The Financial Crisis: What Should I Do?

dr_tectonic asks

If I were informed about the situation at more than a casual level, are there actions I could take that would have a substantial impact on my current or future well-being? (I have some retirement funds, they're all TIAA/CREF and not easily accessible to do anything with them, and I'm not really planning on trying to do anything with them for another three decades.)

My current assumption is that the answer is "no", and that this is a situation, much like 9/11, where more information has at best a marginal benefit, and could do significant (emotional) harm by making me all upset about something I really can't affect, and so, like the dangers posed by nearby supernovae, asteroid impacts, random spree killers, rampaging sewer alligators, and the like, it's really best to just ignore it for the most part.

Short Answer:

I think "no" is the correct answer. Retirement plans are kind of like trees: make sure it's planted in a place that will, in general, get the right amount of light and water and then don't worry about it. If you start panicking about a drought and try to micro-manage your tree's growth (like digging it up and moving it to the other side of your house), you've got a good chance of doing more harm than good. Periodically check on your trees to make sure they're growing the way you want, but don't do so when you're panicked. Humans often make good short-term decisions when we panic (like "Oh no, house on fire, grab the cat and run!"), but we rarely make good long-term decisions in a state of panic.

So don't make any rash decisions, but make sure your investment portfolio is aligned with your investment goals, is diversified, and has low management fees.

Long Answer:

If TIAA/CREF works like my 401(k) plan, you've got a dozen or two mutual funds you can distribute a portion of your paycheck to. You can also log on and move money from one fund to another. Broadly, there are three types of funds based on what they invest in: stocks, bonds, and income. You don't know which particular stocks, bonds, or income investments are currently held by a mutual fund, but the prospectus of the fund will often provide a focus like "We will invest about 75% in technology stocks."

Stocks are small bits of ownership in a company, traded on a stock exchange. Stocks are the most volatile of these types of investment. They have the potential to increase value quickly, but they can also drop like a rock. (The Dow Jones Industrial Average, an index of a certain segment of the New York Stock Exchange, dropped to almost 8000 yesterday compared to its high above 14000 last July).

Bonds are less risky. Companies and governments borrow money in exchange for a promise to pay it back at interest over a period of time, typically several years. These aren't likely to suddenly drop half their value like stocks, but they also won't suddenly double in value. A specific bond will be worth nothing if the issuing company goes broke and can't pay it back. The value of a bond fund will drop if there are lots of people who want to buy bonds, driving down the interest rates.

Income investments are generally short-term loans at small interest rates. For instance, the commercial paper market lets companies borrow $1 million to cover payroll. They'll pay it back the next day for $1 million plus $10,000 (1% interest) the next day after they've processed sales.


In the case of retirement funds, like TIAA/CREF and 401(k) plans, paying attention to the current value of your investments is rarely a good idea. Since you and I aren't planning on doing anything with the money in those accounts for 30 years, we've got plenty of time for them to earn back the losses they've made this year and much more. The Dow Jones is the lowest it's been since we invaded Iraq in 2003, but it's still 10 times what it was 30 years ago. So your retirement plan is probably worth less today than it was a year ago. But in another year or five it'll probably be worth quite a bit more than it was a year ago and it will probably get back to that point faster if your money is in high-growth funds (stocks) rather than safer funds.

I've heard that the best approach to take to a retirement fund is to check on it every year or two and make sure you still like the risk/reward situation you're in. As you get close to retirement, you probably want to reduce risk (shifting from stocks into bonds and income funds) so that a big crash on your 65th birthday doesn't take out half your savings. But in your 30s, you can take a big loss and still end up in good shape.

If you'd had perfect foresight, you could have moved your high-growth investments at their peak (perhaps the middle of last year) into something safer (bonds or income) and then switch back once the stocks hit the bottom, assuming you can guess when that is. However, the current financial situation is largely a "credit crisis," meaning banks and investors are very reticent to lend money right now, since they don't trust it will be paid back. This fear is so pronounced that commercial paper trading stopped cold until the Federal Reserve stepped in. If banks are unwilling to lend each other money over night because they think there's a significant chance of failure, I'm not sure any investment is particularly good.

Also note that in addition to gains and losses due to the market, you're charged a significant fee. If the share price of the fund increases slightly, you can actually lose money if there's a large fee associated. If the share price decreases, you'll lose even more money. It can therefore be wise to invest in an index fund (the S&P 500, say) with a 0.1% expense ratio than in a fund with a 1.5% expense. In the latter case, you're hoping the fund managers are good enough to do significantly better than the S&P (which isn't always easy). If you've currently got high-fee mutual funds, now might be a good time to consider moving them to a lower-fee fund with similar risk and potential for growth.

If you have stock in specific companies (rather than through mutual funds), this would be a great time to look into their financial situation. If you're worried the company won't survive the current financial crisis, you might want to sell that stock. If you think it'll make it out, you probably should hold it until the price goes up after investors regain confidence in the market.


Further reading: Is My Money Safe? from the New York Times via TheMoneyMeltdown.com. Gotcha Capitalism, a book about hidden fees by Bob Sullivan.

The Financial Crisis: What Does It Mean To Me?

slyviolet asks

For those of us with relatively insignificant (in comparison... obviously not insignificant to ME) bank holdings, no credit debt to speak of, no large loans outstanding and no stocks/bonds/other things of that nature, what will the practical personal fallout of the bailout be, if any?

The correct answer to that question requires predicting the future. Economists spend a lot of time predicting the future. But there's a lot of variation between economists' predictions, so you can often pick the prediction you like best and pretend that's what the future holds. "What will happen?" is not nearly as clear as "What could happen?"

First, what won't happen is losing the money in your bank account. The FDIC and NCUA just raised their insurance amount from $100,000 to $250,000. That means that even if your bank or credit union collapses because their loans all fail, you'll keep all your money (checking accounts, saving accounts, money market accounts, etc.) up to a quarter million dollars. So you don't have any reason to withdraw all your cash and stuff it under your mattress.

The key part of the current financial crisis is a halt in lending. Investors have been very reluctant to lend money to businesses and other banks. A lot of companies run on debt—retail stores often don't turn a profit until Christmas season so they borrow money during the rest of the year—and if they can't get loans they may have to fold. I haven't heard of a sudden rash of collapsing companies outside the financial sector. The government has taken a fairly active role in trying to stabilize things and if a lot of companies were suddenly about to collapse for lack of credit, the Federal Reserve would probably step in (which it did a week or so ago when it announced it would buy commercial paper). This is therefore probably a low risk right now, but it wouldn't hurt to check in with anybody you're receiving a regular paycheck from and ask what the company's financial situation is.

I think a bigger risk to companies is a weak Christmas sales season. I heard one time that "If Christmas were canceled one year, the whole American economy would collapse." A lot of people have reduced spending recently due to all the media attention on economic collapse. (Would you buy an iPod after the Secretary of the Treasury says "If we don't pass this bill, we might not have an economy by Monday?") If a lot of retailers collapse due to week holiday spending, you'd probably have some friends that were out of work, you might not be able to buy some of the stuff you want, and so forth. It would be a big sign of wide-spread economic hard times, a recession/depression hitting most Americans. I don't suspect this Christmas Crash scenario will happen, though. September of 2001 also featured a sudden change in market atmosphere and public worry about the future, but January 2002 didn't feature a major collapse of the retail sector (though it was a rough season).

If you're considering taking out a loan soon (to buy a car or a house or start a business or something) you may find it hard to get credit at a reasonable interest rate since lenders are reassessing who they ought to give money to. Depending what options in the bailout plan get activated and what new mortgage-relevant laws get passed, the housing market could go in several directions. If the government takes steps (changing mortgage terms or extra cash or whatever) to help current owners keep homes then I wouldn't expect a big change from the current housing situation, though home prices may continue to fall. If a lot of mortgage holders can't keep their properties, things may get exciting. If you rent a house, or condo (etc.) and the owner can't pay the mortgage, it'll go into foreclosure. If it's bought and the new owner wants to move in, you'll need to find a place to go. On the plus side, if you can afford it there may be some reasonably-priced foreclosures you could buy in such a situation.

Tied to the general economic situation (and not particularly to the bank bailout), commodities prices have fallen recently. Oil was trading around $90 a barrel this week, down from over $140 this summer. You've probably noticed gas prices are down; some of this is seasonal, but some is due to commodities traders selling in the face of uncertain financial future. (I keep typing "commodoties." When their prices go down, it's a nice whirlpool effect.) Food may also get cheaper.

Another thing that could happen: Your parents might get worried about their retirement savings and call you for advice. I spent around an hour explaining recent financial news to my mom last week. I advised her not to withdraw a bunch of money because she wouldn't have a chance to earn back what she's lost in the market. Calls from parents will give you the opportunity to reflect on things that ups and downs of financial markets can't take away: having conversations with people you like. Also: going for walks/hikes/bike rides, lying around in the sun, and socializing over board, card, and role playing games. Anybody want to play Monopoly?

Longer term effects: As the presidential debate moderators have mentioned, the next president will probably need to scale back some of his proposed projects in light of the state of the economy and the fact that $700 billion may be tied up in chunks of mortgages. So if you're hoping for particular proposals to come into effect next year, you might need to brace for disappointment. But really, that's sound advice for any political campaign. On the flip side, if there's a government program you're not fond of, 2009 might be a good time to organize a campaign to defund it. Like, say... "Hey, we've just spent $700 billion on a bank bailout. How about we don't spend another $700 billion on Iraq?"

As things ripple throughout the world, foreign economies may be rather volatile. It might be a great time to go to Europe if the Dollar regains significant ground against the Euro. It sounds like Iceland could use some cash... It's possible that countries who weren't closely tied into the scene become (relatively) better off -- maybe South America will be the place to be instead of China. But unless you're planning on international travel or business, changes in foreign markets won't have a direct effect on you and indirect effects are largely speculation at this point.


Further listening: This American Life: Another Frightening Show About The Economy. NPR: Planet Money podcast and blog. Adam Davidson from NPR (who's also the main guy in the This American Life economy shows) is the best business/economy reporter I've heard. I also like Steve Evans, the sometimes host of Business Daily on the BBC. He has a very engaging interview style