Surviving The Economic Storm: How To Protect Your Financial Future
By: Terry Donahe
Have the recent events in our financial system left your head spinning and your stomach turning? Have
your 401(k), IRA and other investment accounts taken serious losses? Is your home worth less than it
was a year ago? Have you noticed that just about everything … food, energy, entertainment … has
become more expensive.
You are not alone. We are in the midst of the greatest economic storm to hit our economy since the
Great Depression. While we have not experienced the unemployment, poverty and dislocation that
characterized the 1930s, these are challenging times for our nation.
Unlike the depression, the government has acted quickly and taken unprecedented measures to save
the economy from collapsing. The Federal Housing Finance Agency took control of the nation’s two
largest mortgage companies, Fannie Mae and Freddie Mac and placed them in federal conservatorship.
The Federal Reserve orchestrated the takeover of Bear Stearns by JP Morgan Chase and provided $30
billion in credit in the process. The Fed also provided over $123 billion in emergency loan to rescue
multinational insurer AIG.
After allowing investment bank Lehman Brothers to fail and then concluding that the government could
no longer continue to respond to the crisis through a series of individual actions, the Treasury Secretary,
the Chairman of the Federal Reserve and the Chairman of the Securities and Exchange Commission
proposed to Congress a $700 billion program that would attempt to stabilize the financial system.
Following a highly charged national debate and much political maneuvering, Congress passed the
legislation. The Fed has provided liquidity to the money market and the commercial paper market.
More recently, the Fed, acting in concert with central banks around the world, reduced key interest
rates by 0.5%.
What happens next? No one knows for sure. However, there is a widespread belief in the economic
community that this storm won’t pass any time soon. It will probably take months, if not years, for the
government’s efforts to stabilize our economy.
ASSESS THE SITUATION
So, what can you do right now while we struggle through this storm? “Nothing” and “wait it out” are
not the right answer. It is very natural to be reluctant to confront the damage a storm like this has
inflicted on your financial situation. But this will not make it go away and it will certainly not repair it.
Now is the time to look very seriously at your situation and take the appropriate actions to deal with it.
While you will not need to examine every aspect of your financial situation, there are areas that have
been directly affected by this storm and you need to examine the damage and decide what to do about
The place to start is your budget. But, you say, you don’t have a budget. Well, really you do. It’s just
not written down. Every entity that has income and expenses has a budget. A budget becomes useful
when you can use it to achieve your financial goals. So, time to open Microsoft Excel, Quick Books, an
online financial website with budget tools or simply get out some notebook paper and a calculator.
A household budget itemizes income and expenses. Traditionally income goes on the left hand side of
the ledger and expenses go on the right hand side. The difference between income and expenses is
either savings or a deficit. Pretty simple, right?
Hopefully, your budget indicates a savings. You are taking in more than you are spending. This should
allow you to save money for your future. This is a very good thing, because it provides resources to pay
for unexpected expenses and for those items you plan to purchase in the future.
In addition, your savings will help you pay for your normal household expenses when you are not
earning an income. This could happen if you become disabled, you go back to school, or you take off
time from work to travel or care for a family member. When you stop working and retire, your savings,
along with Social Security and your other retirement programs, will be an important source of income.
Financial planners suggest that you keep 3-6 months times your monthly income needs in some kind of
emergency fund. So, if your expenses are $6,000 a month, you need to have $18,000 - $36,000 very
liquid. It could be a money market account, cash value in life insurance or a simple savings account.
If you are like most Americans, your rate of savings may not all that great. According to the US Bureau
of Economic Analysis the personal savings rate in the country has hovered between negative 0.5% and
just over 3% since 2000.
Many Americans have been spending more than they have been earning in income for some time.
How? By borrowing or spending down existing assets. The typical approach to borrowing involves
financing spending with credit cards, auto loans and other consumer debt. In addition, many people
have taken equity out of their homes through refinancing of their primary mortgage, the creation of a
second mortgage or a home equity line of credit. Some people have consumed savings and
Regardless of the method, a situation in which expenses exceed income is not sustainable. Eventually,
the debt that is incurred through excessive spending will overwhelm the household. Credit will no
longer be available and lenders will demand repayment.
So, if you find, upon reviewing your budget, that your expenses are greater than your income, it’s time
to make some changes. You need to adjust your finances, so that you are saving. How? Through some
combination of reducing expenditures and increasing income.
There are many ways to reduce or eliminate expenses. Some are rather modest and simple such as
cutting back on visits to Starbucks. Others are more profound and involved such as moving into a less
expensive residence if you have decided that you cannot afford to live in your current residence.
What about increasing your income? You could find a better paying job, take on additional part time
work or start a business on the side. If you are not currently working, you could return to work.
How much do you need to save? That all depends on your financial situation and your goals.
THE BALANCE SHEET
This leads us to the next step in the personal financial assessment. A balance sheet summarizes assets
An asset for the purposes of personal finance is anything that you own that can be converted to cash.
You probably have a wide variety of assets including a home, savings, and investments. People have
assets because they purchased them with income they earned or they received them as a gift or
A liability is an amount owed arising from a transaction like the purchase of a house or a car. Liabilities
are settled when then the borrower pays back the lender the amount owed plus any accrued interest.
Household liabilities include credit card debt, auto loans, and home mortgages.
To create a balance sheet, you simply list assets on the left hand side of your ledger and liabilities on the
right hand side. Assets minus liabilities equal net worth. This is your net financial position.
It is rather likely that if your balance sheet will be weaker today than it was 1 year ago. Why? Housing
values have fallen and the stock market has declined almost 40%. So, the assets you own are worth less
now. Even if your liabilities have not gone up, your net worth could be lower.
The significance of net worth becomes apparent when you begin to contemplate your future. If you
would plan to stop working someday (i.e. retire), you will need to replace the income from your work
with income from other sources. You will probably have Social Security benefits, but that is not
sufficient for most people.
If you are very fortunate, you will have a pension that you earned during your working years. This may
come from a large corporation, labor union or state or federal government. While pensions were more
common in the last century, today most people do not receive pensions.
So you will need to supplement the income you do receive with income from assets that you accumulate
during your working years. The more assets you have the greater your ability to create income in
retirement. The actual amount of assets you will need is, of course, directly related to the amount of
income you expect to need in your retirement years.
The process of determining this sum of money, sometimes loosely referred to as “the number,” is a bit
more complicated. It requires not only projecting your budget (income and expenses) in your
retirement years, but also making assumptions for important factors such as inflation, tax rates and
If you are proficient with a financial calculator, you may be able to do the calculations necessary to
determine your number. This will require understanding important financial concepts such as the time
value of money, compound interest and inflation. You may wish to check your calculations with
someone you trust who understands the math involved.
There are online calculators at numerous websites that allow an individual to estimate how much
money is needed to fund retirement and how much additional savings is required to reach that sum.
These calculators really vary in terms of their complexity and, therefore, their accuracy. Be sure to use
several of them and then compare the results.
Alternatively, you could work with a CERTIFIED FINANCIAL PLANNER™ who uses financial planning software
to model retirement scenarios for clients. The advantage to this approach is that you will work with an
expert who has the knowledge and the technical tools to guide you through the retirement planning
Now that you have established your budget, your balance sheet and your retirement number, it’s time
to turn your attention to your savings and investments.
You probably have money sitting in a bank, a credit union savings and loan or an online brokerage firm.
Given the recent failure of several of these institutions, you may be concerned about the security of
The Emergency Economic Stabilization Act, which was signed into law on October 3, 2008, included
provisions to increase deposit insurance through the Federal Deposit Insurance Corporation (FDIC). The
new limit is $250,000 per depositor per bank. This is a temporary guarantee through December 31,
FDIC insurance covers all types of deposits received at an insured bank, including deposits in checking,
NOW and savings accounts, money market accounts and time deposit such as certificates of deposit
If you happen to have more than $250,000 in any of these types of bank accounts, you should seriously
consider transferring it, so that your funds are fully insured. This can be done in a variety of ways by
opening additional accounts with different registrations inside your existing banking institutions or by
moving funds to a separate FDIC-insured institution.
You should be aware that traditionally money market accounts held through a securities/brokerage firm
have not been insured against loss. This has been a problem recently as a few money market accounts
have fallen below the investment of value $1.00 per share, a rare phenomenon known as “breaking the
buck.” As a result, several money market accounts have been liquidated and closed.
In response to the disruption this created in the money market sector of the capital markets, The
Treasury Department announced in that it would guarantee money market funds against losses up to
$50 billion using the Exchange Stabilization Fund which was established in the 1930s. However, this is a
temporary guarantee program and applies to shareholders of money market accounts as of September
18, 2008. In addition, the money market fund sponsor must pay a fee to participate in the program.
This federal backing is not automatic. So, if you own a money market account, you should contact the
sponsoring institution to determine if your funds fall under the Treasury guarantee program.
Now it’s time to review your investments. This probably won’t be much fun. But you need to survey the
damage. So, gather your most recent quarterly investment reports for your IRAs, your 401(k) and your
non-retirement investments. The process outlined below is relevant to all of your investments in the
financial markets (stocks, bonds, real estate, etc).
The stock market has been in a period of decline since last October. So, your investments have
probably lost value. While this is disconcerting, it does create some opportunities. For example, you
can sell the investments that have underperformed the market and buy others that you meet your
needs. Before you consider selling the losers in your portfolio, however, you should take a broader view
of the landscape.
INVESTMENT POLICY STATEMENT (IPS)
Start by reviewing your investment policy statement. If you work with a professional investment
advisor, you should have an IPS. If you manage your own investments and don’t have an IPS, you will
benefit greatly from putting one together.
This is the document that outlines your investment situation. What is the goal? How much will you
need? When will you need it? It describes your tolerance for risk and your capacity to accept losses. It
summarizes your investment objectives: rate of return, acceptable levels of risk and levels of volatility.
It describes the general investment philosophy that underlies your investments, such as active or
passive. It addresses investment criteria such as asset allocation, diversification, and liquidity. It will
indicate the kinds of investment vehicles that are to be used to accomplish your goals and those that are
not. It will provide monitoring procedures, including frequency of review, performance evaluation
criteria and rebalancing practices. It will provide guidance relative to trading costs, investment
expenses, and taxes.
To create your own IPS you could simply write it using basic word processing software. You could also
use one of the financial planning web sites that offer tools and templates to create an IPS. If you work
with an professional advisor to manage your investments, the creation of an IPS should be part of the
Think of your IPS as your flight plan. If you were a pilot you would formulate a plan about your
destination, estimated flying time, alternate routes, contingency plans, etc. Once in the air, you would
refer to the visual surroundings, the plane’s instruments and the flight plan to monitor your progress
toward your arrival point.
If, while flying the plane, you found yourself in a storm, the flight plan would provide critical information
about how to make adjustments so that you would still reach your intended destination. The IPS serves
a similar purpose in a financial storm. It will keep you on course even if you have to make significant
adjustments to your original plans.
While there are many approaches to investing, there is a consensus in the investment community that
successful investors follow certain principles. Keep these in mind as you review your current investment
Asset Allocation refers to the process of spreading your assets across a variety of asset classes. An asset
class is a kind of investment such as equities/stock, fixed income/bonds, real estate and cash.
Depending on the source, there are between three and thirty some asset classes.
Considerable academic research indicates that asset allocation affects investment performance more
than any other factor, such as timing the market or security selection. The reason for this is that over
time asset classes will perform in ways that are not correlated to each other. As one investment zigs,
another will zag. The process of selecting several asset classes within a portfolio dampens volatility and
enhances long term performance.
Proper asset allocation is influenced by the various factors included in the investment policy statement.
So, to determine if your current asset allocation is appropriate, refer to your IPS.
If recent losses in your portfolio are causing you to question the appropriateness of the asset allocation
set forth in your IPS, then you really need to carefully review your overall approach to investing.
Volatility is inherent in investing. How much volatility (i.e. declines in value) are you willing to accept in
return for long term gains (i.e. increase in value)?
Too often investors make changes in their portfolios, because of losses that occur in their holdings over
a short period. This causes them to lock in losses and, in many cases, miss the recovery that inevitably
Successful investing involves managing one’s emotions in times of market instability. It requires
resisting one’s inclination to flee the market when the masses are leaving.
Diversification involves spreading funds across a large number of investments, rather than concentrating
them in just a few. This process generally reduces risk and yields higher returns.
Each asset class inside your portfolio should be diversified. As an example, if you own large cap stocks
as one of your asset classes, you would own many such stocks, not just one or two. Most investors
don’t have enough investable assets to achieve meaningful diversification by investing in individual
securities. An attractive alternative would be to use mutual fund and/or exchange traded funds inside
each asset class to achieve the desired diversification.
If you participate in a 401(k) plan or other employer-sponsored retirement plan, be particularly mindful
of not having too much of your investments in your company’s stock. While you may be employed by a
strong company that you admire, prudence dictates that you diversify. Many of the employees of local
companies like Portland General Electric (remember the Enron story?), Intel (tech crash), and
Washington Mutual (mortgage crisis) paid a serious price for not diversifying their retirement accounts.
Most investors do not realize how important expenses are to overall investment returns. The
performance of your portfolio is directly affected, in an adverse way, by the various expenses you incur.
These expenses include trading charges, brokerage commissions, mutual fund sales loads, internal fund
expenses, management fees, and custodial fees. These expenses create a significant drag on a portfolio.
When totaled they can amount to 2.0-3.0% of a portfolio.
Unfortunately, when you review your investments, you may not be able to identify all the expenses you
are incurring. For example, if you own mutual funds, you may need to ask your broker/advisor about
the expense ratio for your funds, because they will not appear on your investment summary. If you are
managing your own portfolio, you probably know these costs. If you don’t, you can do some web based
research on sites like Morningstar, FINRA or any of the online discount brokers.
You should be as focused on minimizing your investment expenses as you are on maximizing your
investment returns. If you were to eliminate 1% of expenses on a $1 million portfolio, you would save
$10,000. If you were able to maintain this savings over a period of 20 years and earn an average return
of 8%, your savings would amount to $457,620. That’s a significant sum to any investor.
DEDUCTING INVESTMENT EXPENSES
Most investors do not realize that there are investment related expenses that they may deduct on their
tax return. Expenses related to the production of income not associated with the purchase or sale of a
specific security are deductible if they exceed 2% of adjusted gross income.
To take advantage of these deductions, you must itemize using Schedule A of Form 1040. The expenses
must be paid or incurred by you. If you have an IRA, you don’t actually own it. Your trustee owns it and
you are the beneficiary. Therefore, you may not deduct fees related to your IRA unless you pay for
these fees out of your pocket.
The expenses you may deduct include investment advisory fees, investment software, investment
magazines, investment related accounting and legal fees, and investment account maintenance and
Note that if your income exceeds certain thresholds or you are subject to the Alternative Minimum Tax,
you may lose some or all of these deductions. So, work with a tax professional and check the numbers
and your eligibility.
TAX EFFICIENT INVESTING
Another way to evaluate your investment portfolio will require you to pull your income tax returns from
the past few years. Look for lines on your returns that show investment income (taxable interest, taxexempt
interest, ordinary dividends, qualified dividends, and capital gain/loss). You would have
received corresponding documentation for this income such as Form 1099-DIV, Form 1099-B, Form
1099-INT and/or Form 1099-OID.
Taxes can seriously erode the value of a portfolio and reduce investment income. Therefore,
investments should be evaluated for their tax efficiency. Mutual funds tend to be fairly tax inefficient,
because of the way they are structured and operate. Exchange traded funds and index funds, on the
other hand, tend to be more tax efficient.
The issue is how much taxes are you paying relative to the size of your portfolio and relative to the
income you are actually receiving from your investments. Get out a calculator and determine your
after-tax returns on your investments. The results may surprise you. During the decade that ended in
2007, for instance, Lipper estimated that fund investors lost anywhere from 17% to 44% of their returns
CAPTURING TAX LOSSES
Given that the equity markets have fallen to levels not seen in several years, you may be able to take
some tax deductions for losses. However, you should follow a disciplined approach as you consider
capturing these losses.
Investments should not be sold simply because they have lost value. Rather, each investment should be
evaluated individually and in the context of its place in your portfolio. If an investment no longer meets
the criteria you established in your investment policy statement, then it would be appropriate to
dispose of it. If this action creates a loss, then you should take full advantage of the loss for tax
According to the Internal Revenue Code, you may use investment losses to offset investment gains. If
your losses exceed your gains, you may deduct up to $3,000 in investment losses. Losses in excess of
$3,000 may be carried forward into future tax years.
If you decide to sell an investment, because it no longer satisfies the criteria in your IPS, and replace it
with one that does, be careful. The Internal Revenue Service’s Wash Sale Rules state that an investor
may not claim a loss on the sale of an investment if a “substantially identical” investment was purchased
within 30 days before or after the sale date. While the IRS has not provided clarification of what this
term means, smart investors will not take actions that jeopardize their ability to take a loss.
If you have questions about the tax consequences of your possible investment decisions, you should
consult a qualified tax professional.
Given the volatility of the financial market over the past 12 months, your investments are almost
certainly no longer allocated as your investment policy statement states. Even if most of your holdings
are down, they probably did not fall in tandem and a few may be up.
Rebalancing is the process of realigning the weightings of your portfolio so that the allocation once
again is consistent with your IPS. It involves buying and selling across your holdings. It should be done
at least annually and preferably quarterly.
IRA TAX PLANNING
If you own an Individual Retirement Account (IRA) and have been considering converting some or all of
it to a Roth IRA, the current bear market may present an excellent opportunity. Roth IRAs are attractive,
because not only do the assets inside them grow tax free, but they may be withdrawn tax free. In
addition, there are no rules requiring that you take distributions soon after turning age 70.
Converting from a traditional IRA to a Roth IRA requires paying ordinary income tax on the amounts
converted. Given that the values in your IRA are probably significantly lower than they were a year ago,
now may be an excellent time to do the conversion. The income taxes due will be lower.
Keep in mind that there are income limitations that apply to those considering a Roth IRA conversion. If
your gross income is $100,000 or more, you may not convert. However, this limit has been removed for
conversions that occur in 2010. In addition, those who convert in 2010 may pay the income tax
associated with the conversation in 2011 and 2012 (half in each year).
You have probably heard that some of the nation’s insurance companies have exposure to some of the
same problems that have been plaguing banks. You may be wondering if your insurance coverage will
There are several ways you can check on the status of your insurance company. You can start by
contacting your insurance agent or the service center for your insurance company. Ask about the
company’s exposure to the institutional mortgage market and what portion of its portfolio is nonperforming.
You may also check on the financial strength and claims paying ability of an insurance company by
reviewing their ratings with the rating agencies: A.M. Best, Moody’s, Standard & Poor’s, Duff & Phelps,
Fitch and Weiss. If you detect a pattern of rating downgrades and notices of heightened monitoring,
you should be concerned.
Insurance companies are regulated at the state level. So, you may wish to contact your state insurance
department and the department of insurance in the state in which the insurance company is domiciled.
Ask about the company’s financial condition and its ability to pay claims.
CASH VALUE LIFE INSURANCE
If you own cash value life insurance (e.g. whole life, universal life, variable life), you should sit down with
your agent and review your coverage. You need to determine whether the policy is sufficiently funded
to remain in force for as long as you live. If you stopped paying premiums on the policy or have a loan
against the cash value, the issue is even more critical. Ask your agent for an “in-force ledger” which will
show you the policy’s values today and what they are projected to be at (and preferably beyond) your
life expectancy. If the policy is projected to fail, you should act quickly to shore up it.
If you own variable life insurance, you should also review the subaccounts inside your contract. You can
use the same methodology you use when reviewing your 401(k): asset allocation, performance, and
expenses. Also, remember to rebalance within the subaccounts.
If you own an annuity, now is a good time to review the company that issued the contract and the
annuity itself. While annuities are generally either “fixed” or ”variable,” there are many variations on
these two structures.
You want to determine that the company that issued the annuity is strong and capable of honoring the
terms of the contract. An annuity is really a guarantee made by an insurance that could well last as long
as you live. It is not covered by FDIC insurance. However, through the National Organization of Life and
Health Insurance Guaranty Associations, every state provides at least $100,000 of coverage for annuity
owners if an insurance company becomes insolvent.
If you are concerned about the insurance company or if you have more than $100,000 in an annuity, it
may be wise to explore making a change. Keep in mind that your annuity probably has a surrender
penalty if you move the contract within some stated period, typically 3-7 years.
10 Property of Cascade Wealth Management, LLC
Annuities can be exchanged in a tax-free manner called a 1035 exchange. Just be careful to follow the
proper procedures to avoid an unnecessary tax hit.
HOME MORTGAGE PROBLEMS
If you find yourself struggling to pay the mortgage on your home, you are not alone. Fortunately, the
federal and state governments are actively intervening in the mortgage industry to help homeowners
remain in their homes. In addition, lenders are increasingly reaching out to borrowers.
The place to start is with the company that holds your current mortgage. You should contact the
company and ask about options that will allow you to restructure the loan. These may range from a
temporary reduction in the interest rate associated with your mortgage to an actual reduction in the
amount of the mortgage itself.
If you are found to be ineligible for relief from the terms of your mortgage, you may need to consider
other solutions. Can you afford to remain in the home? Are you able to sell the home for more than
you owe on the mortgage? If you are not able to sell the home, can you move into a rental and lease
the home? Can you rent out a room and use the rental income to help pay the mortgage?
If you must get out from under the house and you have little or no equity in it, you may face some
unfortunate tax consequences. The IRS states that if you borrow money from a commercial lender and
the lender later cancels or forgives the debt, you may have to include the cancelled amount in income
for tax purposes, depending on the circumstances. There are some exceptions involving bankruptcy,
insolvency and non-recourse loans.
Before you make a final decision, you should obtain tax and legal advice.
We are in the midst of a serious economic storm. The damage to portfolios, house prices and other
assets has been painful. U.S. Stocks have lost $7.5 trillion in market value since indexes hit a record on
October 9, 2007. According to Zillow 77% of U.S homes have declined in value in the in the past year.
We may be in for more losses before the storm dissipates. But eventually the economy will stabilize,
calm will return and the recovery will begin. But you should not wait for the sun to appear before you
assess your situation, make adjustments, minimize your losses, maximize your tax benefits, and position
yourself for the future.
Terry Donahe is a CERTIFIED FINANCIAL PLANNER™ who works with affluent individuals and
families. His firm, Cascade Wealth Management, is a fee only Registered Investment Advisory firm
located in Lake Oswego, Oregon. You may learn more about Terry and his firm at
www.cascadewealth.com. Terry can be reached at (503)675-4381 or by email at
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