Rebuild Your Wealth

By Reshma Kapadia, Janet Paskin And Brad Reagan
1 December 2008

[The nightmarish markets have taken their toll on consumers assets and their confidence. But believe it or not, the crash has also created opportunities. Our guide to getting your financial house in order]

This fall, as the markets plunged and the country's financial system teetered on the brink of collapse, Faris Naman suffered along with everyone else. An electrical contractor in Sylmar, Calif., he's seen his business falter as construction work evaporated-and the less said about his Freddie Mac stock, the better. Eating out is now occasional instead of routine; Naman even asked his wife to unhire the caterers and deejay she'd lined up for his 40th birthday.

But amid all the day-to-day calamity, Naman decided he couldn't give up; he knew he had to think long-term about his financial future. So with that in mind, he has been cautiously eyeing some larger houses in nearby Pasadena, where several properties that were listed for $1.2 million just last spring are now $1 million or less. Naman has saved the cash for a down payment and figures it can be a good investment. "I look at a five-year timetable, so I see this as an opportunity," Naman says.

That kind of optimism is unusual in times like these -- and it's downright gutsy. In the past year, the country has endured plummeting home prices and an ugly encounter with $4-a-gallon gas. We've watched as the financial system entered the twilight zone, with banks failing, money-market funds breaking the buck and plunging markets erasing $14 trillion of investors' wealth. But even as consumers wrestle with a host of new concerns, they're finding new opportunities-and not under their mattresses.

Granted, the new economic climate has many people playing defense, adjusting retirement plans, tweaking portfolios, and making sure they have the cash and coverage needed for a rainy day. But some are also seizing the moment-taking advantage of falling prices to invest for the long haul. You can see signs of life in some housing markets: In hard-hit California, prices still sit more than 40 percent below their bubble peaks, but home sales have risen five months in a row. And even though major indexes have fallen as much as 40 percent from their 2007 peaks, Zecco, a discount brokerage, says its number of accounts grew 62 percent during the last two weeks of September as new customers swooped in to buy amid the turmoil. If they focus on blue chips, those buyers will be choosing from relatively healthy companies: Of the 378 dividend-paying stocks in the Standard & Poor's 500, 209 pay more than they did a year ago.

That's not to say that most of us are going to have an easy time rebuilding our wealth. Even optimists are no longer betting big on a quick recovery for the stock market. And thanks to the sweeping federal bailout, Americans are likely to face a new tax burden, and they could see major changes in their relationships to banks and brokerages. "I've never seen this level of pessimism," says Joseph Davis, economist at Vanguard. "This is going to test everyone's resolve." Still, financial planners say a little flexibility about your saving, spending and retirement plans will go a long way in this environment. Some of the steps to recovery aren't even that painful, including adjusting investments and insurance now to combat higher taxes and health care costs in the future. Rebuilding wealth may also mean preparing to work a year or two longer, as well as being bold enough to look for bargains in housing.

In the end, facing the new economic realities head-on may have benefits you've never considered: For one, you'll actually worry less. When people take even small measures to exercise control, they report less anxiety and less stress, says Patricia Frazier, a professor of psychology at University of Minnesota. It sounds obvious, but when the secretary of the Treasury floats the specter of another Great Depression, it's important to preserve your optimism along with your portfolio.

Retirement

Few people felt calm about Wall Street's autumn free fall, but the country's legions of retirees and near-retirees had the most to worry about. The market's crash has erased nearly $2.7 trillion in retirement savings over the past year -- during one stretch in September and October, it stripped about $65 billion a day from America's collective nest egg. Simply put, anyone counting on those investments for income will have less to spend -- at a time when retiree budgets already face the strains of rapidly rising health care costs and the possibility of higher taxes.

So when it comes to retirement planning, it's time for some fast thinking. The key, according to most financial planners, is flexibility -- including a willingness to work a little longer, which can go a long way toward repairing the recent damage. That's an idea retirees were already getting used to before the crisis -- according to the Bureau of Labor Statistics, 16 percent of Americans 65 and older are still working, the highest rate since 1971 -- and it may well be the best way to juice spending in retirement. For every extra year of work, retirement income can rise as much as 6.4 percent, from investment growth and Social Security increases. Mike Zimmerman is counting on it. Before the most recent market turmoil, the 61-year-old Chicagoan figured he'd run his printing business for another six years. Now, he says, it'll be eight at least, depending on how quickly the market recovers. "I don't mind; I enjoy what I do," says Zimmerman. In the meantime, he's still hoping that his retirement will accommodate his aspirations for fancy cars, fine wine and European vacations. When it arrives, anyway.

In the wake of a year like this one, waiting to tap that portfolio can give it time to recover, especially if you keep saving as you go. And given that taxes are likely to rise -- they're currently at historic lows -- working longer offers an opportunity to shelter more of your future income. About 22 percent of companies now offer Roth 401(k)s, which let you contribute up to $15,500 a year ($20,500 if you're over 50); you fund them with after-tax dollars, but withdrawals aren't taxed. Even on the off chance taxes don't rise, experts say the Roth plans offer a good way to build your savings while hedging your bets.

For current retirees, part-time work or consulting may be a good fit, especially if benefits aren't an issue, says Emily Allen, assistant director of workforce programs at the AARP Foundation. Anything would-be retirees can do to delay tapping Social Security can also help ensure that your money lasts. Social Security benefits are less generous if you take them before full retirement age, but you get a bonus for every year you wait after that. It's the only guaranteed income many retirees have, and while the difference of, say, $150 a month might not seem like much, it can have a huge impact. "No one ever runs out of money in year one," says Maryland financial planner Karen Schaeffer. "It's year 20 you have to plan for." That means planning to pay more for health care, too. Medicare premiums are rising rapidly; health care costs overall are growing 2.5 percent faster than the rest of the economy. For these and other reasons, long-term care insurance is a must. Shopping for it isn't easy -- every policy is different -- but AARP.com and OPM.gov feature sample plans that can serve as guidelines.

Investments

"Be greedy when others are fearful" is Warren Buffett's oft-repeated advice. Of course, it's easier to muster the courage to buy stocks when you've got Buffett's billions as a cushion. Still, history shows the best way to rebuild portfolios is to stay in the stock market -- which means that forward-looking investors are already thinking about rebalancing and diversifying their portfolios, despite the market's terrifying tumbles. "This is likely to be one of the best buying opportunities, if not in the last decade, then in the last century," says financial planner Harold Evensky.

Economists think the U.S. is already in a recession -- and that's good news for stock investors, since stocks tend to rebound before the economy does. Over the past nine recessions, the S&P 500 has gained an average 13 percent during the second half of the downturns and another 13 percent the year after they ended. Even during the Great Depression, the S&P rose 33 percent from the market's trough to the end of the recession. And while it's folly to predict a bottom, with the market down 40 percent from its 2007 high, it may not be far away.

Which isn't to say that it's time to throw caution to the wind. It's worth keeping a portion of portfolios in cash and bonds for emergencies, peace of mind and bargain hunting. Planners like Evensky are keeping many clients at least 15 percent in cash, more than they might in a calmer market -- and investors on the cusp of retirement should have a much higher proportion in cash and bonds. Although inflation concerns have subsided, economists expect them to reemerge in a year or two as the economy digests the costs of the credit crisis. One way to prepare is by buying Treasury Inflation-Protected Securities (TIPS) and limiting bond exposure for now to shorter-term, high-quality issues.

But the stock market remains the place where portfolios will get a rebirth. The best news may be that U.S. stocks are garage-sale cheap; right now the average stock in the S&P 500 sells for less than nine times its cash flow, a low not seen in at least a decade. Still, stocks could continue their roller-coaster ride for a while. "Now's not the time to be a hero" and load up on risky names, says Al Frank fund manager John Buckingham. Instead, strategists favor cash-rich blue chips in defensive sectors, such as consumer staples and health care, that can weather the slowdown better than other companies, as well as technology giants, whose profits have been relatively resilient so far. And with the market expected to return 5 to 8 percent a year over the next decade -- well below the returns taken for granted in the past -- dividends matter even more. The best way to buy is "dollar-cost averaging" -- committing to purchases at regular intervals so that you reduce the impact of short-term price swings.

The losses in some foreign markets make the S&P 500's losses look positively tame. But once the dust settles, exposure abroad will be crucial to rebuilding wealth. Veteran global managers like IVA's Charles de Vaulx see opportunities in more-developed foreign markets, including Japan, where some blue-chip companies pay dividends of up to 5 percent, and parts of Europe outside of England and Spain. And recent deep sell-offs mean emerging markets like China and Brazil are "like a high-end boutique with a half-off sale," says Rob Arnott, chairman of money-management firm Research Associates.

Borrowing

Anyone who's ever taken out a mortgage or a college loan knows that borrowing can be the key to building future wealth. But now that risky debt has sunk Wall Street, lending standards, by some measures, have tightened to their strictest levels in 15 years. With banks disappearing overnight, surviving bankers are fiercely protective of their balance sheets and probably would think twice about lending to their own grandmothers if they didn't sport bulletproof credit.

As a result, your credit score -- the measure of your reliability as a borrower -- is worth protecting like the crown jewels. The basic rules for improving your score haven't changed: Pay bills on time, keep balances low, and vigilantly monitor your credit report for mistakes. But more than ever, even little steps like doing without a department-store charge card can help, since a couple of points may mean thousands of dollars in savings on a mortgage. And just to show how the credit game has evolved: Two years ago a score of 650 would get you the best rates; now that threshold is as high as 740.

The good news is that for the 37 percent of Americans who surpass that score, money could still be plentiful, says John Ulzheimer, president of consumer education at Credit.com. For borrowers with sufficient equity in their homes, rates on equity lines of credit, for example, are already 30 percent lower than they were a year ago. However, since banks may still freeze these lines of credit if property prices tumble in your neighborhood, don't use the money for something you can't live without. Access to loans in the auto-loan market, while tough, isn't as difficult as in the mortgage market because defaults haven't yet been as bad, says Greg McBride, senior financial analyst at Bankrate.com.

For those not at the top of the credit-score class, it can pay to wait. Jason and Kellie Martel overextended themselves on credit card debt in their 20s, shopping liberally even though Jason was just starting up his delivery business. Since then they've focused on building up savings, paying down debt and boosting their credit scores while raising two kids in a Tampa, Fla., suburb. As the local real estate bubble burst, the couple found themselves in an enviable position -- eligible for the best mortgage rates, even as prices dropped. So recently, they started hunting for a three-bedroom ranch house with a pool. "We're nervous," says Kellie, "but we feel like we're in a good position."

For borrowers who don't have time to strengthen their credit ratings, credit unions can be an option. These lenders are more inclined to look past the credit score to see whether other circumstances, like job history and other assets, make you creditworthy. And for those who can't find money even here? Well, the credit crunch may lead more Americans to finally heed calls to save more. "Perhaps this is the wake-up call needed to safeguard the future," Ulzheimer says.

Real Estate

The home is the biggest component of many consumers' personal wealth. So if you want to give folks cold sweats and recurring nightmares, tell them they have to sell in this abysmal market. Life sometimes intervenes -- new job, new baby -- forcing homeowners to relocate. But here's a thought for reluctant sellers: Don't sell, rent.

That's advice a lot of homeowners are now hearing, and for good reason. An overlooked symptom of the housing malaise is that average rental prices are at an all-time high, according to a recent study by the Harvard Joint Center for Housing Studies. In part, that's because families forced out of their homes need someplace to live -- the number of renter households jumped by more than 1 million last year, four times the growth rate during the boom years 2003 to 2006. The result is that it's currently 10 to 15 percent cheaper to own a home than to rent in most parts of the country, concludes a separate study by Columbia University professor Chris Mayer.

Those numbers don't work in all cities -- New York and Miami, to name a couple -- and being a landlord has its costs. But savvy homeowners should do the math to see if they can turn a profit on their home while they wait to sell it. For example, Faris Naman, the would-be Pasadena homebuyer, figures he can rent his old home for close to the amount of its $2,400 monthly mortgage payment. Even if he comes up a few dollars short, he expects to make up that minor deficit -- and then some -- when he sells later, in a rising market.

For those staying put, a few kinds of renovations could pay now and later. Remodeling spending is expected to fall 9 percent this year, says the Harvard Joint Center for Housing Studies. But so-called green projects should be up slightly over the same period. Austin, Texas, builder Clark Wilson recommends retrofitting homes with what he calls the "big three" of energy efficiency: spray-foam insulation, a tankless water heater and an upgraded climate-control system. In Austin, Wilson says, these upgrades run about $23,000 for a 3,000-square-foot home and result in savings of up to $250 a month in energy costs, meaning they pay for themselves in less than eight years. And homeowners able to snare a home-improvement loan -- admittedly, no sure thing in this climate -- can conceivably turn a profit right away; the monthly energy savings will likely surpass the roughly $200 monthly payments on a 15-year loan. And it's a good bet that a big portion of the initial outlay will be recouped when the home is sold. According to a recent American Institute of Architects survey, 90 percent of homebuyers are willing to pay at least $5,000 extra for an energy-efficient home.

Spending

You don't ask, you don't get, the saying goes, and it's never been more true. With the economy flagging, everyone from car dealers and cell phone companies to big-box stores is desperate for business. That means they're increasingly willing to bargain with consumers, especially those who are able to pay cash or have exceptional credit. In recent months about 70 percent of Americans have managed to negotiate a better price on furniture, appliances and home improvements, among other things, according to America's Research Group -- that's up from 45 percent a year ago. In this market, says Z. John Zhang, a professor at Wharton Business School who specializes in pricing, the consumer is in charge.

And these days nothing's off limits. Sixty percent of recent luxury-car sales have included a discount or an incentive package, up from 43 percent a year ago, according to the Power Information Network. National chains like Home Depot, Circuit City and Best Buy are increasingly willing to negotiate; bargaining can save hundreds of dollars on gyms, cell phone plans and rental cars. Even the cost of a truly necessary expense, like health care, isn't fixed: Haggling with doctors yields a rate cut about two-thirds of the time, according to a recent survey by pollsters Harris Interactive. And even with many hotels already offering discounts as deep as 70 percent on room rates, in this environment you can often get a better room, free parking or free passes to the health club "just by asking," says Travelocity spokesperson Joel Frey: "Hotels will do anything to win your loyalty."

But the best deals aren't advertised, and few Americans are practiced hagglers. Asking for a discount can feel awkward, and being turned down for one is embarrassing. But just getting comfortable improves the chances of success, says Adam Galinsky, a professor of leadership and decision making at Northwestern University's Kellogg School of Management; research shows that people who think it's appropriate to negotiate will do better than those who don't. That's also one reason many people bargain better when they're acting on someone else's behalf, he says, because the awkwardness of being a squeaky wheel is lifted. The good news, of course, is that in this economy, it's more acceptable than ever.

With no shame in your game, the guidelines are pretty simple: Be polite, ask for what you want, and be creative. Galinsky's research suggests that making the first offer, and making it specific, frames the negotiation in your favor: "I'd like to pay $350" is a stronger position than "What can you do for me?" Standard strategies still hold -- offering cash, knowing what the competition is charging, keeping track of product cycles (cars, for example, are most deeply discounted at the end of the model year and during January and February). And if you can't get what you want, ask for something else: If a rental-car company isn't willing to give you a better rate, it'll often give you a better car; similarly, with one in every three hotel rooms empty every night, an upgrade is a more than reasonable request.

More Income, Less Risk

Fixed-income investments have always been stereotyped as the stodgier cousins of stocks, but these days stodgy and secure might be just what you're looking for. Still, buying fixed-income investments today doesn't mean running to the safety of money-market accounts or Treasury bonds. Experts say both of those are currently returning next to nothing after inflation, which means they could even essentially cost you over the long run. The good news: Some fixed-income investments can now earn you as much as 10 percent -- and you don't have to take on the risk inherent to the stock market. Here are some attractive fixed-income options from conservative to aggressive.

Conservative

Ginnie Maes

What are they? The Government National Mortgage Association, or Ginnie Mae, guarantees mortgage-backed bonds.

Why now? Unlike its cousins Fannie Mae and Freddie Mac, closely supervised Ginnie Mae avoided riskier mortgages, and Ginnies still pay far more than low-yielding Treasurys. These government-backed bonds are the "standard of a risk-averse portfolio," says Bill Larkin, a money manager with Cabot Money Management in Salem, Mass.

Best way to invest: Stick with funds such as Payden GNMA (PYGNX), which yields 5.5 percent.

Municipal Bonds

What are they? States and towns issue these bonds to fund everything from schools to sewers.

Why now? Thanks to credit market jitters and a favorable tax treatment, some municipal bonds now reward investors with unusually high payouts, as much as 6 percent annually, or the equivalent of a taxable yield of as much as 9 percent. Even with the credit crunch, the default risk is minimal. Since 1986 only 34 municipal bonds issued by the more than 10,000 government bodies rated by Standard & Poor's have defaulted.

Best way to invest: If you invest more than $25,000, consider buying an individual muni bond from your home state, since it can offer significant tax advantages. Otherwise, go with a municipal bond fund such as Vanguard Long-Term Tax-Exempt (VWLTX) or a state-specific bond fund, which also can offer favorable tax treatment to in-state investors.

Aggressive

Energy Master Limited Partnerships

What are they? Companies that own oil and natural gas transporting pipelines.

Why now? MLPs can be volatile investments even when energy prices aren't violently fluctuating. But the drop in oil prices this summer has made them particularly attractive now. MLPs currently sport hefty dividend yields and have a bright future since the nation likely will be spending billions on energy infrastructure over the next several years.

Best way to invest: Plains All American Pipeline (PAA) and Energy Transfer Partners (ETP) have yields of 10.2 and 10.7 percent, respectively. MLP investors must file K-1 tax forms annually.

Global Bonds

What are they? Just like in the U.S., foreign countries and companies sell bonds to finance themselves.

Why now? Investing in foreign bonds offers the benefits of diversification just like investing in foreign stocks does. And most countries didn't get caught up borrowing as recklessly as the United States did. It has been a good year for debt in emerging markets, which often offer higher interest rates than domestic debt. A global economic slowdown, however, could depress bond prices.

Best way to invest: Let professional investors, such as the ones who run Pimco Global Bond Hedged (PGBIX) or its more aggressive sister fund, Pimco Global Bond Unhedged (PIGLX), figure out whether Bolivian or Belarusian debt is a better deal.

— Elizabeth O'Brien