Surviving in a Difficult Economic Atmosphere
How to survive a recession
Skirts getting longer? Cigarette butts shorter? Easier to get a cab or a table at that fashionable restaurant? All these are said to be signs of recession – the dreaded R word. The technical definition of a recession is when the economy has shrunk for at least six months – as measured by negative Gross Domestic Product (GDP) figures for two successive quarters. What this means in practice is more businesses are struggling, orders and sales are down, profits are under pressure and jobs are axed.
Consumers who are in work worry about unemployment and therefore spend less, so putting further pressure on shops and in turn manufacturing. In a simple league table of economic misery, recession is worse than slowdown but not as bad as depression. The bust in boom-and-bust could mean recession, while a slump normally refers to even deeper and more protracted economic problems. Or as President Truman of the US once said: it’s a recession when your neighbour loses his job, a depression when you lose yours.
There is often debate about when precisely an economy is in recession as it is possible for certain business sectors such as manufacturing to be in recession when other sectors aren’t. Likewise not everyone suffers in recession. People who keep earning income and are not in debt stand to benefit from potentially lower prices on the high street and elsewhere. It can be a good time to buy property: house prices may fall and should certainly be less buoyant. But even those who feel reasonably secure in their jobs should review their financial situation – they might have to live with no additional overtime pay or salary increase, for example.
Insulating your finances against recession.
Unemployment insurance
Almost certainly the biggest fear for working people in a recession is losing their job and not being able to meet their financial commitments. And the biggest commitment of all for most people is their mortgage.
But you can no longer solely rely on State help as Government help for the mortgage payments of the unemployed has been scaled back considerably.
If you took out your mortgage after October 1995 – and that includes a remortgage –
you get no assistance for the first 39 weeks – 9 months – of unemployment. After that the government will pay your mortgage interest, but even this help is means tested. And the State will not pay your contributions into any repayment vehicle such as an endowment. The benefit is called ISMI – Income Support for Mortgage Interest.
Even if you took out your mortgage before October 1995, you generally have to wait 6 months before the Government will pay your mortgage interest for you. From week 8 it will pay half your interest.
One way to insure your mortgage payments against unemployment is by taking out Mortgage Payment Protection Insurance (MPPI) – sometimes called Accident, Sickness and Unemployment (ASU). It will pay your mortgage for up to 12 months if you are made redundant or illness leaves you without income.
Be careful when buying a Mortgage Payment Protection Insurance policy as they are currently subject to investigation by the Competition Commission. Straightforward Payment Protection Insurance, which is often sold to consumers who take out a credit card, personal loan or any other credit agreement, is under the most scrutiny. Meanwhile, the Financial Services Authority has handed down big fines to some insurance providers for misselling Payment Protection Insurance policies. The regulator found that many people who took out the cover should not have been sold a policy in the first place.
With all Payment Protection Insurance policies you should double-check the terms and conditions before signing on the dotted line and understand the policy’s limitations, what’s covered and what isn’t. That said Payment Protection Insurance and MPPI could be a lifeline to help paying your mortgage or loan in the event of redundancy or you becoming unable to work due to sickness or an accident.
Only around one in three new mortgages are covered by MPPI Premiums can vary a lot and the cover it provides needs to be considered carefully. Premiums are typically around £5 for each £100 of monthly mortgage payment covered but some policies can be three times the price of others.
Payment Protection Insurance with unemployment cover included should not be seen as a “quick fix” to impending unemployment. Policies generally have an initial exclusion period of up to 60 days during which time if you become unemployed your claim will be thrown out. This is designed to stop people taking out policies when they get wind of plans for redundancy. Then there is an "excess" or waiting period of up to 60 days during which you get no money – so even if you make a qualifying claim you may need to fund your mortgage or loan for up to two months out of savings. Taken together these catches mean that you will not be entitled to any payout for perhaps four months after taking out a policy. You do not need to buy a policy from your lender, nor do you have to buy it when you first take out your mortgage. An IFA will be able to help you find the better value policies.
If you have sufficient health cover elsewhere – perhaps from your employer – you may be able to cut your premiums by restricting the benefits. If you have a joint mortgage you can keep premiums down by each of you being insured for say half of the monthly payment. Cover for all your debts can also be consolidated in a single policy. The self-employed and contract workers need to take particular care in finding unemployment cover – conditions can be onerous.
Reducing debt
Over-borrowing is a classic feature of economic booms, and a classic way of getting into trouble in busts. If your earnings fell, would you still be able to manage your debts, particularly if interest rates should rise? Try to pay off debts before you get into difficulties, starting with the most expensive or the most urgent. Some shops charge over 20 per cent APR on their store cards.
If you have savings, these are almost certainly earning less than the interest you are paying on debts. And while everyone should aim to have some readily available cash, in financial terms you are likely to be better off overall paying down debts.
Paying down some of your mortgage will help protect against negative equity should house prices fall. In the early 90s negative equity – where outstanding loans were greater than the value of properties – was a barrier to homeowners moving. The house value boom that has prevailed in recent years appears to have stalled and such steep rising values are unlikely to be repeated in the short-term.
Transferring plastic card debts to a cheaper credit card will also save interest in the short term, but bear in mind that the lowest rates normally only last for six months or so. The new spending on these cheap cards will often land you with a higher interest bill. Do check out the balance transfer fees that are a feature on many credit cards which can be as much as 3.5 per cent of the amount transferred.
Consolidating personal loans through a debt manager or other credit firm may also appear attractive, but it is important to consider any penalties for switching and the overall cost of the new deal. Just because the new monthly payments are lower does not make it better – you could be paying more in the long term including high admin charges.
If your debts are getting out of control and you cannot meet repayments, talk to your lenders – missing payments is only likely to lead to penalties and additional costs. Or approach a free debt adviser such as the Consumer Credit Counselling Service on 0800 138 1111.
Build up a cash buffer
Ask yourself what you would do if you lost your job tomorrow. How would pay the bills or pay for day-to-day items such as food? Even if you are entitled to benefits these might take some time to come through.
It makes sense to stash away some money to help tide you over until you get a new job or can attempt to adjust your lifestyle to meet a reduced income. Experts recommend having the equivalent of at least a couple of months salary in an easy-access account paying as much interest as possible, although some suggest that up to six months worth is more appropriate.
The average household savings rate is at its lowest for fifty years - it is estimated that average household savings in the UK are just £750. (Source: Office of National Statistics) Likewise, whatever the arguments for investing in a recession, if you think your job may be vulnerable you should be looking to your potential cash requirements before committing money to longer-term investments.
It makes financial sense to make the most of your Individual Savings Account limits – and you can invest up to £3,600 for the 2008/2009 tax year. Cash ISAs tend to pay the highest rates because interest is paid gross – traditional cash savings accounts deduct 20 per cent from the gross amount at source. Take care not to invest in accounts that will penalise you for withdrawing your money without giving notice.
Cut costs
Drawing up a list of your outstanding commitments and your spending is a good way to identify potential savings. Can you achieve the same by spending less?
You could shop at your local market, where fruit and vegetables are cheaper than the supermarkets, while switching to supermarket own-brand food could slash your shopping bill by as much as a third. Likewise, turning your central heating down by a degree or two can knock pounds off your energy bills and reduce your carbon footprint!
Shop around for a better deal, be it for insurance, gas, telephone or mobile phone tariffs. A raft of comparison websites have cropped up in recent years and providers are battling to be the cheapest, which is all good news for the consumer.
Try paying utilities by direct debit or switching companies, find a better value mobile phone tariff or network, or simply try to use your mobile less at peak rate times. Get into text messaging – it could work out cheaper.
When money gets tight, life insurance premiums and pension contributions are often early economies – but don’t act in haste. It may be possible to stop paying into a pension plan without penalty, but check. Keeping up life insurance may be more vital: if times are hard now, think how much worse they would be for your family if you were to die.
Life insurance premiums have fallen in recent years and an IFA may be able to find you a cheaper deal – and even advise you on that pension. Equally, beware of cashing in endowment and other savings plans early – you may be heavily penalised. Other money saving tips worth considering includes:
- Getting rid of a second car, not changing your existing car so often, buying second-hand, or if you’re buying new, try the Internet.
- Cycle instead of using a car or public transport.
- Eat out less and learn to cook with a book from a celebrity chef instead.
- Buy fewer new clothes – even go to charity shops.
- Give up smoking – a recession could be just the discipline you need.
Traditionally, luxuries like gym memberships have been cancelled when times got tough – though some might argue that gyms are now necessities in a stressful modern world. Don’t be too hard on yourself...
Remortgaging
Millions of homeowners could reduce the cost of their single biggest debt by remortgaging. They could also guard against the risk of rising repayments by locking into a fixed or capped rate deal. Lenders continue to offer discount deals with no penalties for switching at the end of the special rate period.
If you are coming to the end of your current deal, moving to your lender's variable rate may not be the best thing to do as rates are likely to be higher than other fixed or tracker deals available on the market.
But be careful not to be tempted solely by a bargain headline rate advertised by the lenders. High arrangement charges, lengthy lock-in periods and high exit fees are just some of the ways in which lenders recoup money lost through a headline-grabbing low rate.
A higher fee can be worth paying if you make savings on interest payments over the term of the mortgage. As a rule of thumb, the bigger the mortgage the more important the rate, rather than the fee, becomes. Conversely, the fee assumes more importance than the rate on smaller mortgages. But the longer you are tied in, the more important the rate becomes as the impact of extra interest increases.
Stepped rates are also worth watching out for. These mortgages offer a competitive low rate in year one before it is ratcheted up in the following years, when the borrower is often locked in to the higher rate.
Flexible mortgages allow borrowers to make overpayments when they can – reducing their overall debt and interest bill – as well as take payment holidays if they need to. A borrower who lost their job could put their mortgage “on ice” or draw down a lump sum to help them out until they find new work. But even if a lender allows a payment holiday, borrowers should remember that the unpaid interest will still be rolling up, increasing the overall debt.
With hundreds of mortgages to choose between at any one time, a good mortgage broker or IFA can help select the right loan for you. However it is important to switch loans while you are still in work – you are highly unlikely to be offered as good a deal and lenders may well not want to offer you a mortgage loan if you have just lost a job.
If you do get into problems with your mortgage payments, talk to your lender as soon as possible. And don’t simply cash in your endowment policy – an IFA may be able to help you get as much as a third more money by going to the traded endowment market.
Beat Inflation
Inflation can play havoc with our finances. Inflation eats into people's finances but there are some steps you can take to beat it when it comes to your household bills.
The rate of inflation is the determined by the overall balance between the economy’s supply of goods and services and demand for them. If total demand rises, this will tend to lead to an increase in inflation as more money chases fewer goods and services. On the other hand if demand falls, inflation will tend to drop back.
The Bank of England uses interest rates to curb inflation. For example, interest rates are often raised to counter inflation because it means consumers will have less money in their pocket – this should reduce demand for goods and services. A fall in interest rates boosts demand putting upward pressure on the inflation rate.
If you are a saver make sure you do not stash your money away in an account paying a low rate of interest, as your actual return after the effect of inflation will be negative. Again, make the most of your Cash ISA allowance, while Index-linked certificates from National Savings & Investment guarantee to beat the Retail Prices Index (a measure of inflation) over either three or five years, free of tax but your money is tied up for the term of the certificate if you are to get these benefits.
Investing in shares is a decent long-term bet to outperform inflation, particularly if the shares deliver a growing dividend stream. The power of the dividend, when reinvested, is worth remembering. Dividend income makes up the lion's share of total returns: according to the 2007 Barclays Equity Gilt Study, £100 invested in equities at the end of 1899 would be worth just £213 in real terms today without the reinvestment of dividend income; with reinvestment the portfolio would have grown to £25,022.
Inflation brings particular problems for people about to retire because even a low level of inflation will seriously dent pensioners' fixed incomes over the years. However, it is not all bad news, as your state pension benefits from indexation and in future years will rise in line with the average earnings index which tends to rise at a higher rate than inflation.
Anyone buying an income for life with their pension pot might assume that an annuity linked to inflation is the solution - these pay less income in the early years of retirement than a standard annuity but eventually catch up and end up paying more later on if you are still alive. There are many ways for your retirement income to be paid from your pension fund. It is worth getting advice from an IFA to weigh up all the options because once an annuity is bought there is no going back.
Making money out of recession
If your finances are already looking shaky, piling into the stock market may be the last thing on your mind. Once you have a sufficient cash buffer, government gilts are another lower risk option.
Don’t dismiss the stock market – it is the time investing in the stock market that counts not your time out of it. With shares, the classic advice is to stick to businesses that are relatively immune to recession, such as supermarkets and utilities that consumers will continue to buy from no matter what. Other so-called defensive stocks include tobacco and drinks companies.
But if you like the idea of switching into these businesses, beware that investor demand hasn’t already driven share prices up. Furthermore, the stock market is something of a leading indicator for the real economy, looking ahead by as much as 18 months, according to experts. So it can fall ahead of recession while the economy is still booming, and then jump again while jobs are still being shed and the business news is bad. Catching this recovery can be profitable – and a good reason for not selling when the economy is at its bleakest.
For investors who do not feel confident picking individual shares or gilts themselves, an IFA should be able to recommend a well-managed investment fund.
If you are concerned that the stock market might fall further – or you don’t want to put aside too much money at a time – saving monthly is worth considering. Regular saving can help you benefit from pound cost averaging – basically you are buying more shares or investment units for your pound as the value of the investment falls.
Unit trusts OEICs, investment trusts and tax-efficient ISAs will accept £50 or less a month. If the market does fall you will be better off than if you had invested everything at the outset. Only an IFA can guide you through all the investments available to you and provide advice whether you want to invest regularly or have a lump sum to invest.
If you do not already have an IFA, our ‘Find an IFA’ hotlines and website enable you to confidentially search for a list of IFAs in your local area. You can search for an IFA based on a whole host of criteria (including product, level of incremental qualifications, gender and payment options) so you can be sure you’ll find an IFA that meets your precise requirements.
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Other guides available online:
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- Equity release guide
- Surviving an economic downturn guide
- Guide to IFA qualifications
Other factsheets available online:
- Long term care
- Confused about endowments?
- Funding for university
- Remortgaging your home?
- Get your Key Facts straight for financial advice
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April 2008
