Minimizing Your Own Exposure to Risks
By RON LIEBER
September 20, 2008
Copyright 2008 The New York Times Co. - Used with permission
Every piece of your financial life involves at least a bit of risk. What made this week extraordinarily rare, and so terribly frightening, was that all of the threats were on display at once.
Sure, investing for retirement involves some ups and downs. But this week, the stock market took the biggest one-day fall in seven years (though it bounced right back as the week ended), and money market funds, long considered rock solid, needed a rescue package.
And yes, plenty of people worry about job security from time to time. But with thousands of financial services jobs gone or in jeopardy and the economy threatening to slow further, you had to wonder whether your job might be next.
Then there was insurance. Maybe once a decade, a big insurance company is on the brink.
This week, the global giant American International Group had a near-bankruptcy experience, leading scores of people to worry themselves sick over their annuities and life insurance policies from that company and others.
And as Treasury Secretary Henry M. Paulson Jr. reminded everyone in his remarks on Friday morning, all of these developments have the mortgage mess at their root, leaving anyone who owns a house (or wants to) wondering whether real estate prices will ever find a bottom.
The stunning confluence of these events was bad enough. But the fact that the federal government may be on the hook for untold billions of dollars just made the pain worse.
I don’t know how or where this will end, and neither do any of the experts.
It’s a humbling time for everyone, and it makes it extremely hard to assess all of these personal risks and come up with a decisive plan of action.
The temptation is to either make drastic changes in your financial life or do nothing and hope that the impact is not too severe.
So here’s another idea, a middle path of sorts. Consider a few modest but concrete things you can do that could reduce your exposure to four of the big areas of risk — investments, job security, your mortgage and insurance — that have been front and center this week.
Some of these suggestions may have more impact for you than others, but they all can help you feel as if you’ve taken back some measure of control.
Investments
Before you do anything with your portfolio, ask yourself this: Do you still believe in capitalism?
Several financial planners I spoke with felt the need to stop and reaffirm the fact that companies will still need to raise money from investors — any quasi-Socialist, short-term federal government intervention aside.
Andrew Orr, a financial planner in Orlando, Fla., says clients with money in index funds are investing in 17,000 companies that seek to generate earnings and pay dividends.
That, he says, is a sustained bet on capitalism itself. “Capitalism is not always pretty. But it’s evolved and gotten better, and there are clearly going to be more protections to come.”
If you’re under 50 or so, you can start by protecting yourself against the biggest investment risk of all, outliving your savings.
Thomas Fisher, a financial planner in Cambridge, Mass., said that this risk was one that people generally underestimate. “Our parents haven’t usually run out of money,” he said. “There has been a whole generation of people with pensions.”
Those days are gone, though. And as he took calls this week from clients considering bailing out of the stock market, he said he realized how few people actually understood the big picture.
The most acute long-term risk is, in fact, too little risk. Unless you’re saving a huge chunk of your income in cash, you’ll need consistent exposure to more risky investments like stocks to produce a suitable retirement balance.
Keep your stock allocation lower if you must for a few months to sleep at night, but don’t get rid of it altogether.
Most people get back into stocks once you explain this. A bigger challenge now is the one facing those who are in or close to retirement and whose portfolios have declined in the last year.
Rebecca Rolfes, a 59-year-old marketing executive in Chicago, has ridden out down markets before, but now her time horizon is shrinking at the same time as her assets. “I keep going on my mutual fund sites but not actually doing anything,” she said.
Even if you can’t bring yourself to make big changes to your portfolio, spending just a bit less money in retirement may make a huge difference.
“Small changes in retirees’ burn rate will affect them far greater than what the market will do today,” said Bill Schultheis, of Sagemark Wealth Management in Kirkland, Wash., and the author of “The Coffeehouse Investor.”
That’s because overspending is a risk you can actually control, even if you can’t predict how the markets perform. “I’ve found that many clients really like that, because they like to be in charge.”
He noted that spending on grandchildren was often a huge item for retirees.
If you can’t bring yourself to cut back there, consider the cost of eating out. He says he is often surprised by the amount people spend on that.
Job Security
Aside from the job losses at financial services companies in the news, there was also concern the economy could slow significantly and ultimately affect employment levels everywhere.
This week, people who work for themselves seemed to feel better about their prospects than those who work for large companies. “It feels safer than having a job with a single employer,” said Mike Sanislo, who helps companies with new product development through his firm High Energy Consulting in Woodbury, Minn.
He says he expects to lose clients every so often, but his business doesn’t fall apart when one goes away.
Though you may not be ready to chuck it all and hang out a shingle, it’s worth considering the approach that Kathy Santos has taken.
Ms. Santos, a webmaster in Pepperell, Mass., has a job by day at the environmental nonprofit group Earthwatch Institute, but is developing a Web design and photography business on the side, Rhino Hill Studios, to spread out her income risk. She also picks up a bit of extra money as an emergency medical technician for the town.
Mortgages
All the problems that funny mortgages have caused have hopefully taught important lessons about interest rate risk. This is something you can control.
If you’re applying for a new mortgage, a fixed-rate mortgage means no risk that the rate will rise. If you have an adjustable-rate mortgage and have enough equity in your house to refinance, get a fixed-rate loan.
Here’s another certainty for those skittish about investing: If you put extra money beyond the minimum toward the monthly payment on a 6 percent mortgage, you’re effectively earning 6 percent by ridding yourself of that extra debt (though the number may be a bit less if you’re taking advantage of the mortgage interest tax deduction).
That’s what Nell Eakle of Sterling, Ill., has been doing, even though she had to ratchet down the overpayment because of a bout with breast cancer.
“We just want to be a little bit ahead,” she said.
An added bonus is that the extra payments mean the mortgage will hit zero about two years ahead of schedule.
A few caveats here. Given the tightened policies among home equity loan providers, you may not be able to easily get this money back out of your house anytime soon.
Also, it makes more sense to first pay down 18 percent credit card debt, or max out any 401(k) match that your employer provides, even if you’re parking the money in cash.
Insurance
A.I.G.’s crisis suggests one simple tactic to reduce your exposure to troubled institutions: Split your life insurance policies and annuities among more than one provider.
Meanwhile, many of the things that insurance protects against are precisely the sorts of risks over which people have the most control.
In uncertain times, there’s some small comfort in taking measures to avoid having to use the insurance at all.
“Stay in during the first snowfall,” said Kevin Albaugh, an engineering consultant in Williamsville, N.Y. “That will shake out all of the people who don’t know how to drive on it. That’s usually when you see a bunch of S.U.V.’s off the side of the road.”
Michael Fripp of Carrollton, Tex., says the only risk he can control is the health risks from the stress.
“The financial risks are beyond my control (and a little beyond my understanding),” he wrote in an e-mail message this week. “I am bicycling to work, walking with the kids and ignoring the 401(k) balance.”
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