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By John Stepek, MoneyWeek
02 October 2008
News of more banking bail-outs keeps on coming.
The US has pushed through an amended version of Hank Paulson’s bail-out plan, which will be voted on by Congress on Friday. Meanwhile, the French may or may not have proposed a similar plan for Europe.
But let’s make something clear. Regardless of what happens to these various schemes, whether they succeed or fail, life is going to get tougher for your average investor in the street.
So it’s time to ignore, for the moment, all the inconceivably high numbers being bandied about by politicians and concentrate on some much more important numbers - the numbers in your investment and savings accounts!
The Western banking system is broken, kaput, bust. Everybody realises it now, and governments are stepping in to attempt to fix it. Some of these attempts will be more successful than others. The Irish, for example, have had a bold go at saving their own banks by saying the Government will guarantee basically their entire banking system for the next two years.
I think that was a pretty clever move. I’ve already had a couple of readers email me to say they’ve opened accounts with Irish banks as a result, and certainly share prices of the banks bounced.
The only problem will be is if the rest of Europe decides to follow Ireland’s example. If all banks are 100% government-backed, then rather than focus on the creditworthiness of each bank, savers will focus on the creditworthiness of each government. And with Ireland’s economy remaining one of the more highly exposed to tumbling property prices, savers might just call the Celtic dynamo’s bluff.
We’ll see. Anyway, whatever governments do, the fact remains that banks aren’t going to be able to lend for a long time. Debt has been cheap and plentiful - now it’s going to get ever more expensive and scarce. We’re already seeing that the number of mortgages available on the market dropped by 11% on Monday alone. And a staggering two-thirds of mortgage brokers have been unable to find a mortgage for clients in the past two months, according to the Intermediary Mortgage Lenders Association.
Trouble is, debt - both public and private - is what’s been propping up our economy. So we get a vicious circle which goes something like this: as property prices fall, so does consumer spending. When people spend less, companies make less money. When companies make less money, they go bust or they lay people off or both. Higher unemployment means higher repossessions, means lower house prices. And that’s not even discussing the impact of tighter lending on small businesses, many of whom will hit the wall purely for cashflow reasons.
So how does this affect you? First things first, you need to get rid of your short-term debt. If you have credit card or personal loan or overdraft debt outstanding, pay it off. That’s your priority. There’s lots of advice out there on how to do this but broadly speaking, tackle the highest interest rate debt first then work your way down.
Next, build up an emergency cash fund. About three to six months of living expenses is right (it may not be terribly pleasant to think about, but the more precarious you feel your job is, the more you should try to put aside). Put it in a safe instant access bank account - as it’s likely to be less than £35,000 it should be covered whichever bank you put it in. But if you want to be sure, National Savings & Investments and Northern Rock are 100% government backed, and you can also look into which Irish banks are now 100% guaranteed (see the latest issue of MoneyWeek, out on Friday, for more on this).
Then there’s the mortgage. I’ll be straight here. I can’t see much reason right now to stick savings in the stock market when you can use excess money to pay extra to your mortgage. Yes, I’ve read all the literature about pound-cost averaging and how “time in the market matters more than timing the market”. Funny how that line always seems to come out when the stock market is falling.
You have no idea of what’s going to happen to the stock market over the next ten years, let alone the next week. But you do know how big your mortgage debt is. If you can save yourself more money in interest by putting your money towards the mortgage, than you can reasonably expect to make by investing it, then it makes sense to get rid of the debt (read Tim Bennett’s recent piece on this topic, for a more in-depth look at this).
And bear in mind that it’s very likely that when you next come to remortgage, your mortgage will probably be more expensive and harder to come by than your current one. At the moment, some company’s best deals are only open to those with 40% equity or more in their homes. It’s all the more reason to try to shrink that debt as much as you can.
So you have an emergency stash, no short-term debts, and you’re happy with the size of your mortgage. The big question is, what can you invest in? Obviously we like gold - say between 5-10% of your portfolio. But remember that, particularly at this level, it should be thought of as insurance. It goes up when everything else goes down, and vice versa.
What about stock markets? The turmoil is going to be global. And the recessions in the US and UK are going to be worse than most people still expect. So it seems likely that company disappointments still aren’t priced in. You’ll see plenty of pundits around just now saying you should buy when everyone else is fearful. But many of the same pundits were recommending plunging into financials pretty much all the way down.
We’re still keen on Japan. The market has been hit along with the rest of world markets, but there are plenty of things to like - its banks have money, stocks are cheap, and buying them gives you exposure to assets that aren’t denominated in sterling. And Asia in general will continue to grow in importance, despite the global slowdown.
