It's safe to say the economy has suffered its share of blows over the past two weeks. In one of the most convulsive weeks in American financial history, we've seen four major banks fail, two investment banks turn into commercial banks and Congress reject a $700-billion bailout plans that could have put the economy back on track.
But while much of the conversation surrounding the financial crisis has centered around the large banks and wealthy CEOs, little time has been devoted to shedding light on how the crumbling economy will affect personal bank accounts, 401(k)s and IRAs.
"If Congress fails to act right now, a lot of people will lose their job," Henry Paulson, the secretary of the treasury, told reporters on Monday. A credit freeze, resulting from shaken confidence in the economy, could have a snowball effect, bringing credit lending to a halt and making it harder for businesses to retain jobs and individuals to obtain credit to buy homes, Paulson said.
On Monday, the bailout bill failed to pass in Congress. Shortly after, the Dow Jones Industrial Average fell 777.68 points--the biggest one-day drop in history--and Standard & Poor's 500 index fell 8.77 percent, the biggest drop since October 1987.
While it's unclear how low the market will sink and how many more banks will crumble, there are some definitive things you can do to shore up your funds:
Don't Make Any Drastic Moves
Watching the news while considering your 401(k) is tough, but don't make any drastic moves. It's important to stay calm. Closing your bank account and withdrawing from your 401(k) is not the answer.
Thanks to the Federal Deposit Insurance Corp., bank accounts are insured up to $100,000. That means your money is safe, even if your bank shuts down or is sold, like Washington Mutual.
Adjust Your Spending Habits
The days of buying on credit are over for a while. That means no more racking up high credit-card debt and simply paying the minimum each month. As the market tightens, the credit market is drying up.
Take time to reassess your finances and look for ways to cut costs without seriously impacting your life. It's important to stop spending money on things you don't need. Wait until the market recovers to think about making frivolous purchases.
Have Faith in Your 401(k)
If you are facing retirement, Monday's market crash is a bit more critical for you. But don't fret; all is not lost. If your portfolio has taken a hit, consider delaying your retirement. Use online retirement calculators, like the one offered by T. Rowe Price, to help plan your retirement.
And no matter what, continue to match or exceed your employer's contribution. Remember: Withdrawing from your 401(k) early for reasons not approved by the IRS will be costly. In addition to having to pay income tax, you'll also be hit with a fee that equals 10 percent of the amount withdrawn. Additionally, T. Rowe Price has made it known its customers are not in immediate danger.
From the T. Rowe Price web site: "It is important to note that the position of T. Rowe Price Group in the financial markets is significantly and fundamentally different from other more diversified financial services companies that may be involved in numerous businesses, such as insurance, lending, investment banking, and various capital market activities. T. Rowe Price focuses on one business: investment management for our clients."
If you must move your money, consider investing in Treasury bills. They are extremely safe investments that don't yield any interest before they mature.
Ride the Wave
Riding out this tough market may at first seem like a bad idea, but history has a way of repeating itself. What goes up must come down, and the market will bounce back. And while the market will probably get worse before it gets better, it's important to remember that if you are investing correctly, you have time on your side.
Although it's impossible to time when the market will improve, some financial experts predict we could begin seeing improvements in three to four years.
Explore Alternative Saving Methods
It's true that obtaining a loan will grow increasingly difficult as the credit market freezes. If you are saving for your teenager's college education or for a down payment on a home, consider exploring alternative saving methods.
For starters, look into opening a 529 plan, which allows you to save either at the current tuition inflation rate or at the rate of the market.
If you are thinking of buying a house, pump as much money as you can into your 401(k), as the IRS allows you to borrow against it to purchase a home without tax penalty.
