Economic Engineering

By now, everyone should have heard that we're officially in a recession. I expect our incoming President and his team of financial advisors to act aggressively to remedy the situation, but it will likely take some time to turn this mammoth boat of an economy around. Meanwhile, it's our job to take any steps possible to ensure our individual success. The strategy I will present is a good idea even in strong economic times, but as the economy worsens, it becomes increasingly important and beneficial.

The strategy is all about weaving financial safety nets. It is by no means a new concept, and it goes by many names. Investors call it hedging. Engineers call it redundancy. Your high school math teacher called it checking your work. Microsoft calls it safe mode. Subaru calls it limp home mode. Computer network experts call it a backup. Anyone who has ever written a long paper on a computer calls it the save button. It's exactly the same as any other ass-covering situation. We do it in almost every aspect of our modern lives, but many people neglect to take similar measures with their finances.

The first measure is simply saving money. A little fiscal discipline goes a long way. Open a savings account or money market (preferably a money market), and make a habit of putting a set amount out of every paycheck into this account. If you're prone to slacking on this sort of thing, some banks can help by setting up automatic transactions. This can be a retirement fund if you never run into trouble, but if you do, it's your backup funding. Aside from the obvious benefit of saving money in case of trouble, removing money from what you allow yourself to spend trains you to keep your cost of living down. This means that the money that you do save will last longer, should you need to use it. With this measure, some redundancy can only help. For instance, I put a set amount into a money market every two weeks, but I also roll and save my coins. In addition to that, whenever I save a substantial amount in my checking account and don't have to spend a lot of money in the foreseeable future, I invest it in the stock market. This way, I keep a system of three backup funding safety nets, and even at the age of 21 and having just finished an emergency car purchase, I should still be able to survive on this money alone for at least a couple of months.

Keep debt to a minimum, but build credit. While a little debt is essential to building good credit, a lot of it can easily put you in a tight spot. I'm not sure how most people look at debt or if some simply choose to ignore it altogether, but it should be viewed as negative cash on hand. A $1,000 credit limit on a new card is not the same as having an extra $1000. It is simply the ability to ecru that amount of debt. If you keep your debt in check, it will help your credit score by improving your debt to income ratio, as well as reducing your personal stress.

Avoid living beyond your means. No-interest financing is a clever marketing tool, and it can make buying the things you want instead of the things you need a very tempting proposal. There may be no interest on that $5,000 plasma TV for a year, but if you don't have the cash on hand to buy it outright, stick with the old TV. Nothing compounds the stress of reduced job security like crippling debt. Any reasonable person will be much happier with a little cash on hand than with a fancy new toy and excessive debt.

A bit about necessary debt. Few people are able to afford a house without a mortgage. A house is different in some ways from other forms of debt. The interest rates are generally lower, and you have a very solid piece of collateral to keep it low. There are some precautions here as well. When you finance your house, be sure that you have a strong credit score. The better your credit, the lower your interest rate. Make a habit of paying your bill as soon as you get it so you don't lose it or forget about it or end up paying late. The last thing you want is for your interest rate to skyrocket on a home loan. Pay more than the minimum, too. Don't go crazy and spend more on your mortgage than you can afford, but paying it down just a little bit faster than the standard rate can pay off big in the long run. It may be hard to see the benefits of this now, but every dollar you spend above the minimum monthly payment goes toward paying down principal, which means it's essentially the same as putting the extra cash in a money market at a rate equal to your interest rate for the remainder of the loan period. The immediate benefit may be nonexistent, but you'll thank yourself in twenty years when you're debt free instead of having to make payments for another ten.

If you already have a house, consider renting out the spare bedroom. It may seem strange to some people, but taking on a boarder can bring in some much needed cash in a pinch. Under solid conditions, the extra income can make a big dent in the mortgage. In bad times, it can mean the difference between getting by and losing your home. Approach this avenue with caution, however. It's possible to run into some unsavory characters in the domicile rental market.

Get a second job. It doesn't have to be anything fancy, and it doesn't have to make as much money as your primary job, but in tough times, it becomes increasingly necessary to have something to fall back on. The benefits of this are best demonstrated with some simple statistics. Let's say, for demonstration's sake, that you stand a 10% chance of getting fired from your current job within the next year. That's 90% annual job security, which is worse than what most people have, but it's not unheard-of. Now, let's say you take a weekend job performing some relatively menial task. The odds of losing that job may be higher because the lower-level jobs tend to have high turnover rates, but even if you only stand an 80% chance of keeping that job for the next year, having both jobs puts the probability of you being unemployed next year at
0.1 x 0.2 = 0.02 = 2%
The chances of you maintaining employment just jumped from 90% to 98%. When things are going well, the second job can fund a nice vacation, or an increase in savings, or some maniacal science projects. In order for it to be a true safety net, though, you have to be able to cut off whatever it funds immediately and use it for primary income, should it become necessary. The secondary job has to be ready to become primary if the need hits. Even if it only works to slow your losses, it's significantly better than nothing.

All of these ideas will help you maintain some financial security in a rough economy, and none of them will hurt in a smooth economy. I think you'll find that some fiscal discipline and planning will make your life much less stressful and more pleasant. I apply as many of these strategies to my own life as possible, being a student and part-time worker who pays rent to live in a friend's house, and I know first-hand that they work. While it may be true that money in itself can't buy you happiness (though studies have actually shown this not to be the case), a little thoughtful financial planning can do much to that end.