By common consent, most parts of the country are said to be bumping along the bottom. But for the Northeast and Mid-Atlantic States, forecaster Sara Johnson of DRI/McGraw-Hill sees six more months of recession ahead.
In such a climate, consumers can’t hope for much in the way of income gains. You can only try to wring more value out of money you already have. A few ideas:
The single best investment this year is reducing debt. Say, for example, that your credit-card balance costs you a burdensome 19 percent. If you pay it off, even by just a few dollars a week, your pretax return on investment comes to 28 percent guaranteed (if you’re taxed in the 33 percent bracket).
If you have any savings, take some of that money to repay your debts. Most folks hate to do this; they treat their CDs like security blankets. But anyone holding 19 percent debt along with a 6 percent CD is losing 13 percent a year. You do need a modest amount of cash in a checking account or money-market fund. But use any surplus to eliminate loans.
What if you fear that you’ll lose your job? You should still raid your savings to pay off your debt, says financial planner Lynn Hopewell of The Monitor Group in Falls Church, Va. Here’s your fallback position if you do get the boot: borrow from the credit cards that you previously paid off. Thanks to your debt-reduction plan, you’ve turned the cards into safety nets.
Here’s another fallback, from Wilmington, Del., planner Judith Lau. If you’re out of work, convert stock investments into cash. You can’t run the risk that the market will fall just when you have to use the money. Buy stocks when you’re re-employed.
The sooner you retire your debt, the less interest you’ll owe. Assume, for example, that you’re holding a 30-year, $100,000 mortgage at 8.5 percent. By paying it back in just 20 years, you’ll save $68,500 in interest. And you’ll build home equity faster, which amounts to another safety net. If you lose your job, you can tap your home for a larger loan.
Some planners argue that it’s dumb to accelerate mortgage payments. Your loan costs only 8 to 10 percent, tax deductible. You’d do better with a stock-owning mutual fund that gets 12 percent a year.
But facts don’t always influence feelings. You might gladly trade high investment returns for more security in your life. Offhand, I can think of two situations where accelerating the mortgage makes sense. (1) If you’re self-employed. Your income is inherently speculative-depending on your own good health and on the prosperity of your clients. To balance that risk, you might want to bend your efforts toward owning your home free and clear. (2) If you’re salaried and middle aged. Any day now, your company might eject you. By reducing your mortgage, you might be able to refinance at lower monthly payments. That could save your home, if you have to take work at a lower wage.
Should you put extra money into your house if you think that your job is not secure? In theory, yes-as long as you have an open home-equity line of credit. That lets you borrow back from the bank any cash you need to have. But you run a risk. If the bank hears that you’re unemployed it might decide to freeze the line.
Here’s one more idea, for the person who wants to pay off the mortgage by a certain date-say, when you’re 60. Find out how much principal you’ll owe, says Muriel Siebert of the New York discount brokerage firm that bears her name. Then buy a zero-coupon bond for that amount and maturity date. (You buy a zero for a fraction of its face value; it accrues interest annually; you redeem it at maturity.) For a tax-deferred retirement account, buy Treasury zeroes, including enough to pay the future tax; otherwise, buy tax-exempt zeroes.
When might you not want to accelerate? If you’re in your 30s and on your way up. Better to buy stock-owning mutual funds for the long term.
Planner John Sestina of Columbus, Ohio, says that many of his clients replace credit-card and auto debt with the proceeds of a home-equity loan. But you’ll come out behind if you (1) run up your credit-card balances all over again or (2) repay your home-equity loan over too many years. Take, for example, a four-year, $12,000 auto loan. At 11 percent, you’ll pay $2,887 in interest. If you switch to a 9 percent home-equity line but stretch the payments over eight years, you’ll owe $4,877 in interest-costlier, even after taxes.
It’s fine for you and me to repay our debt and add to savings. But if everyone does it, won’t the recovery get derailed? No, says Nobel Prize-winning economist Paul Samuelson, provided that the Federal Reserve offsets those savings by reducing interest rates. He wishes rates were dropping faster. But for now, thrift remains all to the
