There are so many questions surrounding retirement savings that it can be difficult to determine the right answer for your specific situation. The following article outlines some commonly asked questions about IRAs.

Nine Frequently Asked Questions About IRAs

visit SmartMoney to view the complete article

Question: How do I figure out the tax owed on an early withdrawal from a Roth IRA?
Answer: If you do a conversion, your Roth IRA can include money from (1) your annual after-tax contributions (2) contributions from one or more converted regular IRAs, and (3) earnings on both types of contributions. To figure out what happens when you later take Roth account withdrawals, you need “ordering rules.”

Withdrawals are treated as coming first from your annual after-tax contributions. As advertised, this layer of money can always be taken out tax-free at any time. Beyond this easy-to-understand rule, be careful.

The next layer comes from contributions of converted traditional IRA money. Withdrawals come first from the taxable amount, then from the nontaxable amount (if any).

You’ll generally owe a 10% penalty if you withdraw the taxable part of a conversion contribution within five years of the conversion. Withdrawals after age 59 1/2 are excepted, and the other exceptions to the 10% premature withdrawal penalty (death, disability, etc.) apply as well. The good news: After five years, this penalty no longer poses a threat. After you’ve yanked out the taxable part of the conversion contribution, you can withdraw the nontaxable part at any time without any tax or penalty.

To sum up, you don’t have to worry about any adverse tax consequences if you wait at least five years before withdrawing any funds from conversion contributions. After all contributions are withdrawn, you are obviously dipping into Roth account earnings. This money comes out tax-free as long as (1) the account has been open more than five years and (2) you are at least age 59 1/2, disabled, or dead. Withdrawals of up to $10,000 for qualified home purchase costs can also be taken tax-free after five years. Withdrawals of earnings that don’t meet these rules are hit with income tax and, in most cases, the 10% premature withdrawal penalty tax as well.

Question: Can a nonworking wife make a deductible contribution to her spousal IRA for 2012, assuming that the husband’s earned income is $150,000, he is an active participant in an employer’s retirement plan, and the couple file a joint return?
Answer: Yes. A spouse who is not covered by a qualified retirement plan can make a $5,000 deductible IRA contribution for 2012 ($6,000 if the nonworking spouse is age 50 or older at yearend) as long as the couple’s adjusted gross income doesn’t exceed $173,000. However, advises New York financial planner Joel Isaacson, it may be wiser for the wife to open a Roth IRA instead. The contribution is not deductible, but withdrawals from Roth IRAs are tax free. Traditional IRA withdrawals, on the other hand, are taxed as income. So, if retirement is still years away and you don’t anticipate being in a much lower tax bracket after retirement, a Roth IRA is probably the better choice.

Deductible IRA Eligibility
Question: I am single and work two jobs. At one, I am covered by a pension plan. At the other, I am not. With regards to IRA deductibility, am I covered by a pension plan or not?
Answer: “Participation in a company plan at any time during the year triggers the deduction phase-out rules,” says CPA Ed Slott, editor of the IRA Advisor newsletter. That might make you ineligible because IRA deductibility for singles phases out between $58,000 and $68,000 for 2012.

Question: Should I convert to a Roth IRA? Here’s my situation. I have about $329,000 in my IRAs. I figure the tax bill on the rollover would be about $107,000, which I can pay from the $150,000 I have in taxable mutual fund accounts. I am 60 years old, semiretired and don’t contribute anything to the IRAs. My dilemma: Would I still benefit from a conversion in the long run, considering the money the $107,000 is currently earning? I had planned to use the taxable funds during retirement if needed, and not the IRA money. All the programs and worksheets don’t make allowances for calculating lost gains on the money used to pay taxes on the rollover.
Answer: You’re on to something here. The tax bill on a Roth IRA rollover is actually larger than it seems at first because you pay the bill with money that would otherwise be invested. So to fairly evaluate the benefit of a rollover, you should compare the after-tax value of your traditional IRA at retirement to the following: the value of your converted Roth account on the same date, minus the future value of the money you would pay in income taxes on the conversion. Sound confusing? Don’t worry. We built a Roth IRA Conversion Calculator (inspired by your question) to help you figure it out.

To be continued…

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

The following article discusses the important duties and responsibilities of financial fiduciaries related to Employee benefits plans in the workplace.

The Significance of Being a Fiduciary

For the entire article, visit U.S. Department of Labor

Fiduciaries have important responsibilities and are subject to standards of conduct because they act on behalf of participants in a retirement plan and their beneficiaries.

These responsibilities include:

Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them

Carrying out their duties prudently

Following the plan documents (unless inconsistent with ERISA)

Diversifying plan investments

Paying only reasonable plan expenses

The duty to act prudently is one of a fiduciary’s central responsibilities under ERISA. It requires expertise in a variety of areas, such as investments. Lacking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions. Prudence focuses on the process for making fiduciary decisions. Therefore, it is wise to document decisions and the basis for those decisions. For instance, in hiring any plan service provider, a fiduciary may want to survey a number of potential providers, asking for the same information and providing the same requirements. By doing so, a fiduciary can document the process and make a meaningful comparison and selection.

Following the terms of the plan document is also an important responsibility. The document serves as the foundation for plan operations. Employers will want to be familiar with their plan document, especially when it is drawn up by a third-party service provider, and periodically review the document to make sure it remains current. For example, if a plan official named in the document changes, the plan document must be updated to reflect that change.

Diversification

Another key fiduciary duty – helps to minimize the risk of large investment losses to the plan. Fiduciaries should consider each plan investment as part of the plan’s entire portfolio. Once again, fiduciaries will want to document their evaluation and investment decision.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

Mutual funds are a common part of a person’s retirement portfolio.  The following article dicusses the advantages and disadvantages between a small or large mutual funds. 

Does Fund Size Erode Mutual Fund Performance?

by Eric Novinson

visit eHow money to view the complete article

Some investors prefer to invest in smaller mutual funds because they believe that a larger mutual fund produces lower returns. Larger mutual funds most often spend a lower percentage of their money on administrative costs and can pay fund managers more, but they also have to find more companies to invest in, or larger companies to invest in. Small and large mutual funds each have their own advantages and disadvantages.

Research Costs

• A mutual fund’s managers need to research every company in which the fund may decide to invest. If a small mutual fund pays its analysts $10,000 to produce a report on a company, it will also cost a large mutual fund $10,000 to produce the same report. The large mutual fund will spend less on each report in comparison to the amount of money it manages. Even if the large fund researches more companies, if it researches five times as many firms as a small fund but it has a hundred times the small fund’s assets, it still spends a smaller proportion of money on research.

Attracting Investors

• Closing a fund is also a helpful sales tactic, even if it doesn’t affect performance. The reputation of the closed fund improves, because other investors believe it is well-managed. A fund family, which offers several mutual funds, attracts investors to its other open funds when it closes one mutual fund. This explains why the fund managers would close the fund, because they would earn higher fees by managing a larger amount of money.

Liquidity

• A larger fund can buy a large number of shares in a few big companies. Funds usually buy more shares in the companies the fund already owns stock in as the fund grows, because the managers have already ruled out competing firms as poor investments. Purchasing a large number of shares in the same company lowers returns. The large fund will pay a higher price because the stock price will increase once it starts buying shares, and it will receive less income because the stock price will drop when it starts selling shares.

Investment Options

• For a large fund, there may not be enough small companies available to invest in with the potential to provide high returns. If the fund is limited to growth firms, or a single sector such as technology, it will have even fewer investment choices. Some mutual funds, small-cap funds, only invest in small companies.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

In addition to getting your finances organized, keep these 10 important tips in mind when preparing for the New Year.

10 year end financial planning tips you don’t want to miss

by Alan Haft

visit alanhaft.com to view the complete article

1.)  Take your required minimum distributions (RMDs).

If you’re not yet retired, this first thought likely won’t apply to you but who knows? With a little of this knowledge, you just might score some points with maybe your folks who just might be in retirement. Score some points and you just might score that new Nano you’ve been hoping for.

2.)  Spend the balance of your Flexible Spending Account (FSA).

If you participate in an FSA for either health or dependent care, check to see if the plan has implemented the new 2½ month extension provision, which allows 2010 FSA money to be used for expenditures through March 15, 2011. If the plan doesn’t have the extension, be sure to use up any balances before the end of the calendar year or they will be forfeited. One way to do so: stock up on over-the-counter medicines for next year.

3.)  Make last-minute charitable contributions.

Maximize itemized deductions by making donations in the form of cash, property, or appreciated stock. The latter could help you avoid capital gains taxes too.

4.)  Make an extra mortgage payment.

Making that one extra payment will, over time, cut the amount of interest you’re paying on your mortgage and actually reduce the number of years you’ll need to make payments before your house is free and clear. It will also help you maximize itemized deductions. Depending on whether or not you see paying your house off as a good thing, this thought could make a tremendous difference in your long-range plans.

5.)  Consider making deductible business purchases by the end of the year.

If you’re self-employed, and know you’ll need to buy deductible business-related items in the following year, you may want to buy them now to maximize your deductions in the current year (and take advantage of holiday sales).

6.)  Think about gifting.

At the time of this writing, you can gift up to a total of $13,000 per year (per person) to as many people as you want. That $13,000 may be given to one person, or distributed to any number of individuals. Your taxable income will be reduced by the amount that you gift.

7.)  Review and balance your capital gains and losses.

Make note of capital gains you’ve realized this year from the sale of stocks or mutual funds. Also find out if any of your mutual funds will be distributing capital gains. When you’ve added up your gains, check to see if there are any losses you can carry forward from previous years to offset these gains. If there aren’t, consider selling underperforming securities. Taxes should never be the sole reason you buy or sell investments, but it may be possible to improve your tax and your investment situations at the same time. Think of it as being a good time to “clean out the closet.” Especially with the likelihood that tax rates are going up next year, this could be my list’s most important idea to pay attention to.

8.)  Consider increasing your final 401(k) contribution.

If you haven’t already contributed the maximum of $16,500 (an additional $5,500 for those 50 and older) to your 401(k), consider increasing your contribution amount from your final paycheck. You have until December 31^st to make your final contribution for the year.

9.)  Open and fund a 529 plan college savings account.

Have kids? Have no idea how you’re going to get them through college? A 529 can help. For those that aren’t aware of it, a 529 plan account offers high maximum contribution limits and significant tax benefits. Money in the account can grow tax-free for years. And, withdrawals are tax-free if used for any number of expenses related to higher education. But some people are using them for estate planning as well, since the money you put into a 529 plan account is considered “a gift.” You’re allowed to contribute up to $55,000 - which is considered five years’ worth of gifting - at one time. The rule is based on a calendar year, so if you make a contribution in December, one of the five years (or $13,000) is applied to the current year. The balance of your gift will carry over and be credited in subsequent years ($13,000 per year).

10.)  Make Your IRA contributions.

You can make IRA contributions through April 17th, but why not consider doing it now so you don’t forget? For 2010 (year of this writing), the IRA contribution limit is $5,000, or and extra $1,000 if you reach age 50 before the end of the year.

One last very important point: I have known many people - especially business owners (sole proprietor, C Corporation, S Corporation, and others) - who amazingly have not set up programs such as Keoghs, SIMPLE IRAs, 401(k)s, etc. What a shame! The ability to “take income off the top” and place it into a qualified plan is a true misfortune. With enough time until the end of the year, it is still possible to set up a qualified plan. I cannot stress this enough: If you have no qualified plan for your business, you absolutely, positively need to make inquiries as to whether or not you can and which one is best for you. Speak to your accountant or a financial advisor. This could be the best thing you do for yourself before popping that cork!

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

Most investors assume that high risk (and the additional stress that goes with it) inevitably accompanies the potential for high returns. However, there is an interesting statistical formula that seeks to measure the amount of stress various investment strategies typically inflict on investors. The Ulcer Index, according to Nelson Freeburg, the respected editor of Formula Research, is “perhaps the most fully realized statistical portrait of risk there is.”

The Ulcer Index is different from other risk measurement indexes, such as standard deviation, beta and the Sharpe ratio, because it does much more than simply measure portfolio volatility. Traditional risk indexes falsely assume that all volatility is bad. The reality is that investors welcome upside volatility-but deplore downside volatility.

The Ulcer Index accounts for this basic psychological fact by ignoring upside volatility and penalizing downside volatility. In addition, it increases the penalty based on the depth and the duration of the drawdown. At a more technical level, the Ulcer Index calculates the difference between each day’s equity and the most recent equity peak. The formula then squares these numbers, averages them, and uses the square root of the average as the Ulcer Index. The smaller the number, the lower the risk.

The following excerpt from the book The Investor’s Guide to Fidelity Funds: Winning Strategies for Mutual Fund Investors goes over some of the basics to understanding the ulcer index.

An Alternative Approach to the Measurement of Investment Risk & Risk-Adjusted Performance

by Peter G. Martin.  To view this article visit tangotools.com.

What is the Ulcer Index?

Ulcer Index (UI) is a method for measuring investment risk that addresses the real concerns of investors, unlike the widely used standard deviation of return (SD). It is a measure of the depth and duration of drawdowns in prices from earlier highs.

Using UI instead of SD can lead to very different conclusions about investment risk and risk-adjusted return, especially when evaluating strategies that seek to avoid major declines in portfolio value (market timing, dynamic asset allocation, hedge funds, etc.).

The Ulcer Index was originally developed by the author of this page in 1987. Since then, it has been widely recognized by the investment community. The Index was first described in The Investor’s Guide to Fidelity Funds: Winning Strategies for Mutual Fund Investors, by Peter Martin & Byron McCann.

Note: There have been instances of the term “Ulcer Index” being used for risk measures that do not strictly follow the details described here. This document explains the correct use of the concept.

What’s Wrong with Standard Deviation of Return?

Standard deviation is a statistical measure of the variability or unpredictability of an investment’s return. It suffers from a number of serious drawbacks:

• Both upward and downward changes in value add to the calculated SD. Real investors associate risk only with the downside. Rising prices create profits, not risk.
• The calculated value of SD is not affected by the sequences in which gains and losses occur. Thus, SD does not recognize the strings of losses that result in significant drawdowns in value. The three hypothetical investments in the chart below have the same annualized return and the same SD, but no rational investor would consider them as having the same risk.

• When SD is used to measure the risk of a market timing strategy, it will tell you roughly how often you were out of the market, but nothing about whether you were out at the right times. SD doesn’t tell you if your strategy reduced risk by avoiding market downturns.
• The calculated value of SD depends on the time period used. For most investments, the SD of annual return is roughly 7.2 times the SD of weekly return (7.2 is the square root of 52 weeks per year). Since the time period is often unstated, this creates an opportunity for misunderstandings.

As a result of these weaknesses, SD does not reward an investment strategy for avoiding market downturns. Using Ulcer Index as a risk measure avoids all of these problems.

What About Other Risk Measures?

Other established risk measures have weaknesses too. For example:

• Some are based on the single worst event over a time period, which by definition has no statistical significance (e.g. Worst Trade and Maximum Drawdown).
• Some are based on absolute rather than percentage price changes, which distorts results over periods with strong price trends (e.g. Average Maximum Retracement).
• Some cannot be used to compare investment alternatives (e.g. Percentage Losing Trades cannot be used to compare a market timing strategy with a buy-and-hold approach, because the latter has no trades).
• Others share some or all of the problems of standard deviation (e.g. Beta).

What Does Ulcer Index Measure?

Ulcer Index measures the depth and duration of percentage drawdowns in price from earlier highs. Technically, it is the square root of the mean of the squared percentage drops in value. The greater a drawdown in value, and the longer it takes to recover to earlier highs, the higher the UI. The squaring effect penalizes large drawdowns proportionately more than small drawdowns (just as it does in the SD calculation).

In effect, UI measures the “severity” of drawdowns, as represented by the dark regions in the charts below:

Drawdowns in value: S&P 500 index with dividends reinvested

Drawdowns in value: Fidelity Select Precious Metals & Minerals fund

The algorithm for computing UI is simple, and can be seen in the pseudo-code fragment below:

SumSq = 0
MaxValue = 0
for T = 1 to NumOfPeriods do

if Value[T] > MaxValue then MaxValue = Value[T]
else SumSq = SumSq + sqr(100 * ((Value[T] / MaxValue) - 1))

UI = sqrt(SumSq / NumOfPeriods)

Unlike SD, the calculated value of UI is essentially the same regardless of the time interval per data point. Weekly price data is a good compromise, but daily data can be used as well. As the interval is extended beyond a week, there is an increasing danger of missing significant intra-period retracement-and-recovery events. The use of quarterly or longer intervals is strongly discouraged for this reason.

An Excel spreadsheet showing how to calculate the Ulcer Index is available at http://www.tangotools.com/ui/UlcerIndex.xls

Measuring Investment Performance

A popular method for measuring investment “performance” is to divide the excess return of an investment by its risk. (Excess return is total return minus the return offered by risk-free investments). This calculation provides a single number that accounts for both return and risk. It reports the additional return achieved per unit of risk assumed. Traditionally the Sharpe Ratio is used, where risk is again represented by the standard deviation of return:

Sharpe Ratio = (Total return - Risk-free return) / SD

Just as SD is a poor risk measure, so is this formula a poor performance measure. This problem is solved by simply replacing SD with UI. This new performance measure has been dubbed the “Martin Ratio” or “Ulcer Performance Index” (UPI).

Martin Ratio = (Total return - Risk-free return) / UI

In either case, compounded annual returns should be used for consistency. These figures should include reinvestment of dividends and other distributions; and should be net of all recurring fees, transaction costs and trading slippage.

When plotting investments on a risk vs return chart, UI can be used instead of SD for the horizontal (risk) axis.

If a line is drawn between the points representing the risk-free return and a risky investment, the slope of the line is equal to the Martin Ratio. As with the Sharpe Ratio, if an investment lies above the line joining the risk-free return with the S&P 500, the investment is “beating the market” on a risk-adjusted basis.

Market Timing Example

The table below shows the results achieved with both UI and SD. We compared two strategies over the period 1940-1997: buy-and-hold the S&P 500 index, and timing the index with a simple indicator. Results include reinvestment of dividends in both cases.
 

For the timing system, annualized total return is increased by a modest 2.2 percentage points. SD reports risk 18% lower and performance (Sharpe Ratio) 53% higher. UI reports risk 42% lower and performance (Martin Ratio) 119% higher. Thus, UI places a much higher value on the market timing system.

The timing system offers a modest 2% increase in annual return, but it more than doubles the risk-adjusted return calculated with UI.

Other experimental work has shown that many popular market timing systems have little value when SD is used to measure risk, but significant value when UI is used instead. This arises largely because SD fails to recognize the success of timing systems in avoiding major market downturns.

Caveat Emptor

With any method for computing risk and performance, it is important to use data covering as long a time period as possible. In particular, the time period should include both bull and bear markets for the investments of interest. Needless to say, when comparing multiple investments, the same time period must be used in each case.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

photo by thefuturistics

This article gives several good tips to help you save money and plan for an enjoyable retirement. Feel free to leave your comments and thoughts on the subject.

Financial Tips for a Better Future

Taken from the Article Directory Online

In this era of credit crunch, people are going through tough time of their lives, as it is driving people out of their jobs, and causing the businesses to shutdown. People are now using their saved up money, which is consuming their savings, which they have accumulated over the years.

Saving money should be your lifestyle, but not everyone is good at it. There are ways to stretch your money and to save them in the bank accounts. First of all, we have to stop the extravagant spending and should start using our money wisely. If we start from today, we will be able to save a lot, and ultimately it will pay us back in huge dividends. Let us have a look at certain tips which can help us getting grip on our bank balance.

For a start, one must have a planned budget, which must be followed, people do not have such habits, and in this time of credit crunch, it is important to do so. When one sticks to plans, which will eventually lead to better debts payments, and savings for holidays, educational purposes, and for emergencies, and above all for carefree life after retirement.

If you keep track of your spending you would know where your money is going, and when you know where your money goes, you know where you are spending. If you limit the purchase of luxury items, which includes your usual morning coffee, you would definitely save a lot of money by the end of every month. By knowing your spending, you would avoid late or overdraft fees and interest payments on your account. Following this method with your budget will be a dynamic duo!

You can get membership of local area library to have access to movies, and DVDs at much lesser cost as compared to the video rental stores, which will help you a lot in saving. Moreover, you can also borrow books of your interest instead of buying them from bookstores.

Getting rid of the TV cable connection can be very useful in different ways. First, it will be a way to save. Secondly, people think that TV cable is one of the major ways to get cheap entertainment, and to remain informed about the happenings of the outside world. In fact, without cable TV, you can give more time to your family, and can spend holidays with them. Moreover, you can do some constructive household project to keep yourself busy . Thirdly, when there is no cable TV, one will have free mind with respect to its bill payment.

The struggling class of the society is usually the one who cannot pay their bills on time. Late payment of the bill will lead to credit payments, which will keep increasing your debt, this may lead to worsen financial standing then before. Thus, one should pay the bills on time to stay out of trouble.

By limiting the spending on luxury, you would have more money in the pocket at the end of each month. Moderation is what is required in the first place. Do not go for brand names; purchase what looks good on you. Do not waste your money on cigarettes and tobacco stuff. This will not do well but will only damage your health.

photo by mckaysavage

It is true.

“When people win, they like risk. When they lose they hate it.”

- Olivia Mellan, Investment Advisor Magazine

It is easy for an investor to set his or her risk tolerance high when things are going well, but when things aren’t going very well, it is another story.

As an investor, it is important to ask yourself, “Will I be okay if my account drops 10, 20, or even 50 percent?” This will help you determine your investment risk tolerance level.

When you set your risk tolerance level properly, you will be happy when your account is doing well, and will be able to sleep at night when it is not doing so well.

At Paragon Wealth Management, we have created a risk tolerance survey to help investors determine how much risk they can tolerate. This survey determines how conservative or how aggressive you need to be invested. Click on the link below to determine your risk tolerance.

At Paragon Wealth Management we talk a lot about having a good investment strategy, and planning ahead for times that are both good and bad. This will help you to stay focused on the long-term instead of being swayed each day by what is in the news. Below is a good article that goes along with this idea.

How to Stay Frugal and Focused in a Recovery

Written by Wojciech Kulicki (a.k.a. Wojo) at
Fiscal Fizzle

A lot of people are talking about recovery–you can feel the buzz in the air, and the excitement of many of us who have felt the pressure of the economy take a direct hit on our ability to earn an income and maintain a basic lifestyle.

However, and it’s a big however, research and consensus around the web and major money magazines seems to indicate that we have a very short memory. So short, in fact, that our national savings rates and other major spending/savings indicators correlate exactly to the economic conditions of our time.

In other words, when the economy is tight, we spend less and save a lot. When it gets better, we tend to spend more and save less.

I was speaking to a fellow blogger a few days ago, who remarked that he “doesn’t buy into the economy.” In other words, he believes that doing the right things on a personal level should be our primary concern.

I agree to a certain extent–reacting to the news of the day, especially for long-term decisions like investments, is financial suicide.

But I do believe we need to be reactive to a certain extent. As our circumstances change for the worse, we may need to contract our budget more than expected. When they get better, we may need more help being diligent with savings when everyone around us is going on shopping sprees.

To that extent, and being very mindful of our natural, “wired-in” tendencies to go with the economic flow, I have several suggestions for how to keep your “recession” state of financial mind as we come out of this mess (whenever that may be).

Why Would I Want to Be Stuck Here?

By now you might be thinking–all right, Wojciech, I see what you’re saying, but why in the world would I want to be “stuck” in a recession mindset? Haven’t we endured this long enough?

I agree–going through a recession is anything but pleasant. But let’s take a look at some of the financial habits we’ve developed as a result:

• As a country, we’ve saving more than we have in a long, long time.
• Frugality has become the buzz word of the year, as more and more people discover that value is more important that price.
• We’ve simplified, contracted, and streamlined our financial processes, businesses, and spending habits.
• Lending practices, although they have over-contracted for now, will be more reasonable for the foreseeable future.

So while a recession may not be the best things in terms of pure economic sense, it’s a great cleansing and reset mechanism for our money.

Maintenance Strategies

Understanding our run-away tendencies to over-correct in an upturn, here are some of the things we will be doing in the coming months to prepare:

• Automate as much as possible. When we remove emotional decision-making from our financial life, we can reduce or eliminate decisions that hurt our long-term success with money. Consider your current situation and determine what you can automate–retirement contributions and savings are two that come to mind immediately, but you can also play tricks with extra payments to your mortgage or something similar. The more beneficial activity that happens behind the scenes, the better.

• Cultivate a peaks-and-valleys philosophy. If you haven’t read Peaks and Valleys yet, I recommend it–it took me less than an hour to get through the book. The basic concept is that you appreciate and manage the good times, while finding and using the good in bad times. If you come to understand the book, you’ll see why saving for a “rainy day” is such an important philosophy–it helps you get through the valley and onto the next peak.

• Catch yourself constantly. One of the most valuable characteristics of human beings is self-reflection. We are uniquely capable of analyzing our own thoughts and behaviors, and changing them at will. One of the ways we can control our ascent out of recession is constant self-reflection. Ask yourself–would I have done this a year ago? Is this a responsible use of my money, or am I spending just because I now can?

• Lock in your current behavior. One way to do this is to make note of all the relevant “ratios” that you can think of–debt to income, savings to income, etc. Another practical method is to monitor your net worth over a period of months and years. Finally, taking a “snapshot” of your budget–reminding you of how much you were spending during the recession, is another fantastic mental cue to take it easy.

• Curb your enthusiasm. Yes, I realize that’s the title of a hit HBO series. But it’s also a great strategy for not getting ahead of yourself during recovery. When financial circumstances get bad, we tend to resist lowering our spending habits. When times get better, we are quick to follow with our wallets. Slow down. Maintain a lower level of lifestyle, longer. Save the difference and experience the security of knowing that there is space between your income and expenses.

If Nothing Else…

If there’s one concept I would like you to take away from today’s post, it’s to have patience and react slowly to upcoming changes. While your financial situation may be far below “normal” right now, we don’t have to over-compensate when times are good and send it above that normal level.

Instead, we need to use the excess to prepare for the next downturn, so that we can maintain our “normal” level longer, perhaps through the entirety of the next recession.

How Will You Manage Recovery?

These are only my strategies for managing our mindset and finances through an economic recovery. What are some of the things you’re planning as times get better and we face the risk of forgetting how bad it got?

photo by AMagill