Wall Street Woes: Where to Put Your Cash

Sept. 15, 2008 — -- Bank deposits remain insured, credit card payments will be processed as usual, and home buyers with good credit and a down payment will still be able to obtain a mortgage.

Keep these thoughts in mind as you consider your response to the collapse of Lehman Brothers and the fire sale of Merrill Lynch. Yes, Wall Street is in crisis, but no, the U.S. financial system is not falling apart.

That's why small-time investors and borrowers must resist the urge to panic after a stunning weekend for the nation's financial markets. For most of us, it will be business as usual today, tomorrow and the next day.

We'll keep going to work, adding to our retirement plans and paying down our debts. And that's what you want to keep doing as we wait for housing prices to stabilize and stock prices to recover.

The truth is it's tough to know exactly what the fallout will be from the current turmoil that can all be traced back to a price decline in a heavily mortgaged housing sector.

But there are steps you can take -- and steps to avoid -- to prepare yourself for the eventual recovery.

First, avoid rash moves like liquidating an entire portfolio and buying a single, five-year CD. This will lock in losses, ravage a retirement plan, expose you to inflation risk and possibly trigger ugly tax consequences.

Think no one would do something so extreme? Think again.

I know folks so spooked by the 9/11 attacks that they did just that. For a year or two, it seemed like a smart move, but then their savings wallowed as the stock market went on a terrific run. Don't put yourself in that position this time around.

Second, if you feel compelled to act, do so in moderation. Whether you're accumulating funds for retirement, a college education or some other goal, investing is not an all-or-nothing activity. Portfolios are made up of pieces, and it might not be a bad idea to seek safety for a portion of your nest egg, particularly if those are funds you will need to draw upon in the near term.

One option might be to invest a portion of money in a short-term bond fund, which is less volatile than a stock fund but offers the potential for a higher rate of return than a bank account. Bond values, as you may know, rise and fall with changes in interest rates (up when rates fall, down when rates rise). But a short-term bond fund will fluctuate less than one holding long-term bonds.

Safe Investments

Third, do everything possible to improve your credit score. That means making sure your bills are paid on time, particularly credit cards, and that you're reducing your overall debt load.

The final impact from the current crisis will remain unclear for some time. But one thing is certain. The days of easy credit are over. Obtaining a loan to buy a car, a home or anything else is going to be much tougher two years from now than it was two years ago.

Your best defense is a higher credit score. If you can show a lender that you're a good credit risk, you will have more opportunities.

Toward that end, it is critical that consumers make their credit card payments on time. As they look to make up for mortgage losses, banks that issue credit cards are quicker than ever to raise your interest rates and impose a penalty fee if you're late with a payment. Given current conditions, that situation is unlikely to change anytime soon.

If you're juggling more than one credit card with a balance, find a way to either consolidate the debts or pay off one of the cards outright. The more cards you juggle, the greater your chances you will mess up.

Finally, every consumer and investor should brace themselves for changes in the financial institutions they do business with.

Bank Customers

Regardless of whether you're satisfied with the service you've received, it might be time to revisit your own banking and financial relationships.

And even if you're not a Bank of America or Merrill Lynch customer, you very well could be affected in the future as more financial sector mergers and takeovers are likely in the months ahead.

On this issue and others, the key is to be prepared to respond in a rational way rather than panic.

This work is the opinion of the columnist, and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.