The Great Recession of 2009 was a real awakening for one-time spendthrifts like me who have rediscovered an old-time religion known as thrift along with a new-found freedom. Things, after all, are just things.
Call it financial shock therapy. The trauma of losing a job, seeing investment and home values implode, or merely watching others in financial peril, has transformed the American consumer zeitgeist faster and more furiously that any savings incentive a Washington policymaker could concoct.
But will the shift to thrift last? After dropping to an all-time low of 0.8% in April 2008 (near the frothy high of the stock market and real estate bubble), the personal savings rate surged to 6.2% in May -- the highest since December 1992. Then in November, the savings rate slid back to 4.7%, perhaps in a spate of holiday frugality fatigue, before inching up to 4.8% in December. Still, many economists believe the upward march will pick up, particularly in the wake of the recent downshift in stocks, plus continuing high unemployment, collapsed real estate values and looming tax hikes. Indeed, many think we are headed back toward a personal savings rate in the 8% to 10% range, which was common for decades prior to the mid-1980s.
Meanwhile, there are signs that Americans are beginning to unhook themselves from a debt addiction that mirrors a similar national affliction, where the federal debt has hit an all-time high of almost $12.4 trillion, or more than $40,000 for every U.S. citizen. In 1990, household debt was growing by about $200 billion a year. By 2007, it was surging by more than $1 trillion a year. But the credit crisis, recession and declining net worth put the breaks on household borrowing, by 2009, Americans were actually paying down debt -- by about $350 billion a year. Overnight it seems we had turned from a nation of borrowers to a nation of savers.
In the short term, of course, less spending and more savings is a drag on the economy. But longer term, the shift to thrift lays the groundwork for a stronger future for the economy at large, and families too. The change comes not a minute too soon. The recession left a record-low 13% of Americans confident that they could retire comfortably, according to the Employee Benefits Research Institute. Surely, a debt-laden federal government can’t help. So, before a recovery in the stock and job markets lures you back to those bad old days of excess-is-best, here are seven steps to take now to build a sturdier financial future this year.
1. Make the most of your 401(k). There are very few free lunches left in the financial world, but 401(k), 403(b) and 457 retirement savings plans are standouts. If you’re lucky enough to have an employer who matches part or all of your contributions, stretch to grab the full match. After all, this is free money. Plus, your investments in these accounts can grow tax-deferred until withdrawn at retirement. For example, if you’re 29 making $40,000 a year and deposit 10% of your salary into a 401(k) each year with a corporate 50% match up to 6% of your salary – and earn 8% a year, you’ll have a little over a million when you retire at 65 – and that’s without ever getting a raise. To estimate how your own 401k might grow, check out 401(K) savings calculator at Bankrate.com.
2. Think about converting your traditional 401(k) or IRA to a Roth. This year for the first time, anyone, regardless of income, can convert traditional IRAs and 401(k)s into Roths. You’ll owe taxes on the pre-tax dollars you put into the traditional IRA, though you can split that tax bill between 2011 and 2012. After converting, your contributions to the Roth can grow tax-free. And at retirement, contributions can be withdrawn tax-free. Roths are attractive if you think your tax rate will be higher in retirement. What’s more, there are no minimum required distributions with a Roth. And since you’ve effectively pre-paid income taxes on a Roth, the estate tax your heirs may owe will be lower. Deciding whether a Roth is right for you can be complicated, so you’ll probably want to check with a financial planner and/or tax professional.
3. Pay down high-cost debt – and avoid bank fees. If you relapsed a bit during the holidays, get back on track by aggressively paying down high-rate credit card balances, where interest rates average 12% but can rise into the high 20% range. To see what an accelerated payment plan can save you, run a couple of different scenarios with the credit card calculator on Bankrate.com. Then set up electronic bill paying to avoid late payment fees.
4. Buff up your credit score. Were you lured into taking on a store credit card over the holidays to capture a discount on holiday gifts? Did you use a debit card when you checked into a hotel? These are just a few of the small and seemingly innocuous choices that can ding your credit rating, and push up your credit card and other borrowing costs. So, take the time to check your credit scores at all three ratings agencies. But beware of bogus sites offering “free” credit reports, which are actually contingent on other purchases. You can get a free copy once a year at AnnualCreditReport.com or by calling 877 322-8228. A high credit score helps you get a low-interest mortgage or a better deal on a car loan. For example, raising your score from 620 to 760 can reduce your interest rate on a $300,000 30-year fixed-rate mortgage from 6.3% to 4.7%, saving $300 a month and $107,838 over 30 years.
5. Make sure you have an emergency fund. During any financial downturn, it helps to have an emergency fund, so you can avoid dipping into your investments when they are down. Most financial planners recommend keeping three to six months of basic living expenses in assets that you can draw on immediately. That means savings accounts or money market funds—not CD’s or lines of credit, which can dry up like a prune in the sun. For longer term cash needs, bank CDs or ultra-short bond funds can offer a little more yield. To compare yields in your area, go to Bankrate.com.
6. Put savings – and investing -- on autopilot. Set up an automatic savings plan at work or a brokerage firm. And if you get a bonus or raise, try to put half or more into savings. But make sure you stay diversified among and within asset classes. If can’t do that yourself hire a financial advisor, or use a target date fund that automatically rebalances your assets based on your targeted retirement date.
7. Consider refinancing your home. With growth picking up and deficits still out-of-control, it’s hard to imagine that interest rates can go anywhere but up over the next few years. So, if you still have an adjustable rate mortgage and plan to stay in your home for another five or more years, consider locking in a fixed rate mortgage.