more to your stock holdings. That’s what’s known as “buying low,” since stocks are now a lot lower in price than they were earlier this year.
 
Being well diversified is still the best way to protect your investments over the long haul. That’s what the suggestions in this column will help you do. 
 
 
Advice for Home Buyers, Home Sellers, and Homeowners

If you’re in the market for a home and you have enough cash to make a down payment of at least 10 percent, you’re in a great position. The real estate market won’t turn around on a dime, so take your time finding the perfect place.
 
On the other hand, home sellers face many challenges. Home prices continue to decline in many areas of the country, and the pool of potential home buyers is not very large.
 
If you don’t have to sell right away, wait until the real estate market in your area begins to recover. If you do have to sell, realtors say the key to a quick sale is to price the home realistically.
 
Finally, if you are a homeowner, keep in mind that the reasons you bought a home in the first place are above and beyond the property’s investment value. Owning a home offers advantages not available to renters, including tax deductions for mortgage interest and property taxes, controlling your housing costs, and the possibility of some day being mortgage-free. Like any other worthwhile investment, real estate periodically declines in value. In the past, those cyclical declines have turned out to be temporary interruptions to long-term increases in home costs.

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