5 personal finance lessons we all should re-learn from the present financial crisis

We are probably already living in the longest recession since the great depression of the late 1920’s and early 1930’s. Many people have lost jobs; many large and small businesses have gone under; it’s difficult to get credit which many were so dependent on and need the most now. For many people like me this is the first recession they are seeing and things have been tough.

Now, I did not intend to scare you by saying all this but it is such difficult times that get us thinking on how could one prepare for such a situation if it was to happen again or still continue to worsen? How one could avoid the adverse effect of such a situation on their finances and wealth?

I read, discussed and pondered and then it struck me that we all knew the solution all along, but probably due to the economic prosperity we have seen in the recent years, one did not give these lessons enough importance. If only we re-learn these five lessons…

Buy a home that you can really afford.

Home ownership is touted as ‘The American Dream’. While home ownership has many advantages, buying a home is a big decision which if gone wrong can have several negative consequences like foreclosure, bankruptcy, etc. If you qualify for a mortgage it does not necessarily mean you can afford it. Buy a house for which you can comfortably afford to pay the monthly mortgage payment for throughout the duration of the loan and not just a teaser rate for the early years.

Build an Emergency Fund.

An emergency fund is like a safety net you can build to insulate yourself in case of any unfortunate events that may happens in your life. When we have a steady source of income we tend to ignore this and assume that things will continue to be smooth.  Some people depend on their credit cards limit for their emergency fund but it is not certain you will have it when you need it. Your credit line may be reduced or worse the credit card company may go under. One should also learn how to invest the emergency fund.

Stock market investment is not for everyone.

Historically stock market returns have been better than many other investments that are easily accessible but there has been significant volatility in their returns in the short run. Any money you need in the near future say 5 years (may be for college tuitions, travel, buying a home, medical expenses, etc.) should not be in the stock market. Passive investment in stock market (aka index funds, mutual funds) can also lose a lot of money (The stock market had tanked more than 50% in the eighteen months leading to March 2009).

Do not over invest in your company’s stock (or sector).

So let us say you worked for Chrysler/Lehman Brothers and also had a significant portion of your investment in their stock (normal accounts or via retirement savings accounts like 401K), what could happen? Your job may be in danger and a significant portion of your investments would have been wiped out, even worse, if you are close to retirement that savings could be your life’s hard work. I guess you see the point.

Frugality

A word that had some negative connotation associated with it has gained some popularity now. More and more people have started seeing the value in saving money for the future, trying to spend on necessities than luxuries and living within your means have become the ‘in thing’.