Be Your Own Financial Regulator

With Washington bogged down in debates about how best to protect consumers from the dangers of the financial markets, here's an idea: be your own financial regulator. Given what's happened over the last decade, you've got the knowledge to do most of this yourself.

Stock Market. By now you should know that whatever money you allocate to stocks you better be prepared to see it decline by at least 50%. When you look at your portfolio, take whatever you have in stocks and cut it in half. If you can live with the results, then you've probably got the appropriate allocation. If you can't, then you're taking too much risk.

• You'll be kicking yourself if the next time the market crashes your retirement plans go down with it. No government disclosure can substitute for the lessons you've learned about stocks over the last 10 years. So don't forget them.

Credit Cards. If you carry a balance from month to month, then you're basically engaged in an abusive financial relationship. It's not a good idea to pay interest rates of 12% to 20% to buy things you currently can't afford. Moreover, credit card companies work hard to figure out ways to charge you for all sorts of foot-faults. If you carry a balance, you've probably been through this drill multiple times. Do you really need ten pages of disclosures to understand that credit card debt is bad for your finances? If you have it, figure out how to get out of it as soon as possible. It's never going to be a good deal.

Housing. Next time you go house shopping, don't kid yourself into thinking houses are great investments. Now, prior to this recent crisis, I think we can all get somewhat of a pass in this area. We really hadn't seen much of a decline in real estate values and certainly nothing like the crash we're dealing with. But now we know. Housing prices don't always go up, and sometimes they go way down.

• Real estate is risky, especially because you borrow money to buy it. And small declines in the price can wipe out all your equity. Consider that on a $300,000 house, if you put down 5%, you have $15,000 of equity in the house. Now if the house declines 5% in value to $285,000, you have wiped out all your equity, which is a 100% loss on only a 5% decline.
• Over the long term, don't anticipate that the value of your house will grow any faster than the average wage growth in your region. Why? Because if home values grow faster than wages for an extended period of time, nobody can afford a house. So over the long term, real estate values generally don't appreciate much more than wages grow. That's generally somewhere between 1% and 2% above inflation. Accept it and buy accordingly.
• Also, don't buy a house thinking that your income "will grow into" the housing payment, meaning that down the line you'll be making more money and thus will be able to afford the home. Your pay can stagnate or even decline in bad economic periods, so only buy what you can comfortably afford on your current pay.

Mortgages. Given what you know about the mortgage markets, do you think an interest only, adjustable or negative amortization loan is a good idea? Of course not. These loans are highly likely to get you into trouble down the line if rates go up and payments increase. Unfortunately, many people used these loans to get into homes they otherwise couldn't afford. Again, somewhat understandable considering how people perceived the real estate market in 2006. But next time you go to get a loan, don't be tempted to make the same mistakes again. Do what your parents did: get a fixed 15 or 30 year mortgage and pay it off. These are simple loans and will keep you out of trouble.

Savings. Since you can't rely on increasing stock markets or real estate values all the time, you need to save more. Don't expect to retire with any degree of financial security if you only save 5% of your pay. It's just not going to be enough. In general, you've got to be in the 12% to 15% range every year.

• You know you need to do it, and you've got a pretty good idea about how much you need to save. A government brochure won't provide any more motivation.

Regulations. Now, we do need good and effective financial markets regulation. There are bad actors out there, and many innocent people get into transactions they don't understand. So regulations help keep financial services firms honest, and help ensure more fair dealings between these firms and their customers. But most of things that are bound to get you into real big trouble you already know about.

Bottom line. Don't wait for Washington to regulate your financial life. Learn from the last decade and start regulating yourself.

Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at amazon.com The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.

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