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Lessons from the financial crisis

Five things to try now to help improve your personal economy.

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The financial crisis that began five years ago triggered a recession and dramatic drop in stock and housing prices that hit Americans hard. The unemployment level reached its highest mark in nearly 30 years, foreclosure rates quadrupled, and many investors suffered significant setbacks to their savings plans.1 It’s no wonder that in a recent Fidelity survey more than 64% of respondents said they felt scared or confused at that time.2

Five years later, however, one benefit may have emerged from the downturn: Many Americans have become more focused on their financial lives—more than 56% told us that instead of “scared or confused,” they now feel “confident and prepared.” “From the depths of the recession and volatile market conditions, many investors found resolve and started making very positive changes to their personal economy,” says Kathleen Murphy, president of Personal Investing at Fidelity. “Whether it’s increasing contribution rates to a 401(k) or IRA, adjusting asset allocation, or increasing the frequency of financial discussions with family, the silver lining of this recession was that it spurred investors to reassess and improve their finances.”

How did they do it? The short answer: They took control.

While our respondents were split between blaming the crisis on banks and lenders and blaming it on Americans getting overextended financially, 56% of respondents said they now believe that it’s solely their responsibility to prepare for retirement. And they have already begun to take action. About two-thirds told us they have become more knowledgeable about their finances, and about three-quarters are monitoring their investments more carefully.

How can you learn from them? Consider these five steps to take control and help strengthen your personal economy.

1. Save more—and smarter—for retirement.

You can’t control the markets, but you can save more—and doing so can pay off. Among investors who went from feeling scared to prepared, 42% said they increased their contributions to their workplace savings plans—401(k)s, 403(b)s, 457s, health savings accounts (HSAs)—as well as to individual retirement accounts (IRAs).

Why is it so important to save in these accounts? The combination of tax-deferred investments and disciplined savings mean even small changes can have a big impact on your future lifestyle. Take an individual who now makes $70,000 a year. Let’s say he increases his workplace savings rate from 5% to 7%, and that money grows tax deferred at a hypothetical average annual rate of 6%. After 20 years, his balance would be 15% higher (see the graph to the right for additional assumptions).

So, take advantage of your workplace savings plans. For most people, the top priority should be contributing enough to capture any company match. Not doing so could be leaving money on the table. Also, try to take full advantage of other tax-advantaged savings vehicles, like HSAs, IRAs, and annuities.

How much is enough? We think a good starting point is to have saved at least eight times your ending income by the time you retire, though your number can be significantly higher or lower, depending on your situation and some key choices you make. Among those choices are the age at which you plan to retire and the amount of your income you want to use in retirement.

► To learn more about our 8X rule of thumb, read the Fidelity Viewpoints article "How much do you need to retire?"

2. Prepare for the unexpected.

Talk of risk management at the market top was the proverbial skunk at the picnic. But staring into the financial abyss was a hearty reminder of the value of preparedness. In our survey, about half of respondents said they had reduced their personal debt, reflecting a nationwide shift to thrift. In aggregate, U.S. household debt as a percentage of GDP dropped from a high of 14% in 2007 to slightly above 10% at the end of 2012, the lowest level since the government began collecting the data in 1980. Of those respondents who now feel confident and prepared, nearly three-quarters said they have less personal debt than they did before the crisis.

If you have high interest credit card debt, try to pay it down as soon as possible, starting with the cards with the highest rates. If you can’t pay it all off, consider consolidating the debt in a low interest rate home equity loan or line of credit. Also consider these important strategies:

  • Build an emergency fund. Having enough savings to deal with a flood, a broken car, or a lost job can allow you to keep your long-term investments on track, even when things don’t go as you plan. Fidelity recommends that you keep at least six months of cash on hand in highly liquid accounts like a money market fund or savings account. If you do decide to sock away some cash for a rainy day, you may want to be strategic—using cash-back rewards can help build your savings faster, and keeping costs down for accounts and ATM transactions will leave more of your savings for your goals. The emergency fund has caught on recently, with 42% of the investors who went from scared to prepared said they added to their emergency fund since the crisis. For comparison, just 24% of the investors who told us they were still feeling scared or confused had increased their emergency funds.

    ► Learn why you may want to consider an emergency fund and how one family built one.
  • For those approaching or in retirement, consider adding guaranteed income to the mix: In building an income stream for retirement, Fidelity believes that most people should cover their essential expenses with guaranteed sources of income, like Social Security, pensions, and annuities. Since the downturn, many investors have been looking for some income guarantees—nearly 40% of investors who went from scared to prepared said guaranteed income products, such as annuities, look more attractive now.

    ► Learn more about retirement income planning.

3. Rethink risk.

Even the most seasoned investors may have felt weak in the knees as they watched the financial crisis evaporate stock and housing wealth. Among those in our survey, 21% shifted to a more conservative investment mix, but more than 50% stuck with their plan. Five years later, those who stayed in the markets may have reason to celebrate. Although they lost more in the early years, they benefited from the 125% rise in the S&P 500® Index since March 2, 2009. Those investors who fled the stocks for the apparent safety of bonds and cash may have missed that recovery. An earlier Fidelity research study showed that 401(k) savers who continued making contributions and stuck with their asset allocation had higher balances than investors who tried to time the markets (see charts below for results and important information about methodology).

So what if you were rattled by the volatility and increased your investment in bonds, beyond your long-term plan, in an effort to reduce risk? You may need to rethink what is risky. In recent years, bonds have been investor favorites, and assets in taxable-bond funds have more than doubled since the end of 2008, climbing from $1.1 trillion to $2.5 trillion, according to Morningstar. But, bonds have been beneficiaries of 30 years of generally falling interest rates, and thanks to investor demand and central bank policy, today rates are historically low. There is no guarantee that rates will go up soon, but if they do, bonds may suffer price losses. Those will be partially offset by climbing income on funds, but interest rate risk may make bond investments more risky than some investors may realize.

Bottom line: Get a plan you can stick with for the long term that has a realistic chance of meeting your needs. Consider making regular monthly investments—no matter what the market is doing. If the market moves strongly, considering rebalancing at least annually or when your portfolio is more than 5% away from your target asset mix. Those practices could help give you the discipline to try to buy low and sell high.

4. Manage your tax and inflation exposure.

Five years ago, deflation was the big economic fear. But today, massive deficits and unprecedented central bank asset purchases have turned the tables and pushed taxes and inflation to the top of investors’ worry list. More than half of the investors we surveyed said that tax and inflation strategy had become more of a focus during the last five years. If you want to build your portfolio for the next five years and beyond, you need to consider these risks.

  • Prepare for inflation. Inflation can erode the purchasing power of savings. Even with a low, 2% inflation rate, money held in a money market fund yielding 0.01% is losing money in real terms. Ditto for a Treasury bond yielding 1.92%.3 Indeed, the eroding purchase power and rising rates associated with inflation can eat away at most bond investments to varying degrees. As a result, investors may want to consider including in their diversified portfolios some income sources that have some ability to react to inflation—for instance, leveraged loans, TIPS, or stocks.

    ► Learn what to do about inflation.
  • Manage your tax exposure. The first federal income tax increase since the 1990s passed as part of the fiscal cliff deal in early January. But with government deficits remaining high, it may not be the last. So today's savers should take time to understand the new tax law and look at ways to manage taxes, including the use of Roth accounts, tax-smart asset location, tax loss harvesting, and more.

    ► For tax-smart investing ideas, read “A taxpayer's guide to 2013”, “Get real: Focus on real after-tax returns,” and “Asset location: Seek higher after-tax returns”.

5. Don’t go it alone.

One last lesson from the downturn is that you don’t have to go it alone. As the financial crisis started to unfold, 30% of our respondents said they turned to a financial adviser for help, while 26% chose a spouse or family members. But reaching out to others can help strengthen families financially and personally in good times as well as bad.

  • Include the family. As you build and manage your financial plan, remember to share it with your loved ones. Families across the United States struggle with the subject of money, and many consider it to be a topic that is off limits. Yet, the consequences of not discussing money issues with children often creates unnecessary angst and less than optimal financial decisions. That can mean setbacks later on in life, and makes it harder when it comes time for the family to talk about inheritance and estate planning.

    ► For strategies to get this important conversation going, read “Communication gap.
  • Talk it over with a pro. Guidance from financial professionals ranked among the highest in helpfulness in our survey—at 90%. Now nearly one quarter of respondents say they rely more on a financial professional than they did in the past.

A new day

Five years after the financial crisis, the world looks different, with new risks and challenges. The good news is that many people are responding with a new commitment to taking control of their financial lives.

For help, consider:

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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
1. Unemployment data are from the U.S. Bureau of Labor Statistics , foreclosure data are from The Russell Sage Foundation and The Stanford Center on Poverty and Inequality, and savings data are based on the National Bureau of Economic Research.
2. The Fidelity Five Years Later study was conducted online among 1,154 adult investors by GfK Roper Public Affairs & Corporate Communications using GfK’s KnowledgePanel® during the period of February 12–25, 2013. The qualified respondent is at least 25 years old, a financial decision maker for his/her household, and holds investments other than simply a savings account or certificate of deposit.
3. Inflation is based on the March 15 Consumer Price Index summary from the U.S. Bureau of Labor Statistics, taxable money market yields are based on Fidelity.com as of March 27, and 10 year Treasury yields as of March 26, 2013, according to the U.S. Treasury Resource Center.
Diversification cannot ensure a profit or protect against a loss.
Past performance is no guarantee of future results.
S&P 500 and S&P are registered service marks of The McGraw-Hill Companies, Inc., and are licensed for use by Fidelity Distributors Corporation and its affiliates. The S&P 500® Index is an unmanaged market–capitalization weighted index of common stocks.
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

Retirement Income Planner is an educational tool.
Leveraged loans typically contain maintenance covenants that stipulate certain financial tests the company must meet every quarter.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
Increases in real interest rates can cause the price of inflation-protected debt securities to decrease.
Fidelity does not provide legal or tax advice, and the information provided above is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific legal or tax situation.
Fidelity Portfolio Advisory Service® is a service of Strategic Advisers, Inc., a registered investment adviser and a Fidelity Investments company. This service provides discretionary money management for a fee.
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