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Seeking Direction: What to Do with Your Money

How should you invest in a volatile market? And what if you can't invest? You're bound to find yourself in one of the following three scenarios. Whether you're flush with cash, completely strapped or somewhere in between, read on for tips you can use right now.

Does this scenario sound like you?

Sitting on Cash

"I just got back from a deployment to Afghanistan. Between tax breaks and having nothing to spend my money on while I was there, I've got $10,000 to put to work — but where?"

We all need cash, but it's possible to have too much of a good thing — and in plain economic terms, there's no use having it just sit there. So how much is enough?

The answer starts with understanding that cash is best used for short-term spending needs and emergencies. "Your cash stash should probably be equal to six to 12 months of your regular expenses," says J.J. Montanaro, a Certified Financial Planner™ practitioner with USAA. "If you're holding much more than that, you might be sacrificing the opportunity for growth." That's especially true in this era of rock-bottom interest rates. "Getting the best return on your safe money takes a little more work these days," says Montanaro. He recommends building a certificate of deposit "ladder" — a variety of CDs with staggered maturity dates — or considering a short-term bond fund, which invests in fixed-income securities with shorter maturity dates. This type of investment may be particularly effective in a volatile market.

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Once you've set aside the right amount of cash for you, think about putting the rest into longer-term investments, such as stock and bond mutual funds. In a roller-coaster market, this may sound like bad advice. But, there is an edge you can use. Michael Kitces, a financial-planning industry commentator and co-author of Tools & Techniques of Retirement Income Planning, explains, "If you've left the market and have a willingness to move back in, do it slowly. If you try to do it all at once, you'll become very sensitive to the timing of when you do it, and you'll be anxious about whether you chose the best hour, day or month to do so." Kitces recommends moving portions of your money back into the market over a period of three, six or even 12 months.

Some investors attribute their nervousness to a fear that inflation may be lurking in the shadows if the economy really takes off. For those concerned about that, Kitces recommends diversifying portfolios with Treasury Inflation-Protected Securities, or TIPS, which are government bonds with special features to provide protection against inflation, as well as a small allocation to gold. Another option is a real-return fund, a carefully managed mutual fund designed to produce income that outpaces the rate of inflation.

Another consideration for investing with borrowing rates so low is real estate. Enticing? Yes. Smart? Well, it depends. Since home prices in many areas are well below original value, investing directly in real estate holds several potential pitfalls. "If you don't have enough money to buy the property with cash, that means taking on a mortgage, and investing with borrowed money is a riskier proposition," says Kitces. Given the risk of not finding a tenant and the headaches of becoming a landlord, those with an interest in property may be better off investing in a mutual fund with real estate exposure.

Does this scenario sound like you?

Holding Pattern

"When the crisis hit, we just held on to our investments for dear life — and haven't made any changes since."

Every investor needs to be reminded that there's a fine line between inactivity and neglect. "It's important to recognize that inaction is still a decision about your portfolio — and not necessarily a good one," says Kitces. "That doesn't mean everyone needs to make a change, but you should take some time to review each position in your portfolio to see how it's performing and if it's consistent with a level of risk you're comfortable with."

The rough stock market exposed what Kitces calls a "risk perception" problem. "A lot of people really weren't that comfortable with the risk they were taking, but they convinced themselves — since the market had gone up for a few years — that risk only meant there was a question of how much it would continue to go up," he says.

USAA's Montanaro suggests a practical approach. If your portfolio has been batted around by the whims of the market, create some stability by adding investments guaranteed not to falter, no matter the turmoil. Certificates of deposit will do the trick, and retirement-minded investors may find that guaranteed savings annuities offer better rates. "Beyond guaranteeing you won't lose a cent, annuities offer a big tax break: Interest isn't included in your income until you withdraw it," says Montanaro.

In addition to teaching investors a painful lesson about risk, the market's turbulence should also spark a resetting of expectations about investment returns. "With the economy and markets potentially facing a challenging and volatile future, it's hardly safe to assume you'll earn double-digit returns over the coming years," says Montanaro. Whether you're saving for retirement, college tuition or another goal, lower returns may mean you need to save more to stay on target.

If you're not comfortable juggling your portfolio, you can, of course, find help. "We've seen renewed interest in people's desire to work with a professional, such as a Certified Financial Planner™," says Kitces. "Some people still want to control the decisions, but like having a professional opinion before making a move. Others like the idea of delegating to an advisor the authority to make transactions on their behalf."

Does this situation sound like you?

Tackling Debt First

"My wife lost her job when her company downsized. Now that we're down to just one income, our credit card balances are way up and we're struggling to find money to invest."

Investing for the future is important, but there are times when you need to put the idea firmly in the back seat — especially if debt is a problem. In fact, paying off high-interest debt can be one of the best "investments" you'll ever make. "If you make an extra payment on a credit card balance that has a 15 percent interest rate, that's equivalent to earning a guaranteed 15 percent return on your money — a promise the stock market can't match," says Montanaro.

If you have to retreat from investing, make sure you apply the right priorities. For example, many families are saving for two hefty goals — retirement and college. "If you have to put one on the back burner, it should definitely be college," says Montanaro. While there are many other ways to pay for college — including scholarships, grants, loans and part-time work — retirement isn't nearly as flexible. That said, your circumstances may even call for slashing your contributions to your 401(k), TSP or other employer retirement plan — but if you decide on that, there's one caveat. "If your employer matches your contributions, try to contribute at least enough to get every ‘free' dollar that's on the table," advises Montanaro.

Unfortunately, getting into debt is far easier than getting out of it. If you're struggling just to keep up, be open-minded about what you can do to recover. Kitces advises people in heavy debt to consider selling the things responsible for their debt — especially cars. "Cars tend to be money demons in our society," says Kitces. "There are a lot of used cars that will get you from home to work. You don't have to do that in a $20,000 or $30,000 automobile."

Shorter-term sacrifices — such as disconnecting or reducing cable TV service, getting rid of a land-line phone, or switching children from private to public schools — could be must-do steps to greater security or, in some cases, survival. However, don't focus exclusively on cutting expenses. Think creatively about ways to generate more income. That could include renting out a room in your house, having a garage or yard sale, or even taking a second job.

You may be able to accelerate your campaign against your debt by restructuring it. For example, shifting credit card balances to a home equity loan may lower your rate while also making your interest tax-deductible. For some of us, that's a smart move. Borrowing from an employer retirement plan, such as a 401(k), rather than cashing it out may also be a good way to tackle other debts, but be careful — if you leave that employer without paying it back first, you'll face taxes and penalties on whatever's outstanding.


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