The Post-Crisis New Money Rules

BY KAREN BLUMENTHAL

The New Money Rules

We look back at what we’ve learned since the financial crisis about investing, savings and debt.

Nov. 1, 2013 6:38 p.m. ET

The stock market reached new highs again this past week, further dimming the grim memories of five years ago, when the financial world looked pretty bleak. I started this column just a few months before, and when I wrote that the fallout from this steep decline would be less severe than the crash of 1929, a few readers taunted me for months. After all, in November 2008, the Dow Jones Industrial Average had dropped a third from its 2007 peak and was on its way to losing more than half its value by March 2009. Unemployment was climbing and foreclosures and debt defaults were soaring. Today, much of the sting and stomach-churning terror of the crash has faded, and home prices have taken off—or at least have begun to rebound—in many markets. Still, unemployment remains uncomfortably high and the prospect of higher interest rates threatens to ruin our recent fun. Here are some essential money lessons for those who survived the financial crisis and those who are just starting their financial lives.You can’t control swings in the stock market or the economy—but you can control your debt and your savings.

Sometimes we have to borrow to buy a first car or even a first suit, and most of us will borrow for a home or to pay for college or graduate school. But how much we borrow and how we manage that debt have a long-term impact.

People with little or no outstanding debt beyond a mortgage have more financial options, especially in a downturn. That is why it makes sense to limit what you take on and to repay credit cards, car loans and even education loans as soon as you can.

Similarly, saving regularly means you will have choices if you lose a job or face a financial curve ball. If you aren’t saving at least a little every paycheck, you need to rethink either your spending or your income.

Ideally, you should save 10% to 15% of your income for medium-term needs and to ensure your retirement.

The rules of credit and credit scoring are illogical and infuriating, but you will benefit if you play the game.

What are the rules? You need credit to have a good credit score, preferably two or three credit cards or loans. How much credit you have available doesn’t matter, as long as you use it regularly (to show you can pay your bills) and don’t use too much of it at any one time (so it doesn’t look like you are in need).

Paying off your bill in full every month is the right thing to do, but it doesn’t help your credit score. The key factor is to pay on time. Miss a payment, and you will suffer with higher interest charges and a black mark that stays on your credit report for seven years.

A high credit score will give you financial flexibility in a downturn by, for instance, allowing you to buy a great home at a lower price. It also might help you get better offers today, such as credit-card rewards and an additional discount on a new car.

A home is a home, not an investment or a piggy bank.

From time to time, real-estate markets get hot and our houses soar in value. And from time to time, those home values sink like a stone. Avoid that game and buy a home to raise a family and enjoy your own space and neighborhood. Take cash out only to improve it or, in a pinch, to help send your kids to college, since rates are low and mortgage interest is largely tax-deductible.

At its best, that home equity will become valuable savings in your later years and could help fund your retirement or pay for long-term care.

If you are only going to master one financial concept, make it expenses.

More than anything else, the expenses you pay for financial services affect your results. They eat away at your investment returns in good years and add to your losses in down years. To be sure, everything has some cost, and even relatively high expenses could be worthwhile if they give you confidence and security and keep you from making impulsive mistakes.

But you wouldn’t buy a dishwasher or a car without comparing prices, so don’t sign up for a mutual fund, mortgage or insurance—or sign on with an adviser—without understanding the cost and weighing whether that is a reasonable price for you to pay.

Taking outsize risk is overrated.

Forget about beating the market. Your first investing goal is to beat inflation, which will eat up your hard-earned savings. To do that, you will have to invest at least some of your money in stocks.

But you don’t have to put 80% or 90% of your savings in stocks, nor do you have to chase commodities, which are typically volatile investments.

What you do need to know is how much risk you are taking—and how much you can tolerate. Just ignore the blowhard at your holiday parties who brags about his recent returns. You know how quickly that can change.

Invest with the long term in mind.

If you try to time the market, you might sell before the big decline—but you likely will also miss the big recovery. If you panic and sell near the bottom, you might never regain what you had. Jumping from hot fund to hot fund, or returning to the stock market only after it has soared, means you always will buy high. Most of the time, slow and steady wins this race.

Keep in mind that there is no one right way to invest. You can sock away a little over time or big chunks at once. You can meet your goals if 50% or 60% of your long-term savings are in stocks. What is most important is to choose a mix of investments and stick to your plan in good times and bad.

If you lose sleep over having enough cash in a downturn, keep a large emergency fund, and don’t fret when it doesn’t earn real interest.

In truth, all of these lessons were as true before 2008 as today, but we often get complacent in heady markets and have to learn them again. Get a head start now, and you will be well-prepared for the inevitable next downturn.