What You Need to Do Now: An 8-Point Action Plan to Secure Your Financial Independence

IS YOUR INVESTMENT INCOME SAFE?

We all were reminded on that day that our mutual fund and brokerage accounts can be rendered as illiquid as real estate. Bank accounts can be frozen, too, although this didn't happen in the wake of the recent attack. (It last happened on March 6, 1933, when Franklin Roosevelt declared a three-day "bank holiday" at the height of the Depression.)

For most American investors, the market's four-day closing was inconsequential-perhaps even beneficial. After all, by not being able to trade, investors were unable to sell during the worst of their emotional insecurity. The delay in trading for nearly a week gave investors a chance to calm down. Besides, most investors didn't really need to trade during that week. So what if you had to wait a few days to buy Acme Widgets or sell Ajax Hoozits? For most investors, the market's closing was more a conversation topic than an impact.

But there are some investors for whom the shutdown was a problem. For these investors, the failure to reopen the markets quickly could have become a personal financial crisis.

Who are these people? They are retirees and others who receive monthly income from their investments. Although most investors are socking away money for their future, for retirees the future is now. They live off the income their investments generate. They receive dividend income, interest income, and income from capital gains.

When retirees establish mutual fund accounts, they often instruct the fund to send them a monthly check. Called a "systematic withdrawal," these checks go out to account holders on the 1st, the 15th, or the 30th of every month.

The checks due September 15 didn't arrive.

They couldn't. Not only was September 15 a Saturday, meaning transactions would be posted on Monday, but the markets were closed from the 11th through the 16th. Realizing the potential interruption that some of our clients might be facing, we quickly contacted the mutual fund companies that held our clients' assets, verified the status of their distributions, and contacted our clients with the news.

The news was good: Because the markets were scheduled to reopen on the 17th, the checks would be delayed by only a few days. All our clients who were due to receive checks on the 15th got them by the 19th. No one missed a mortgage payment.

This time.

This is why you need cash reserves. You need to have money readily available to you in case a check you're expecting fails to arrive. This time, the checks were delayed because the markets were closed for logistic reasons, not because of nationwide financial panic, government instability, or economic uncertainty. The result was the same, however: Mutual fund companies were unable to execute liquidation requests, even routine ones like monthly redemptions for retirees.

Next time, the delay might be caused by something as mundane as a disruption in mail service or as dramatic as the failure of a financial institution.

Ironically, I had warned of this risk on my weekly radio show just three weeks before the cowardly attack on America. As I explained then, most people do not understand that mutual funds have the legal right to withhold liquidation requests. It takes extraordinarily rare circumstances, but it does happen. For example, in 2000, one mutual fund managed to lose 70% in a single day. Amazingly, this fund was not invested in tech stocks-in fact, it wasn't even a stock fund! It was a fund that invested in municipal bonds.

Most people consider muni bonds to be among the safest investments. After all, most are government guaranteed. But this particular fund had bought muni bonds that were not guaranteed. Instead, the bonds had been issued by state agencies that weren't even rated by muni bond rating services. The fund's management began to realize that nobody really knew what these bonds were worth in the marketplace, and the manager decided to reprice the bonds. He cut their value by 70%, literally overnight.

As you can imagine, that move angered the shareholders, who responded by filing more than 20 class action lawsuits. Federal regulators are still investigating.

But get this: The regulators have frozen the fund's assets while it's under investigation. For more than a year now monthly dividends have stopped and no one has been allowed to redeem his or her money.

I mention this to remind you that it is possible-however unlikely-that your mutual fund might not promptly execute a redemption request.

Makes you question the meaning of "liquid investment," doesn't it?

IS YOUR PAYCHECK SAFE?

Even if you're not receiving income from your investments, you still need cash reserves. Why? Because your next paycheck might never arrive. Hundreds of thousands of New Yorkers found themselves unable to go to work in the days after September 11. Thousands of businesses were closed. With no revenue, these businesses found it difficult, if not impossible, to pay their employees. If you were one of them, you suddenly had a problem.

HOW MUCH CASH TO KEEP IN RESERVE

So whether your income comes from pensions, investments, or a paycheck, it's important that you maintain cash reserves. Ordinarily, financial planners like me encourage consumers to maintain cash reserves in case your car breaks down or the roof leaks. After all, as I said in The Truth About Money, you need cash reserves because every single day in America, 15,000 washing machines break down (according to Sears, which sells more washing machines than anyone).

The calamity of September 11 has caused us to renew our emphasis on this mundane topic. Until September 11, we generally advised that the amount you should keep in reserves depended on two factors: your monthly expenses and the stability of your income. Now we discount the stability of your income, because if there's anything that the tragedy showed us, it's that no one's income is safe.

Therefore, I want you to determine how much money you spend each month. One way to do that is to simply look at your checkbook. The problem with this method, though, is that your checkbook might not fully reflect credit card charges or expenses that occur sporadically (such as annual tax or insurance bills).

So let's track your monthly expenses more effectively. To do this, review your checkbook and credit card statements for the past six months, ignoring any one-time or other nonrecurring expenses. This will give you a much more accurate picture of your actual expenses. For more on tracking expenses, see Chapter 51 of The Truth About Money.

Keep in cash reserves a minimum of three months' worth of spending, and preferably six months'. If your income is very uncertain, you might want to increase your reserves to a full year's worth of expenses.

Please note that if you plan to incur a large expense within the next two years, such as home improvements, the purchase of a car, wedding or college costs, or other big-ticket expenses, you should set aside money for these expenses in addition to your cash reserves. Your goal is to maintain reserves at a fully funded level at all times. And, if some crisis does force you to dip into your reserves, your first task is to build them back up again.

WHERE TO KEEP YOUR CASH RESERVES
- AND WHERE NOT TO

Once you determine how much you ought to place into cash reserves, make sure you stash that cash-and leave it alone. Never touch your reserves unless you incur a crisis, just as you'd never touch your umbrella unless it started raining.

There are six places you can stash your cash:

· your mattress,
· checking accounts,
· savings accounts,
· money market funds,
· short-term bank CDs,
· U.S. Treasury bills.

Each location has its pitfalls. Money under your mattress is the ultimate in liquidity-and the easiest to lose. Fire and theft-or even a paper-eating dog like my weimaraner, Liza-can render the cash in your house unavailable when you need it. Because money market funds are operated by mutual fund companies, these accounts can be frozen unexpectedly, as they were right after September 11. Bank accounts, too, can be closed, like they were in 1933. So, there's no perfect answer, but it's the best we've got to offer.

For a variety of reasons, including liquidation costs and taxes, the following are not suitable places to put your cash reserves:

· U.S. Treasury notes,
· U.S. Treasury bonds,
· EE savings bonds,
· commercial paper,
· insurance policies,
· fixed annuities.

If you don't have the cash reserves you now realize you need, it would be prudent to raise the cash-even if it means selling or repositioning your investments to do so. Selling mutual funds, stocks, bonds, and real estate might not be the smartest investment strategy-especially if selling would force you to incur transaction costs and taxes or if prices are currently depressed-but I'm not talking about investment strategies here. I'm talking about your survival.

If you don't have investments you can sell, consider what you do have. Baseball cards? Used video game collection? Get creative-and serious about tending to your family's financial future.