Stress Test Your Finances

While the government is busy stress testing the banks, it's a good time for you to stress test your own finances. Even though the financial markets have improved lately, the economy is still getting worse. Hopefully, we're in a bottoming process, but if not, you need to be prepared to get through it.

Here's what to do:

• Reserves. Just like with the banks, the key is to build up your reserves. For most families, this means building up a larger cash emergency fund. If your income declines or you lose your job, the emergency fund will help you keep the household running until things improve. A good estimate for your reserves is six month's worth of living expenses.
• Expenses. You need to cut expenses. Big business all over the world are cutting costs and for good reason. They know that if the economy gets worse, they need to be lean and mean to survive. You should take the same approach. Look at what you're spending money on each month and eliminate those items that you don't really need. You can always add them back later.
• New Income. Look for new income sources. Even though the economy is in recession, you still need to look toward the future. Keep pushing ahead for new job or career opportunities. If you're married, having both spouses work provides another layer of defense against a slowing economy.

The one thing you really don't want to do is tap into your 401(k) or IRA to help you get through a financial crisis. Using those funds can really knock you off track for retirement.

If you're under age 59 1/2, you generally need to pay both a 10 percent penalty tax and income taxes on any money taken out of your retirement plans. The taxes could easily total 35 percent or more. That means if you need $20,000, it will really cost you about $30,700.

Bottom line: Look for every opportunity to build cash reserves, cut unnecessary expenses and improve your future prospects for income. Hopefully, the economy will get better soon. But if not, you need to be prepared to get through it without doing long term damage to your finances.

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