Moneywise24 Personal Finance

After a period of recovery, stock markets fell sharply this Monday, as fears on Europe’s debt crisis keeps dominating. Whereas the problems around Greece have been postponed, new fears arise that Italy, Europe’s second largest economy, might might fall into a debt crisis.

According to Reuters, the IShares MSCI Italy Index Fund, dropped by 4.9% to a value of 15.63 USD (read the full article here). Additionally, the FTSE Italia All-Share fell by 4.33%. One hour after opening, the Dow Jones fell by 1.45%. The fear, that the debt crisis may expand into the entire European region, is clearly dominating.

Especially finance-related stocks have much to endure today. Banks and insurance companies, which are largely sensitive to the global economy, fell sharply. Again, fear seems to dominate the market, at least on the short-term, while all eyes are looking toward the beginning of the Q2 results announcements. Alcoa is traditionally starting the season later today.

Personally, I am putting a hold on taking on any new positions. I will sell any investments at my stop-loss immediately, and generally simply lay back and watch the show. The Q2 results will surely be very interesting, but it will be more interesting whether companies will make statements to their expected Q3 and Q4 results.

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Just a quick search via Google, and the term “double dip recession” returns 1.8 million results. The topic is hot, and many people, if not the majority, believe that a double dip recession is on its way. Many articles speak of fear of a double dip, and try to anticipate whether and when a double dip might hit us.

Although such discussions are highly interesting, I tend to focus more on how to handle such a recession for now; because if it hits us, there will be nothing we can do to stop it, no matter whether we fear it or not. The question I ask myself is how I handle it, and even more importantly what I can do to stay out of trouble when it hits.

My first concern is securing my income. I am not yet in a position in which I run my own company, or where I can live off my savings for years. So, having a job is important. Where I live, in Germany, it is very difficult to fire employees. However, if a recession hits, even those employees doing a good job may be fired if else the existence of the company is in danger. Since I am male, single, and have no children, I would the first person gone. I would receive 70% of my last salary for nearly a year, but what about after that?

I took an insurance a while ago, which aims specifically at unemployment through no fault of one’s own. This insurance ensures that I receive up to a specific amount. I have calculated my minimum living standards, and added a buffer, which is the minimum amount I need to live off. If for some reason my living expenses go up (e.g. I bought a car, or rent increased), I can adjust the insurance to a new payout level.

Secondly, I continuously keep increasing my cash assets. This is my emergency fund, which I can use for unexpected expenses, either in or outside a recession. Having cash readily available gives me a more secure feeling.

On the long run I am investing in mutual funds. The amount is still small, but as soon as I sell these shares I will need to pay taxes. Therefore, I tend to keep the funds in my portfolio, but I will stop investing more money into them until the recession is bottoming out. This allows me to not unnecessarily increase my losses. Additionally, I might buy put options on one or more indexes, as a form of insurance. As the mutual funds (or stocks) are losing value, the put options are gaining value and are balancing out the losses, either completely or partially. However, I will monitor economic developments closely, and not judge too soon. The technical analysis functions help me to make an estimation of whether we are simply having volatile markets, or whether a recession is in the making.

When it comes to stocks, I tend to follow cyclical movements. I am not a big fan of the notorious buy-and-hold strategy, since these strategies were largely developed in the last millennium, where markets were not as volatile as today, and steadily increasing. When I buy stocks, I will look at undervalued or high-potential companies, but I will consider their cyclical movements. This means that I will set a stop-loss at all times, and in the event of a recession the stock will be sold automatically. Following the recession movement, it allows me to re-enter the market at lower prices.

During a recession, my expense policy changes slightly. I watch more closely not to buy items I do not necessarily need, and I am very keen on building my cash emergency assets. I might use the car less and take public transportation, and use each and every opportunity to save a bit of money. Also, I find a recession a great opportunity to visit friends at their homes, or invite people over, and just stay home and have a fun evening.

Surely I hope the double dip will not come… but a next recession will come for sure. Just as a fact: by the end of 2012, another batch of mortgage contracts will phase out, and there is a real estate bubble in China in the making, which is 5 times as large as in the US in 2008/2009. This is another reason why I prefer to stay out of any mutual funds or stocks with a real estate focus.

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I was thinking a few things over last night, amont others how my financial situation would look if everything crashed: stocks plummet and I would lose my job due to a financial crisis. In my case, this wouldn’t look good at all.

Currently I keep 3 different bank accounts:

• a checking account, where my employer transfers my monthly income, and which I use for day-to-day expenses.
• a short-term savings account, which I use to park money which I do not need immediately. I use this money for clothes, a new computer, furniture, etc.
• an investment account, which I use to buy shares and make other long-term investments.

I figured, one thing is missing. What happens when I would lose my job, and my investments would plummet? Or if my house is burnt down and I need money immediately in order to start up again with having nothing? It came to me, that having an emergency account is actually of great importance. For me, an emergency account would ideally be an account which has virtually no risk of the money being lost. Probably, the best solution is a savings account, with a potentially low interest, where the money is ‘parked’, but always readily available, for situations when I would need money fast.

The Bank

Different banks have different policies. We may assume, that each bank will invest our money and our savings into some form of investment, share, or fund, and in exchange we receive an interest. My biggest concern when selecting a bank, is the amount which I am guaranteed to have when things go heavily wrong with the economy. We have probably all heard about the Iceland banks and its account holders, who lost all its money since the bank did not have enough reserves available when shares plummeted with the financial crisis in 2008. Myself, I am Dutch, and I know that my bank guarantees reserves of at least 25,000 Euros per account holder; the governement is thinking about raising this amount to 100,000 by law. Surely for those having some million Euros on their bank accounts, it poses a great risk. But for my purposes, it will definitely do.

Availability

The second criteria is that my money is always readily available when I need it. Firstly, this means that the account type itself is not locked for a specific number of years, and I am allowed to transfer money from that account to my checking account when necessary. Second, it means that the bank should have an online banking system available, which operates in real-time, and that transfers are conducted immediately. I currently have accounts at two different banks; one of them, for example, would withdraw the transfer amount from my account but keep it for a couple of days before transfering it where I want it. This means that the money which I might need in an emergency situation is not available for a few days; not good.

Interest

I do not want my money to sit around without any interest being paid. Since I will not be investing this money anywhere, I will look at the best interest deals available, within the frame of the two previous points mentioned. As such, my money can grow over time.

Amount

The amount, which should sit on the account, should be enough to either be able to live off it for a period of 6 month in case I have no income, or it should be enough to build a new existence from nothing. The exact amount, which someone needs should be determined on a case-by-case basis, but below is the calculation I made for myself:

• My monthly living expenses are approximately 1,200 Euros per month. These are only necessary expenses, which I will have in any case, and does not include clothing, excursions, or anything which I do not need to get by. 1,200 Euros over a period of 6 months is 7,200 Euros.
• Looking at the 7,200 Euros above, this is also quite sufficient to build up something new; initial costs for renting a new apartments, costs for moving existing furniture to the new place, or buying new furniture.

The biggest trick, ofcourse, is not to touch this money whatever happens. If I do not badly need it, it should simply rest on my account. Should I not have needed the money until my retirement, I can then use it as a small retirement bonus.

By the way: if I leave this 7,200 Euros sit on the account for 30 years at an annual interest rate of 3.0%, it will be worth 17,476 Euros by the time I retire; that is a really nice trip around the world.

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