Suze explains how to navigate improving economic conditions without letting yourself veer off course.
I'm totally a worrywart, but even I'm encouraged by recent financial trends. Real estate values have started to rebound. The stock market is surging. Frankly, in this environment, it would be easy to get caught up in the moment and act hastily. But if you keep your head, you can find lasting financial security and long-term happiness. Here's how...
The Good News: It's Easier to Borrow
The economy continues its slow growth, but the Federal Reserve has no plans to raise interest rates. As a result, borrowing has never been cheaper, and lenders are increasingly willing to offer deals. I'm particularly heartened by the Fed's recent survey of bank officers: About 6 percent said they were making it easier for people with solid income and credit histories to get a mortgage (which could mean anything from requiring smaller down payments to accepting higher debt-to-income ratios from prospective buyers). Nearly 10 percent of lenders revealed that they're raising spending limits on credit cards again. And more than 13 percent of banks are loosening the rules for car loans by offering customers longer maturities.
Getting to a Happy Place The expansion of credit is wonderful—for some people. By that I mean it's crucial to be realistic about your current financial obligations and whether you're in a position to borrow.
Whatever you decide to do, don't fall for a lender's preapproved mortgage amount, which may be more money than you actually need. Take out only enough to support a lifestyle that's below, not within, your means.
While you're at it, ignore the increased limits credit card issuers have started to offer. If you pay off your balance every month, you don't need a larger credit line. Besides, I recommend that you use a debit card for most purchases, which will prevent you from spending more money than you have in your bank account.
Finally, don't let seemingly great loan terms seduce you into buying an expensive car—it's a depreciating asset. Borrow the least amount possible and pay it back quickly even if a lender gives you the opportunity to finance a purchase over five years instead of three.
The Good News: Home Values Are Rising, But Mortgage Rates Aren't
A national index of house prices in 20 U.S. cities rose 8.1 percent in the 12 months preceding February (the most recent data available). Stabilizing home values have spurred demand; more renters want to buy, and more owners have the confidence and equity to trade up. Meanwhile, interest on a 30-year, fixed-rate loan is about half the level it was five years ago.
Getting to a Happy Place Ignore the headlines about why now is a great time to buy a house, and ask yourself whether the moment is right for you to purchase one. Do you have savings set aside? Can you afford a 20 percent down payment? (I don't care if lenders are willing to accept a smaller amount.) Are you planning to stay put for at least five years? Answer no to any of these questions and you shouldn't become a homeowner just yet.
But if you are ready to buy or trade up, remember that less is more. Purchase the least expensive home that meets your needs so you'll have cash available for other investment goals. For example, if you choose a 30-year, fixed-rate mortgage on a home that costs $300,000 instead of one that's $350,000, you'll save approximately $225 on your monthly payment. Invest that amount in a Roth IRA that earns a 6 percent annualized return, and you could have more than $226,000 saved for retirement by the time you've paid off your mortgage.
Bear in mind, too, that bidding wars have returned and lots of buyers are chasing after a small supply of homes for sale. But don't let competition push you out of your comfort zone. If your budget is $300,000 and your agent tells you houses typically sell for 10 percent above list price, you should be shopping for homes that cost around $270,000. Otherwise you'll be tempted to overstretch if multiple bids push the price up.
The Good News: Strong Market Returns Have Buoyed Retirement Accounts
The Dow has already made up for its bear market losses. In fact, major indexes have more than doubled in value since 2009.
Getting to a Happy Place In the wake of the financial crisis, investors pulled hundreds of billions of dollars out of stocks. But after significant market gains earlier this year, money has poured back into stock mutual funds—the most common way to invest in a 401(k). Think about it: Even if you plan to retire soon, you'll need some of your money to last for another two decades, and stocks offer the best chance to make inflation-beating gains. With that in mind, you may find it easier to accept the short-term volatility associated with equities.
As a general rule, the percentage of stock in your portfolio should equal your age subtracted from 100 or 110 (if you're 35, that means 65 or 75 percent). Make sure to check your allocation once a year. If your portfolio falls in value, buy additional shares to stay close to your target. If your stocks end up being worth more than your ideal allocation, trim back a bit. That might sound counterintuitive, but it's fundamental to successful investing: Buy low and sell high.
The Good News: You Can Save More for Retirement and Take Advantage of Roth 401(K)s
In 2013 you're allowed to set aside up to $17,500 ($23,000 if you're at least 50 years old) in a 401(k)—a $1,000 increase from just two years ago. What's more, nearly half of employers now allow contributions to a retirement plan on an after-tax basis through Roth 401(k)s (which means future withdrawals will be tax-free), and many include conversions from traditional 401(k) accounts.
Getting to a Happy Place You probably don't think you need to save more for retirement, and that's a mistake that could haunt you. I recommend that you withdraw only 4 percent of your total savings the year you stop working. (You could always increase that percentage over time, but starting low ensures you won't outlast your income.) If you have $500,000, for example, you could take out $1,667 a month for 25 years. You'll also have Social Security, but the average monthly payout is only about $1,150. Those of you who work in the public sector may also have a pension, but that kind of benefit has become rare. The bottom line is, you'll need a lot more money than you expect to retire with confidence.
The next time you receive a raise, immediately save two-thirds of it. If it's a 3 percent bump, increase your 401(k) or IRA contributions by 2 percent. You won't miss that money if you never see it in your paycheck.
And by all means, try to make new contributions into a Roth 401(k) if your employer offers it. That's a no-brainer if you're just starting out and not earning much money; you'd lose very little by forgoing the tax breaks that come with a traditional 401(k). Work with an accountant if you plan to roll an existing 401(k) into a Roth, though; you'll owe tax today on any amount you convert.
The Good News: Unemployment Is Falling
Yes, we still have a long way to go. But after reaching 10 percent in 2009—a 26-year high—the jobless rate has slowly inched its way back down to 7.5 percent as of May.
Getting to a Happy Place I hope everyone has learned one big lesson from the financial crisis: how important it is to save for emergencies while you have consistent employment. In a 2012 bankrate.com survey, 28 percent of respondents said they had no money set aside, and another 21 percent said they had less than three months' worth of living expenses saved.
As you start to receive regular paychecks again, focus on building an emergency fund that could help you survive eight months without an income—that's the foundation of your financial security and, ultimately, your happiness.