Ten years ago this week Bear Stearns collapsed, the first major meltdown of the 2008 financial crisis. Other financial titans soon followed, including Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, AIG and Washington Mutual. Some failed outright, some were bailed out, others were merged into healthier firms, but they all fell victim to the worst financial crisis since the Great Depression.
The local impact of the crisis was enormous. Real estate values plummeted. Businesses went bankrupt. A lot of people suddenly found themselves out of work and upside down on their mortgages. Many of them went bankrupt, too.
Most of that is behind us now. Real estate values have recovered and then some. Unemployment is at record lows as the economy continues to create more jobs than we have workers to fill them. With all the good news, we might be tempted to forget 2008, but that would be a mistake. If we remember the past, we can learn from it. And if there is one lesson I hope we learned from the pain of the 2008 debacle it is this: cultivate financial flexibility in your life.
Financial flexibility is the ability to adapt to adverse changes in financial circumstances and pursue opportunities when they arise. It is a very simple, but powerful principle and will lead to tremendous peace of mind during periods of financial stress. High tech mega companies like Alphabet, the parent of Google, have learned this lesson well. That’s why Alphabet carries more than $100 billion of cash and short-term investments on its balance sheet with less than $4 billion in debt. Their balance sheet is a competitive edge. They will never have to worry about a financial crunch impairing their pursuit of their mission. Likewise, increasing your personal financial flexibility enhances your ability to confidently pursue your goals in life.
Financial flexibility increases as you build financial reserves. Most financial planners will tell you that you need reserves equal to somewhere between 3 and 6 months of core living expenses, including mortgage payments and expected health care costs. That’s a good rule of thumb. However, you will want to refine it for your particular situation.
For example, if your family has two incomes you can probably get away with reserves at the lower end of the range since it is unlikely both income sources will dry up at the same time. On the other hand, if your family has special needs or a single income, you may want to have significantly more than 6 months of reserves.
As many people discovered in 2008, debt also affects financial flexibility. In the years leading up to the crisis, the debt burden of American households grew dramatically. By the end of 2007, households were devoting a greater portion of their disposable income to service debt than ever before. When the financial crisis hit, heavily indebted households had very little room to maneuver.
While most people cannot avoid all debt, especially if they own a house, everyone can eliminate credit card debt and car loans. As far as mortgages are concerned, my personal preference is to pay mortgages down as rapidly as possible. However, you must be careful not to compromise your financial reserves in the process. Your financial planner can help you figure out how much mortgage is right for you given your situation and your goals. As you reduce your debt, you will increase your financial flexibility.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to: email@example.com